Swimming uphill- the challenging environment for funding
EMF Disturbance Monitors, inc. is not a young start-up. We were incorporated in 2012 and will soon have our 13th anniversary as a company. During our journey, I have learned quite a lot about how to fund your start-up.
First off, founder funding remains the most reliable method of moving forward. Whether it’s cash that founders contribute or sweat equity that early employees donate, start-ups move forward because the founders have faith in their idea and are willing to commit their own money and energy to create a new company. There are those unicorn founders with a history of success who announce a new-start-up and immediately get 7-figure investments from Venture Capital. They are the exception. Let’s be real. Founders who have a paying job and work part-time on their start-up have a much better chance of keeping their company moving forward because money needs to be directed at things other than payroll. Your day job is paying for your groceries and your start-up is your aspirational pursuit.
Non-dilutive funding from grants is often quoted as increasing the chance of obtaining Venture Capital funding. Getting grants from local, state and federal organizations is helpful, especially in public relations. However, when you weigh the burden of time needed to apply for grants against the percentage of actual funding, the cost-benefit analysis isn’t great. Unfortunately, the dollar amount of these grants is often insufficient to pay even one full-time employee minimum wage (roughly $ 18,100 counting salary and FICA). There is also the psychological damage that occurs when you are not chosen for grant funding, implying that your company’s value proposal has already been labeled as a failure. I’m not saying that you shouldn’t apply for grant funding. I’m simply saying that applying for grants is a job requiring time for research, writing and submission. Your time may be better used identifying customers, recruiting beta-users or cold-calling Venture Capital.
The current environment for large-scale federal grants is very uncertain. NSF, SBIR and STTR grants are large dollar, nondilutive funding that that may propel your start-up forward into the world of real Venture Capital. There is little transparency on the effects of DOGE cuts to NIH and NSF funding. The assumption is that the total amounts for future funding will be lower. The successful funding percentage for SBIR grants is quoted as approximately 20% but this includes applicants with prior successful SBIR funding. Prior successful SBIR funding doubles the chance of subsequent successful SBIR funding. The one metric the NIH doesn’t advertise is the percentage of successful funding for first-time applicants. A reasonable estimate is 5-10% of first-time start-up applicants will be successfully funded. This means that you would need to submit 10-20 grant applications to receive one funded grant. I would estimate that this would be a full-time job for 1-2 years for a start-up employee. You need to take this into consideration when you start down the path of federal grant applications.
Lastly, we’ll talk about Venture Capital. Venture Capital is a business model which only succeeds if investors are consistently rewarded for placing their hard-earned money at risk. Over the past 20 years, Venture Capital has evolved away from “Pre-Seed” and “Seed” funding to “Series A” and Series B” funding. The failure rate for investment in “Pre-Seed” and “Seed” stages is unacceptably high for investors. The odds of a successful acquisition or IPO are much higher if a start-up has reached the “Series A” or “Series B” stage. This leaves most early-stage companies ineligible for Venture Capital. The result is the emergence of intermediaries who “screen” start-ups and present them to “Venture Capital” for consideration of funding. These intermediaries charge start-ups ever-increasing, up-front charges claiming to give you access to Venture Capital firms, private wealth or family offices for investor consideration. These intermediaries are also a business who use your fees to pay their employees. Using an intermediary is risky, since you are investing in their purported connections to investor lists that are unpublished.
As I said in a previous blog, the U.S. and other countries can help support the start-up ecosystem by changing tax law. Investments in “Pre-Seed” and “Seed” start-ups by private Venture Capital is shrinking due to the risk of company failure. Funding early start-up employee salaries creates tax income for local, state and federal treasuries. This is an immediate benefit. Start-up employees buy groceries and pay for utilities (like Internet access) which increases the GDP. This is a secondary benefit. The vast majority of salary income for start-up employees is spent on the real economy. If Venture Capital firms were given lucrative tax deductions for funding early start-ups, the investors would benefit as would the start-ups. Even if the start-up failure rate remains high, the short-term benefit to investors and the economy would change the value proposition. This would likely increase the appetite for Venture Capital to consider funding earlier stage start-ups. I hope our elected officials will consider creating better tax incentives for start-ups so that the US can continue to be a leader in new products and new technologies.
