Where to Find the Money

December 2009 / January 2010 By: Jon Doherty Volume 7 Number 6

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It has never been easy for entrepreneurs to find funding for their great new ideas and it's a lot tougher now. But it's not impossible. We offer a set of articles intended to help entrepreneurs find the money. First, an essential primer followed by an encouraging report from Silicon Valley. Finally, a first-person story on how the money was, in fact, found.

Obtaining funding for early stage ventures is no easy task. As an entrepreneur/inventor you have slaved over your invention for years. You have the passion and you have the perseverance to establish a business to introduce your invention to the world. You have the vision to see the light at the end of the tunnel and the riches that await you from achieving your dream. If only you could convince the world to invest in your idea you could achieve all your dreams.

The reality is much different. As a frustrated inventor and innovation voyeur, I have twice been through the process of finding money for a great idea. Once I met with modest success and once with colossal failure. I learned first hand that the process of seeking funding for these inventions came with some stark realities for which no graduate education in business can prepare you.

The facts: Around 60 percent of ventures fail. Lack of access to capital is the No. 1 reason inventions never see the marketplace.

Getting your technology out of the lab and into the marketplace can takes a substantial amount of money that most of us just don't have. For the most part, we start funding our entrepreneurial dreams with some of our own seed money. We then branch out to our network of friends and family. Usually this can get you through the initial stages of creating a product from your idea and crafting a business plan. The next step involves convincing strangers to invest in your idea. This process sounds enticing and if done right holds the promise of the proverbial pot of gold at the end of the rainbow.

Raising capital is a vital step in the commercialization of any invention. Taking money from external sources will come with strings attached. Therefore, it is important to decide the absolute smallest amount of money you can work with, and to make a promise to yourself to not take a penny more that what you need. There are several potential funding sources that are worth discussing. We will begin with friends and family, review public sector sources and then work our way to venture capital.

There are as many barriers to funding as there are sources. This article attempts to give you some guidelines on how to start to look for funding from your personal network and provides you with some best practices to follow and guidance on avoiding the mistakes that many inventors make when talking to potential investors. Conventional loans and financing are not addressed here.

Types of Investors and Investments

Friends & Family
Of all of the ways that exist to raise money, getting it from friends and family can sometimes be the quickest way to fund your business venture. However, taking money from friends and family should only be done when they completely understand all of the risks and the rewards and what you will do if you can't pay them back. Make sure your friends and family are comfortable with the percentage of future profits they stand to gain based upon the amount they invest with you. This way ensures that both parties feel their investment has a strong chance of generating a return.

Key Issues when raising capital from friends and family
—Flexibility—€”the more you get the more you have to give.
—Type of Investment—€”stock, promissory note, etc.
—Securities Law—€”compliance requires a degree of knowledge

The process of seeking investment from friends and family is very good practice for going after angel and venture capital investment. If you can sell your friends and family on your concept you have the beginnings of a strong business venture that can create value and a return on their investment. Conversely, if your friends and family won't invest you may have to work on honing your value proposition.

Public Sector Funding
The next source of funding to consider comes in the form of grants and loans that emanate out of government programs that seek to advance the state of science and technology. These funding sources give an inventor the opportunity to mature their technology, assess and validate markets demand and investigate alternative applications. These programs attract other types of investors (angels, VCs, institutional), and can help to establish contacts within the local and national commercialization and investment community.

State and Local Government Sources
Many economic development organizations provide basic support services to startup companies looking for funding. It is a common misperception that these organizations provide direct funding. While some operate "pseudo equity funds," that are designed to support the growth and startup of firms in a specific region, a majority of these organizations only provide assistance in finding sources. Many economic development groups across the country have good relationships with local venture capital and angel investor networks.

Many state governments and universities have recognized the economic value of keeping inventors in their respective states. As evidence, numerous states have developed technology funds to foster innovation and to keep these enterprises close to home.

One widely publicized program, the Texas Emerging Technology Fund, invests millions of dollars in qualified startup ventures that have been vetted and recommended by regional consortiums of venture capitalists and state funded economic development entities. These funds are only made available to emerging businesses that have been vetted by VCs.

Federal Government
The Small Business Administration provides access to venture capital financing through the Small Business Investment Company (SBIC) Program. This entity is a novel public/private investment partnership. The SBA does not make direct investments, rather, they work with SBICs, which SBA licenses to provide financing to small businesses with private capital they raise and with funds borrowed at favorable rates through SBA (www.sba.gov/financial assistance/borrowers/vc/index.html). Working with this program may be another good way to test the venture capital waters and establish a network of funding contacts.

The Small Business Innovation Research (SBIR) and the Small Business Technology Transfer (STTR) programs provide funding to small businesses to conduct research and develop technologies on behalf of several federal agencies. The SBIR program is a competitive three-phase award system that presents small businesses with opportunities to propose innovative ideas that meet the specific research and R&D needs of federal government agencies.

