Non-dilutable options

I have an entity I've been working on for roughly 4 years, the last being a real push to get it out the door. A student recently joined me and got us into a student business plan competition and we won $10K, so I thought.

Something they don't tell you up front in these "competitions" is that the University wants the OPTION to purchase 1% of the entity for $1 in accepting the prize. The option seems to be exercisable in a 5 year period after either a significant investment by others (myself excluded), or 5 years. And that options is effectively non-dilutable. They get 1% of the company for $1 when they execute the option. Which means to me they can wait and wait and wait then grab 1%.

So much for "winning" a prize, eh? It's like winning a headache. I'm already told that 2 other "winning" contestants have refused "to move forward" with the award because of this option. I feel that they may be taking advantage of students who don't have the experience or capacity to understand these things.

So, I've never heard of this kind of option. The only way I see it being an option is instead of taking a percentage of dilutable shares upfront, is that the percentage is only up for dilution whenever they exercise it.

Also, I say "seems to be", because there doesn't seem to be an explicit expiry date. It is written in the language of "The University may exercise.....", and the word "only" never shows up, unless you take "may" to be "may only" implicitly.

Aside from needing the $10K, I'm wondering, is this "award" better off being left on the table?

That sort of arrangement is actually pretty typical from universities, but it usually happens in licensing deals: "We give you this technology, and you give us an undiluted 2% of your company until X happens." And, 'X' is usually something like the passage of time, an equity round of $5M or more, etc....

It's not that onerous if it's 1% of the common (or an an as-converted-to-common basis), and doesn't restrict your ability to sell preferred stock. Future investors are going to want to make sure that they get their money back first, so as long as the university deal doesn't interfere with that (and, they typically don't), you're not shooting yourself in the foot.

You got $10k. Not $1. They are taking a big risk. There is a time limit so I don't see the problem.

You can walk away from it - that's your choice.

Worst case scenario for you is that you have to give up 1% of your company after it is worth billions.

Is that a bad scenario?

Keep taking a 0 off the end of the valuation. Are there ANY scenarios where the 1% is so bad for you to walk away? If so, then walk away.

Seems like a no-brainer to me. You just got $10k investment and the cachet that comes with it.

Would you take $100,000 for 10%? Many pre-revenue start-ups would and there are several incubators that provide funding in that range. Doesn't sound like a bad deal providing the terms aren't too onerous.

Imagine this scenario: 10 years from now, you're working on getting funding for your 3rd startup and the VC asks you where you went to school. It just so happens that the cousin of his brother-in-law knows the neighbor of a professor there. So the VC sends a quick Linkedin message and asks about you. Now suppose the professor says "oh yeah, we remember him: we helped him get a project going, I even voted for him in commission so that he'd win a prize and then he was a real d##k about some options. Not sure what happened afterwards." If this is your first deal and you're just getting started then I think you should take it and put that on your resume. Like TimJ said, use the cachet, build ethos.