Government funding · Investments

Private investment attraction (or not) to start-ups that have accepted government funding?

Rudy Darken Professor at Naval Postgraduate School

May 17th, 2016

What (in general) is private investment's attitude about start-ups that have used government funding to develop their products? For example, a start-up applies for and wins an SBIR or STTR grant and uses the funds, in part, to develop a product they wish to commercialize for a worldwide market. The government gets their limited data rights to whatever they funded, but the company has the opportunity to commercialize, but they need further investment to do so. Now they offer a pitch to a private investor.

Questions for you: 
Do investors see prior government funding as an entanglement (or any other "negative" in deciding whether or not to fund)?
Does the fact that the company doesn't need to pay back those funds any part of the decision equation? (a "positive"?)
How would an investor address the government funding issue in the deal to fund? Or would they?
Are there concerns regarding IP and who owns it?

I'm mainly interested in federal funding, but I'd be interested in any experiences with any type of government funding.

Thanks for your replies!

SBIR = small business innovation research
STTR = small business technology transfer

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Richard Alcott Marketing and Communications

May 17th, 2016

Rudy - it seems you are addressing a Phase 3 scenario. If that is the case, you have successfully delivered on Phase 1 & Phase 2 requirements which validate the research. Moving to a commercialization Phase presents its own risk depending upon the application, IP, market maturity and competition. Do investors see prior government funding as an entanglement (or any other "negative" in deciding whether or not to fund)? In my experience grant funding is not a negative because there is no dilutive investment attached to funding that allows development of a proof of concept. Does the fact that the company doesn't need to pay back those funds any part of the decision equation? (a "positive"?) Generally speaking the positive is the company has a validated concept with a rigorous methodology to support results. Essentially it was seed money with no dilution. How would an investor address the government funding issue in the deal to fund? Or would they? In my experience investors won't address grant funding except where there is a requirement to supply the government a favored nation cost of goods/services that is at a stipulated discount that must be maintained and not offered to any other customer. If the business plan is driven by private and government market place opportunities then I view the government model as cashflow and private segment as growth and long term profitability. The business plan needs to reflect market opportunity and financial risk. Are there concerns regarding IP and who owns it? IP clarification is crucial. Ideally the Company owns the IP or has an exclusive unencumbered license ideally for the life of the IP. Many times the exclusive license allows Founders to continue their work with IP they developed with a University/Institution in which the University/Institution owns and maintains the IP. The only challenge I have seen is soliciting foreign investment. Many times, foreign investors will ask that the Company and IP be transferred into a foreign entity. Universities may not find that acceptable. Richard

Franklin Madison Founder & Managing Director: Chimera Capital & Finance LLC, Gaia Ventures

May 17th, 2016

*Rudy, I was Regional Director for SBIR for the State of NY for 6 years. I have an intimate knowledge of how investors see it. Its positive because it provides "proof of concept" for the technology that you have developed.* What (in general) is private investment's attitude about start-ups that have used government funding to develop their products? For example, a start-up applies for and wins an SBIR or STTR grant and uses the funds, in part, to develop a product they wish to commercialize for a worldwide market. *The SBIR money is good, the capital goes to your side of the valuation in the company, or your side of the table. So any savvy investor? willl know you have proven your business model (presale) with the SBIR. Dont assume however that all investors know what SBIR is,* The government gets their limited data rights to whatever they funded, but the company has the opportunity to commercialize, but they need further investment to do so. Now they offer a pitch to a private investor. *It depends on the SBIR and the agency. In some instances if its a contracting agency they may pay you for the rights to use the technology that you developed.* Questions for you: Do investors see prior government funding as an entanglement (or any other "negative" in deciding whether or not to fund)? *Not in the case of SBIR, again if they know what it is.* Does the fact that the company doesn't need to pay back those funds any part of the decision equation? (a "positive"?) *Its good business sense, it should excite the investor....you found another source for early stage capital* How would an investor address the government funding issue in the deal to fund? Or would they? *They will, it goes to your higher valuation of the company* Are there concerns regarding IP and who owns it? *You own it, even in SBIR....the govt has the right to use the IP. You own the IP and decide who to license it too* I'm mainly interested in federal funding, but I'd be interested in any experiences with any type of government funding. *SBIR is your best bet....* Thanks for your replies! SBIR = small business innovation research STTR = small business technology transfer *Franklin Madison* *[removed to protect privacy] T: [removed to protect privacy] * *Skype: blacqlock Twitter: NapoleonSolo* *about.me/frankmadison * *linkedin.com/pub/franklin-madison/0/5a/914 * *plus.google.com/+FrankMadison/posts/p/pub *

Franklin Madison Founder & Managing Director: Chimera Capital & Finance LLC, Gaia Ventures

May 18th, 2016

Tech Transfer is "university speak" commercialization is what the SBIR/STTR program is about. The Feds mandate is to set aside 2% of their annual budget for every agency to have small companies assist them with "their need". The SBIR program isnt a "give-away" its specifically designed to have innovation drive new advancements (I spent enough time putting companies through it and lobbying for it). The IP that they "own" like NASA are items that "they" have developed with different pots of money and in some instances (like NASA) they are inviting companies to take these technologies off their plate and put them into the marketplace THAT IS A DIFFERENT POT OF MONEY THAN SBIR (Not yelling just emphasis). SBIR is working, its paying for R&D within companies that investors dont want to pay for. Investor dont want to pay for proof of concept, they want it proven and with traction prior to you coming to them for a check. 

