University Startups and Spin-Offs: Guide for Entrepreneurs in Academia (2015)

Part I. Strategies for University Startup Entrepreneurs

Chapter 11. Startup Grants:Can Government Programs Stimulate Entrepreneurship?

A discussion about startup entrepreneurship out of universities would be incomplete without touching on the subject of grant funding. Many first-time entrepreneurs believe the initial order of business is to get a grant. Obviously, entrepreneurs need to pay bills and have to eat, and product development requires capital. All this makes it necessary to spend some time writing a good proposal, then submit it, and hopefully impress a panel of experts enough to receive some money. This tides over the startup team for the early months while they labor in their lab on a better mousetrap. This is the mainstream view under which most people operate, because most have never started a business and see this adventure through the lens of the employee. Nobody would show up at their job if they were not paid, so why should the entrepreneur? A result of this thinking is that first-time entrepreneurs are often more concerned about paying for their health insurance than market-testing their product.

This, unfortunately, is exactly the wrong approach to entrepreneurship. A fundamental misunderstand about funding and its usefulness lies at the heart of it. Startups need funding only when they have a validated product, ready to launch in the market. This is possible only when they have proof that enough people need this product and are ready and willing to pay for it—after they have repeatedly tested their ideas directly in the market, confirmed their approach and business model, and have done much soul-searching about whether they have the willpower to see their startup through. When a startup stands ready to launch a validated product, that’s when raising funds makes sense. The investment is necessary to scale up the startup and help produce its final product. Any money collected before then dilutes the focus of the startup and sets it off on the wrong trajectory.

Launching a startup has little to do with asking for permission from a panel or with sitting quietly at a desk, writing proposals and business plans. True game changers often go against the grain of what the mainstream accepts as normal and useful. How often have you read the story of a first-time author who sent a new book to 100 publishers who all thought it was not worth the paper it was printed on? The 101st publisher relented and accidentally ended up making a fortune when the book turned out to be an international bestseller. Similar stories abound, and it is the same with disruptive startups. They will never receive grant funding, and the public will rarely deem them worthwhile until they have launched and proven that their product or service is something that nobody is willing to live without.

Early Funding Can Be an Early Grave

In my opinion, early funding can be an early grave for a startup. It avoids all the inconvenient questions that build a foundation for success down the road. Startup founders should not ask themselves, “Where can I get $50,000?” but “Do I really need $50,000?” When the government makes startup grants available, this question is bypassed and drowned in months of concentrated grant-proposal and business-plan writing. This happens at universities that funnel their startups into the grant pipeline. Theoretical planning and scrambling for funding replace firsthand experience in the market. The startup must have an entrepreneurial fire that puts everything else in second place. If this is absent, then it will be very difficult to compete with those who have that fire burning in them, despite any amount of funding.

Grants make sense much later, after the entrepreneurs have undergone some soul-searching and idea testing and have launched a prototype of their product or service. Additional capital may even be unnecessary at that point, if the venture is already profitable or has found a joint venture partner.

During the initial unfunded startup stage, some founders learn that they lack what it takes to be a startup entrepreneur—they fail to launch a valuable product or stop much earlier than that. A grant would have just delayed the inevitable and would have wasted taxpayer money.

Network Effects and Other Government Programs

There are obviously ways in which a government can assist startups, other than grant funding. Undoubtedly, entrepreneurship benefits from network effects: if there are 20 other startups nearby, a new one benefits form existing infrastructure; support services such as lawyers and patent specialists; inexpensive co-work spaces; and other positive externalities. Such a setup depends on the entrepreneurial climate and the ease of conducting business in a country.

Government policy can help lower the boundary to entry for new startups by making incorporation simple and straightforward. The less bureaucracy and the fewer roadblocks exist, the better. The environment may even attract entrepreneurs from abroad. At this point, an entrepreneurial ecosystem may be in the making, from which additional network effects originate. The first step of introducing or removing a certain government policy may seem insignificant, but when it starts to take effect, change can occur rapidly.

Unfortunately, governments hardly have the best reputation for helping startups succeed. Author Josh Lerner lists the following examples of government policies that were meant to boost entrepreneurship but that went wrong¹:

· When hurriedly rolling out the Small Business Investment Company program in the early 1960s, the U.S. Small Business Administration poured capital into hundreds of funds whose managers were incompetent or corrupt.

· The incubators in Australia’s 1999 Building on Information Technology Strengths (BITS) program captured the principal share of the subsidies aimed toward entrepreneurs by forcing startups to buy their overpriced services.

· Malaysia opened a vast BioValley complex in 2005 with little consideration about whether there would be demand for the premises. BioValley became known as the “Valley of the Bio-Ghosts.”

· Britain’s Labor and Conservative governments heavily subsidized and gave exclusive rights in the 1980s to the biotechnology firm Celltech, whose management team turned out to be inept at exploiting those resources.

· Norway wasted much of its oil wealth in the 1970s and 80s by propping up failing companies and funding new businesses that were badly planned by relatives of parliamentarians and bureaucrats.

Money Cannot Buy Entrepreneurship

Grant funding is a great idea in theory, and it made some sense when it was much more expensive to start a company. With today’s advances in IT and rapid prototyping, entrepreneurs can test their assumptions much more quickly without spending $50,000, $10,000, or even $5,000. This applies not just to Internet startups, but to any other project as well. Once they have proof that the market is ready to pay money for the technology, the startup is already up and running. If the market has no interest in a product, then there is no business, and the entrepreneurs have to decide whether they want to go back to the drawing board or abandon their venture. Money will hardly help entrepreneurs come up with fantastic new ideas, but internal drive will. Taking months to write business plans and grant proposals is time spent unwisely. It will chip away at the internal drive of otherwise motivated entrepreneurs.

