Considering Grants

Financing the creation of a high-potential startup is challenging – and the lure of non-dilutive grant money is appealing. However, the strategy of pursuing grants has its pros and cons for a founding startup team.

Building a startup requires resources. Resources often are not free – requiring money to secure the people, prototype components, legal services, facilities, computer time, and the endless other costs. So, what is a founding entrepreneur to do? Hunting for money is often one of the most time and effort-consuming parts of an early-stage startup. Options include personal resources like savings, credit cards, and mortgages; funds from business plan competitions, economic development programs, university bridge funding, and other sources; and ultimately, investments from family and friends, angel investors, and VCs. As an entrepreneur explores many options, looming in the background is the enticing appeal of grants.

Grants are particularly appealing at the earliest stages because they are often structured to support research and development into the kind of transformational technologies that can form the foundation of a high-tech, high-potential startup. Typically funded by government agencies, grants have structured open application processes with clear instructions for what is needed to apply (unlike many forms of fundraising, which involve much more confusing and ambiguous processes). Ultimately, grants are non-dilutive funding sources, which means that the entrepreneur does not have to give up an ownership stake in the startup for the money, making grant money sometimes feel “free.”

With all of these attractive aspects of grant funding – and with the fact that applying for federal, state, or other source grants is often widely promoted and applying feels more within the entrepreneurial team’s control, it makes sense that entrepreneurs will often pour lots of time and energy into pursuing this type of funding. However, when entrepreneurs consider how they are allocating their efforts, it is worth considering some of the arguments against applying for grants, including:

• The Funding Needs of a Startup and the Scope of Grant Funding Often Diverge:  Grants are designed to meet the specific goals of the grant-providing agency and often restrict the use of grant funds to activities that promote those goals while disallowing other ordinary startup expenses. For example, grants frequently do not allow funding for costs related to sales and marketing, intellectual property protection, other fundraising costs, independent R&D costs, and so forth.   It is essential to carefully review the grant program restrictions, exercise vigilance to comply with guidelines, and consider what resources the startup will have to cover unallowed costs. Bottom line, know the rules!
  
  
• The Need to Share the Resources: Many grant programs devote a significant portion of the application to confirming that the grant recipient has the facilities and resources to complete the proposed project. Often given considerable weight by the grant application scoring rubric, such questions can be pretty difficult for an early-stage startup to demonstrate such capabilities, given that these questions often focus on the adequacy of existing facilities, equipment, and expertise that early-stage startups have not had the funding to build. One solution is to partner with a university that can bring many of those resources to bear. However, that can mean sharing a substantial amount of the grant funds to cover the universities’ expenses and overhead, which diminishes the resources available to the startup.
  
  
• Substantial Time and Effort Required for Grant Applications:  By their very nature, grant applications are almost always written applications, with very few involving more interactive or in-person methods of making your case for receiving the funding. This means the applications will often involve elaborate written responses, often with strict length limits, making them quite challenging and time-consuming to complete. Plus, grant proposals may involve securing letters of support, developing a grant budget, and doing other work to meet the application requirements. In addition, the structure of the application and the nature of the questions asked are often quite different than the typical way a startup promotes itself. From my experience both successfully and unsuccessfully securing grant funding, I usually assume that completing a federal grant application will require at least a person-month of effort when considering whether it will be worth it.
  
  
• Lengthy Decision Timelines:  The timeline for a funding decision for a grant application is typically a number of months, during which the startup will have to figure out a way to fund its operations or just await a decision, which carries its own risks. Then, when following a grant-based funding strategy, getting follow-up grant funding will often involve another application process.  There is usually a significant many-month gap and a risk of not receiving the follow-on grant.  This will make it tough to keep the team together and continue to make forward progress. Except at the very inception of a startup, these lengthy decision timelines can be brutal hurdles for a startup team to navigate while maintaining momentum.
  
  
• Low Likelihood of Receiving a Grant:  Perhaps the most important reason not to apply for a grant is that grants are highly competitive, which means that you are not likely to get that pot of gold you are hoping for. Look at the statistics for grant awards versus the number of applications for various grant programs. For example, success rates for federal SBIR grants have fallen to well below 20% — and the earliest-stage grants are the most competitive. A recently awarded state grant funded less than 2% of the funding requests received. Despite how wonderfully the grant objectives seem to fit the startup’s mission, it is imperative to remember how intensely competitive these grants are and that there will be many other applicants with well-developed applications. Therefore, it is critical to consider how much time and effort it takes to complete a grant application when the likelihood of funding is quite low.
  
  
• Mixed Reaction from Potential Investors:  This may feel like an odd one, but investors may or may not be thrilled by a startup’s ability to secure grant funding. On the one hand, sophisticated investors know that securing grant funding is a highly competitive process, and the ability to secure such funding can demonstrate how impressive the assembled team and proposal are and provide a non-dilutive infusion of cash. However, sophisticated investors also know all of the arguments against pursuing grant funding that I just listed, so this can also raise questions about how business-focused and sophisticated the team is, how much time is being invested in the pursuit of grants, and whether the product is at too early an R&D stage (which is what grants typically fund) for venture investment. Here, it is critical not to overpromise before getting an award, succeed in securing the grant, and then argue how the awarded grant funds will leverage the investors’ money. 

While securing grant funding can be a great lift to an early-stage startup, it is not always the best strategy to pursue them given the substantial opportunity costs in terms of time and resources for the application process, how high the odds are stacked against the startup for getting the funding, and the often urgent need to create positive momentum in building the company and its innovative products. I have funded startups with grant funding and without, and as I have gained experience, my threshold for investing in the grant proposal processes has steadily increased for all the reasons stated above. Of course, congratulations and make the most of it if you do manage to secure one of these coveted funding sources!