Over the past decade, I have helped develop and launch more than 20 high-technology startups. Regardless of trends, the whisper in the back of founders’ minds remains: “what happens when I run out of capital?”
Pre-seed and seed stage technology startups are often still validating their products and solutions and customer revenue are just a glimmer of light. Because these startups are way too new, they compete for capital through local angel investor groups or early-stage venture capital firms. Yet high-tech startups require a significant amount of early-stage capital to finalize their research, begin manufacturing, and launch to the market. Herein lies the conundrum.
The venture industry provided more than $136 billion in investments to US companies in 2019. Much of that invested capital was into well matured and growing companies, with only a small fraction going to early-stage startups.
The 2019 median deal size for angel rounds was about $600,000. Median seed round deals were approximately $2 million. According to industry data provider PitchBook, this median total of $2.6 million was based on a media pre-money valuation of $7.5 million. This means that the typical tech startup founder has given 25 percent of their company’s value to outside investors very early in the company’s history. Much of this funding has most likely been spent on value-adding activities such as engineering, product design, and prototyping.
These companies will most likely require an additional round of funding at the Series A stage to launch their products into the market, meaning founders will see their ownership dilute even more. Founder Collective, an early-stage venture fund, analyzed 71 tech-sector IPOs. The findings? On average, collectively the founders owned only 15 percent of their company at the time of the IPO. Imagine how much ownership the founders would have retained if they did not have to sell a quarter or half of their company to investors before even reaching the first customer.
The non-dilutive capital solution
More traditional forms of financing, such as venture capital or angel investment, require that the company receiving the funding give up some part of the firm, whether equity ownership, a say in the firm’s direction, or perhaps both. Non-dilutive capital, on the other hand, is company funding that’s free of such strings. It comes in a variety of forms, including grants and low-cost loans. In any event, it can be used alongside traditional, dilutive financing to help extend a startup’s runway, as well as a way to promote public-private partnerships working for the greater good.
Immediately after college, I joined Southwest Research Institute, a nonprofit think tank in San Antonio that received federal funding to research new innovative ideas. I went on to join, and eventually lead, a defense contracting startup focused on undertaking R&D for the government, followed by The Ohio State University, where I helped revamp the research institution’s technology startup and commercialization programs. Through my two decades of helping to foster technological development, I have become deeply familiar with the various local, state, and federal programs that support our local science and engineering brain trust via non-dilutive capital. In fact, over the past ten years, I’ve helped startups connect with more than $100 million in non-dilutive capital. Here’s what companies need to know:
- These programs are varied in nature, but almost all provide funding required for early startup activities such as research, development, prototyping, and market analysis. Some programs even offer funding amounts that exceed that $2.6 million figure — and without triggering any founder equity dilution.
- Many of these programs are not commonly known by technology startup founders. Yet they should be explored by all technology entrepreneurs. The little extra effort to register or apply to these programs could mean less dilution and higher valuations. Better yet, many of these programs have federally funded “helper programs” to facilitate small business engagement. Services from these programs are usually provided at no cost to the startups.
- A list of the common non-dilutive funding sources and support programs often overlooked by technology startups are outlined below. Check them out. It could mean an extra $100 million in your pocket down the road.
SBIR and STTR Programs: The Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) programs encourage domestic small businesses to engage in federal research/research and development (R/R&D) that shows strong commercialization potential. Funding more than $2.7 billion on an annual basis, agencies may issue a Phase I award worth up to $256,580 and a Phase II award up to $1,710,531 to small, innovative businesses.
Department of Defense Other Transaction Authority Contracts: In 2015, Congress granted the Department of Defense permanent authority to use agreements known as “other transactions” to acquire prototype projects that, among other things, demonstrate whether technologies and products can be adapted for department use. This contracting approach can help attract companies such as commercial science and technology firms that might otherwise overlook opportunities with the Department of Defense. These contracts do not require the usual auditing required of startups doing business with DOD. In 2018, more than $3.8 billion of funding was awarded through other transaction authority (OTA) contracts.
Small Business Development Centers: The U.S Small Business Administration (SBA) administers the Small Business Development Center (SBDC) program to provide management assistance to current and prospective small business owners. SBDCs offer one-stop assistance to individuals and small businesses by providing a wide variety of information and guidance in every state in the US. Free services include but are not limited to assisting small businesses with financial, marketing, production, organization, engineering and technical problems, and feasibility studies. Special SBDC programs and economic development activities include international trade assistance, technical assistance, procurement assistance, venture capital formation and rural development.
Manufacturing Extension Partnership: MEP is a public-private partnership with centers in all 50 states and Puerto Rico dedicated to serving small and medium-sized manufacturers. Although many technology startups do not think of themselves as manufacturers, they typically qualify as such. In 2019, MEP centers interacted with 28,213 manufacturers, leading to $15.7 billion in sales, $1.5 billion in cost savings, $4.5 billion in new client investments, and helped create or retain 114,650 jobs.
For tech-focused startups, non-dilutive capital can be a great step forward in both developing and bringing your idea to market while keeping more of the reins over your business. Traditional financing has its perks but for early-stage projects looking to gain traction and make an impact, non-dilutive capital is a way to bring innovation and research to the next level.
Eric Wagner is CEO of Converge Ventures