Martin Omansky Independent Venture Capital & Private Equity Professional

May 17th, 2016

We have seen a lot of this. Here is my response: (1) Since 1980, IP belongs to the recipient of government funds. Government has data rights Nd royalty-free pricing. but neither is a big deal. (2) Investors usually like government funds in advance of equity funds be as of credibility and non-dilutive financing at the highest risk stage. (3) some state-based incentive funds are more likely to contain provisions that make investors nervous, so I recommend reading the fine print. (4) Some federal programs, such as SBA loans, impose certain restrictions and requirements. I would fully understand the SBA rules and depend upon independent counsel to advise you on the desire ability of accessing from this source. Sent from my iPhone

Scott Davison Accomplished Entrepreneur & Executive

May 17th, 2016

I think the answer is: it depends...

As both an investor, and a former advanced tech start-up founder (where we raised about $25m in Fed. funding), private investors look at government funding from two perspectives:

1) Non-dillutive capital: Government grants, especially SBIR and STTR type grants, do not come with a whole lot of strings attached. There is really no significant IP or commercialization entanglement with this type of funding. The Feds are investing this grant money specifically because they want to see you develop and commercialize your idea. The only issue that arises with regard to government rights comes up if you cannot or will not commercialize IP that the government has helped fund.  So in this sense, government funding helps you invest in early state research and development on the government's dime. This is good for you in terms of retention of equity in your idea, but is also good for your investor, because you are not burning his or her $$ on early stage R&D.

2) The other perspective that investors should have on this type of funding relates to how much it will cost the company to pursue and execute the grants. Government funding mechanisms, especially phase I grants, can take a lot of resources to go after and they rarely ever materialize very quickly. Unless you are pretty wired with the group that will administer the grants, you can burn a lot of time writing grant applications that will never be successful. Even when you are successful, the money will take time to wrestle into place, and then there is a certain amount of overhead to administering the grant effort.

Summary:  as an investor, I'd be thrilled if a company had already been awarded government grants and spent it as non-dilutive capital on R&D.  I'd be ok with ongoing funding as long as it doesn't diminish the company's ability to move quickly and pivot when necessary. But, if an idea is truly appealing, I would prefer to put private capital to work instead of leashing the company to a slow government process for evaluating applications and granting relatively small amounts of money in the early phases.

Good luck to you.

Ken Anderson Director, Entrepreneurial and Small Business Development, Delaware Economic Development Office

May 17th, 2016

This requires a much more expanded response than what I will give here, but there is one aspect of this question I have found to be consistent. That is that private investors generally believe, rightly or wrongly, that state and federal funders, which are few and far between outside of the SBIR and STTR highly competitive process, are rarely the "first to fund." As a result, private funders perceive that entities that receive early state or federal "seed" funding, have been thoroughly vetted, financially and technically and as a result, makes the entity more appealing to external investors. Of course, this is not always actually true.

Martin Omansky Independent Venture Capital & Private Equity Professional

May 17th, 2016

Feds are lousy at funding commercialization. Projects in the life sciences are particularly vulnerable. Indeed there have been some high profile exceptions (microprocessors from NASA to general use, for example) but generally tech transfer is not a strength of the federal government. Sent from my iPhone

Rudy Darken Professor at Naval Postgraduate School

May 18th, 2016

Then who "owns" the tech transfer problem? The feds clearly want it (or there wouldn't be the Bayh-Dole Act among other things) but as you say, it isn't their job. So when DARPA, ONR, NIH, and other federal agencies have loads of federally funded IP that could be transferred (either developed, licensed, or sold) but isn't, it must be driven by incentive and enabled in some way. 
What, in your opinion, is working and what is not?

Franklin Madison Founder & Managing Director: Chimera Capital & Finance LLC, Gaia Ventures

May 18th, 2016

Robert Levin is absolutely correct by the way. Brilliant answer

Rudy Darken Professor at Naval Postgraduate School

May 18th, 2016

Tech transfer includes both (a) programs that were designed to facilitate tech transfer, like SBIR/STTR, and (b) everything else, assuming that no classification issues would prevent it. As you say, they are indeed separate pots of funding. Since the question here is about how well we are doing, then I ask:
  1. Is there any published data on the success rate of commercialization within SBIR/STTR programs? Several of you have said that you think these programs are doing well. Is there data to support that? Sounds like something that would be tracked, but I don't know.
  2. Since the SBIR/STTR pot of funds is much, much smaller than the "other" category, what incentives are in place to align the objectives of the parties so that recipients of non-SBIR R&D funds are motivated to commercialize? Or are there incentives at all?
One last point, several people I have worked with who have served as federal program officers can speak to this issue much better than I, but I have *never* seen any R&D program use SBIR funds as anything other than a "nice to have" "add-on" project to their primary portfolio. So even if the data does show that SBIR recipients are successfully commercializing, those same projects are not transitioning into the federal programs they are also supposed to serve -- and that's a serious vulnerability. In an ideal world, SBIR and all other federal programs are valued both on the federal side and (where appropriate) have commercialization value of interest to private investment -- that is, they both "transfer" to the private sector if possible, and "transition" within the government to programs of record (or wherever they can be best utilized).

Can someone with federal program management experience can speak to that point? Federal programs are vast and I only know my small corner of it. Maybe the situation is different in other sectors?