Startup competitions have become a vital component of the entrepreneurial ecosystem, providing nascent businesses with essential funding, mentorship, and visibility. One standout organization in Saint Louis is Arch Grants, which conducts a startup competition where winners receive non-equity grants. As an inaugural judge for Arch Grants, I have seen firsthand the impact of this approach.
The concept of non-equity grants is compelling. As Arch Grants’ FAQ states, “We do not take an equity stake in the companies to which we award grants. Our ‘return on investment’ is the success and growth of our portfolio companies and their impact on the St. Louis region.” This model is gaining traction, with my alma mater, Saint Louis University’s New Venture Accelerator, also adopting a similar approach to equity-free investments. Innovation needs people willing to make big bets and take chances. These grants help accelerate progress.
(Before continuing, let me be absolutely crystal clear. We need programs like Arch Grants and SLU NVA. They are incredible. They should continue. They are doing immense good, and I wish I had them when starting Contegix. Period. Full Stop.)
However, it is crucial to recognize that every decision carries unintended consequences. Recently, I have developed a growing concern about a blind spot in these competitions regarding the types of rewards they offer: grants versus equity. While grants provide non-dilutive funding, they can pose significant long-term challenges for entrepreneurs by leaving them unprepared for the realities of equity management.
Understanding Grants vs. Equity
Grants are non-repayable funds given to startups, often without strings attached. They provide crucial financial support without diluting ownership or imposing financial burdens on the nascent company.
Equity, on the other hand, involves giving a portion of the company’s ownership in exchange for funding. This form of investment aligns the interests of investors with those of the entrepreneurs, as both parties benefit from the company’s growth and success. However, equity comes with its complexities, such as understanding the implications of ownership dilution, preference rights, and the long-term strategic impact of giving away a stake in the company.
The Equity Dilemma in Grant-Based Startup Competitions
While grants can provide significant capital without diluting ownership, they often leave entrepreneurs ill-prepared for the nuances of equity management when they eventually seek investment. This lack of understanding can manifest in several problematic ways:
- Misunderstanding the Value of Equity: Many entrepreneurs, particularly those in the early stages, may not fully grasp the value and potential of their equity. When competitions inherently place no value on equity, it can create an unconscious price-value bias. This phenomenon is similar to how bottled water, despite being nearly free as tap water, is perceived as valuable due to commodification and artificial scarcity. (Tap water is effectively free with a median price of $0.004/gallon. Bottled water that it has a median price of $1.22/gallon.)
- Inappropriate Equity Preferences: Without exposure to equity-based funding scenarios, entrepreneurs may not learn about the complexities of preference rights. This lack of knowledge can result in founders agreeing to unfavorable terms in later funding rounds, potentially creating “walking zombies” – startups that continue to operate but with little potential for founder returns. This is a phenomenon I have seen too often.
- Long-Term Strategic Implications: Receiving grants early on without understanding the long-term implications of future equity deals can hinder a startup’s ability to attract subsequent investment. Sophisticated investors in later rounds may be deterred by a cap table that is not strategically managed.
- Delayed Realization of Mistakes: The consequences of equity-related mistakes often do not become apparent until much later. By the time entrepreneurs realize the impact of their early decisions, they may have already compromised significant portions of their ownership and control.
The Need for Education and Support
To mitigate these issues, it is imperative that startup competitions offering grants also provide comprehensive education and support around equity management. This includes:
- Workshops and Mentorship: Programs that educate entrepreneurs on the basics of equity, valuation, dilution, and preference rights.
- Legal and Financial Advisory: Access to legal and financial advisors who can help founders understand the implications of equity deals and negotiate favorable terms.
- Post-Competition Support: Continued support and resources to help startups navigate subsequent funding rounds and avoid common pitfalls.
Conclusion
The potential unintended consequences of grant-based startup competitions remind me of the story in Black Sabbath’s “Iron Man.” Just as the man in the song unintentionally brings about the apocalypse he tried to prevent, these competitions could inadvertently cause a startup’s demise instead of helping it launch and scale.
While grants from startup competitions can be incredibly valuable by providing non-dilutive funding, they also come with significant risks if entrepreneurs are not adequately prepared for future equity management. To foster a more sustainable entrepreneurial ecosystem, it is crucial that these competitions incorporate robust educational components and ongoing support to help founders make informed decisions about their equity.
The intent is not to change from grants to equity investments, but to address these issues head-on. Only by coupling non-dilutive funding with comprehensive equity education can we ensure that these competitions truly serve as a springboard for long-term success, rather than an unintended stumbling block.