When entrepreneurs are pushed down the grant track, they get the wrong impression of what startup entrepreneurship entails. As in a feudal society, this approach makes it seem as though entrepreneurship is an exercise in sending a proposal to an all-knowing entity who gives it the thumbs-up or -down. If the gatekeepers like what they see, startups may proceed. Otherwise, their ideas need further research. This is more akin to school than the reality of launching a company.

Furthermore, the silliest-sounding ideas are often the best ones. Those ideas are like the book that fell through 100 times before it became a bestseller. They have the power to become blockbusters, not the ones that everyone agrees on. Entrepreneurship is about taking matters into your own hands and staking a claim, regardless of what a bureaucrat or professor thinks.

Grants Crowd Out Investors and Advisors

At the 21st Singapore Economic Roundtable, organized by the Institute of Policy Studies and The Business Times in 2014, an angel investor raised the issue that grant funding made it harder for angel investors to invest in startups. He also argued that early support from the government enabled less-innovative companies to survive.² This investor brought up an issue that many others were aware of but hesitated to mention in the open. And its relevance is not limited to Singapore. The revolving door from incubator to incubator has created a situation where startups rely on the government to cover their overhead without coming up with innovative products.

Authors Paul Miller and Kirsten Bound make a comparable point: they suggest that startup accelerators may be more attractive for B-grade companies. In their opinion, if a business finds an accelerator or incubator attractive, it probably will be less successful than a company that does not need support.³

When startup entrepreneurs land early government grant funding, all their problems seem to have come to an end. They often stop seeking advice and keep working on their challenges with the logic they have always applied. Working with investors with extensive startup experience is the better choice. Their support goes beyond money and includes advice from seasoned experts in the field. This is useful, especially when things are not going smoothly; as the saying goes, “It’s too late to make friends when you need them.” Startups can benefit greatly from having experienced investors or entrepreneurs on their side, but they get crowded out by easily accessible grants.

But Startups Need Funding, Right?

How can we fund all these university startups, if not through grants? As already mentioned, funding makes sense only when a startup is ready to hit the market with a validated product. If the bar was higher for startups to collect grant money, much less of it would be necessary. Talented students and researchers would launch products and attract joint venture partners, and those with weak motivation to get their ventures off the ground would give up before they qualified for grants. Still, many startups collect grants as the first order of business, because such funding is often extremely easy to get.

Let’s look at exactly what is being funded with all this government grant money. Is it groundbreaking technology that needs a large investment to get off the ground? Is it a drug with the potential to save millions of lives that requires expensive trials to get to market? Or a special device aimed at improving living conditions in developing countries that can only be produced inexpensively in huge amounts? None of the above. The lion’s share of grant money goes toward the high salaries of startup entrepreneurs and the bills of external advisors and specialists. Conversely, high salaries and reliance on external specialists are outrages for private investors. When a startup raises seed-round funding in Silicon Valley, the salaries for the entrepreneurs should be zero or low; and they must be able to do the core work in-house, because they are the brains behind the operation. If entrepreneurs cannot do with little money, how can they reign in the finances of their startup?

I know an entrepreneur who received a grant of about $200,000 for his software startup. As they always do, the grant came with strings attached: for example, how much of the grant could be paid in salary to the founders. The entrepreneur’s first and foremost concern was how to double his salary allotment through subterfuge. The next step was finding a foreign contractor who would do all the work for the remaining amount of the capital. Did taxpayers fund innovation with this grant? It all went toward someone’s salary and a foreign programming firm. The product was derivative and untested in the marketplace, and it has not yet seen the light of day.

Sadly, early grant funding props up businesses that have not undergone a single test in the market. In most cases, considerable money and time are spent building a better mousetrap, only to find out that the market is largely oblivious to the expensive prototype. Taxpayers should see their money put to better use.

The issue is that researchers often approach startup entrepreneurship as an afterthought. This may be because they are unaware that a startup is an available choice early in their career. Or it may be that when their research project ends, they scramble for a way to stay on board and stumble on the possibility of a startup, which then becomes their lifesaver to stay at the university a little longer. Whatever the case, the motivation to become an entrepreneur should never be entitlement or complacency, but an unquenchable drive and desire to make an impact in the world with your ideas. If this is the case, then you will find a way to begin the startup process in your free time while still being on salary with the university, so no further capital is necessary. You can also leverage your research work and infrastructure directly into the startup, removing overhead costs for offices, a workshop, and materials. If your technology is patentable, then take advantage of the university’s invention-disclosure process to pay for the patent. If you need a certain person’s expertise, try to get them on your startup team as a co-founder. Before you know it, your startup costs will be close to zero. This is the true power of a university as a launch pad, not the availability of easy government grants. Make do with less. Recycle and leverage, instead of turning on the faucet and trying to fill a bucket that is full of holes.

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¹Joshua Lerner, Boulevard of Broken Dreams: Why Public Efforts to Boost Entrepreneurship and Venture Capital Have Failed, and What to Do About It (Princeton: Princeton University Press, 2009).

²Kelly Tay, “Government Grants Seen Crowding Out Angel Investors,” Business Times (June 9, 2014).

³Paul Miller and Kirsten Bound, The Startup Factories: The Rise of Accelerator Programmes to Support New Technology Ventures (London: Nesta, 2011).