These needs are advertised through solicitations and can be found on various public and private web sites. To be considered for funding one submits a proposal that demonstrates how your solution meets the needs of the agency. The Department of Defense SBIR and STTR programs fund a billion dollars each year in early stage R&D projects with small technology companies.

The SBIR program typically provides around $850,000 in early stage R&D funding directly to small technology companies. The STTR program provides up to $850,000 in early stage R&D funding directly to companies that work cooperatively with universities and other research institutions. Small companies do retain the rights to intellectual property they develop.
In addition to DOD, several other federal agencies participate in the SBIR programs. The National Institutes of Health, Department of Commerce, Department of Health and Human Services and the National Science Foundation (NSF) all participate in SBIR programs to commercialize demonstrated technology. (See www.sbir.gov for full list.)

Angel Funding
Another way to raise funds for your invention is to attract the interest of an angel investor. Angel investors are individuals who make small investments in new businesses. They often act as a catalyst to venture capital investment.
Angels also provide expertise and industry contacts to help you get established. The advantage of using angels over venture capitalists is that angels tend to take a more of a hands-off approach to their involvement in the business. They will provide money and guidance, but for the most part let you run the business. Angels have a long-term vision for the investments they make. Angels usually have a great deal of experience in an industry and have a passionate attachment to an industry, technology or field of science. They often seek a mentor/protégé relationship where they can coach a budding entrepreneur through the commercialization/startup process.

Nearly every state has an association of angel investors. Another way to start to connect with angels is through your alma mater. Many universities develop and maintain alumni angel networks. This can be a good way to get your foot in the door to pitch your concept and obtain constructive feedback on your value proposition and business plan.

Angels also form organized non-profit networks. For example, the New Mexico Angels is a non-profit organization that links angel investors together and provides support services like mentoring, referrals to inventors, etc.

Venture Capital Funding
A venture capital firm is an entity that invests relatively large sums of money into a business in exchange for an ownership stake with the purpose of generating a return on investment for the entities that have provided the capital to the VC (typically the insurance industry, retirement funds, university trusts, etc.)

Venture capital can be the catalyst for getting your business off the ground. However, obtaining VC funding is a challenging undertaking. By getting funding you will give up an ownership stake and control of various aspects of the business. When deciding if you want to obtain venture capital funding you must determine how much of your invention and your enterprise you are willing to sign over to investors.

VCs are an attractive financing option because they have access to investment capital and most have a track record of success that helps in avoiding the most common pitfalls that startups face. They also have connections to key industry players that would take years to cultivate on your own.

There is more to venture capital investment than money. Many VCs will expect to have some control of the business and will insert their own people into various positions within the company. There are some VCs that have a hands-off management style. It pays to find a firm that you can work with that matches your personal style and shares your vision for your enterprise.

Getting in front of VCs can also be challenging. You will need to invest time into understanding what venture capitalists seek in an investment. An interesting approach has been developed over the years at business schools around the world and there are many at universities where you can get your business plan in front of VCs. The Venture Capital Investment Competition (VCIC) at the University of North Carolina Kenan-Flager Business School conducts competitions for entrepreneurs (www.vcic.unc.edu.) Technology Ventures Corporation, publisher of this magazine, has held equity capital forums for more than 16 years that successfully bring investors and entrepreneurs together. (www.techventures.org.) TVC is a nonprofit organization that doesn't charge for its services.

Questions to Ask Before Seeking Venture Capital Funding:
 

• Is there a good fit for your business plan and the needs of the venture capital fund?
• Are you ready for venture capital?
• Are you ready to become a minority stakeholder?
• How can I ensure that the VC can add value?
• Where are you in the VC's funding life cycle?
• Does the VC have an early stage funding focus?
• Does the VC have experience in your sector?

The Funding Gap
There is an inherent obstacle in seeking funding for your venture. Frequently referred to as the "funding gap" it is a stage in the process after seeking investment from friends and family.

Steps to Success
In order to get money you have to communicate and position yourself to attract money. It is important to obtain an independent review of your business plan. It may cost you some money but it is well worth it. The following list of issues can act as a guideline in helping you avoid some of the common problems that entrepreneurs face when seeking funding for their startup.

• Protect your intellectual property
• Test your concept with everyone you know. Refine, refine.
• Network with successful entrepreneurs and seek out mentors
• Market yourself and your invention
• Obtain third party endorsements
• Invest in an independent review of your business plan
• Consider joining a local business incubator program
• Refine your strategies through feedback and dialogue with reputable investors
• Identify and qualify the applications and markets for your technology
• All funding sources are not the same. Do your homework.

Last, be wary of partners that are not a good fit. They may have the money but they may not share your passion for your technology. You need to make sure that once you have their money that they are still someone you would want to work with. If not, you should skip the deal or pursue a smaller investment that can help you retain a controlling interest in your enterprise.

The process of finding money to fund the commercialization of emerging technology is never easy. Which funding option you pursue depends largely on your needs. If you only need a few thousand dollars or so to get started, you may not want to expend the energy and resources required to attract venture capital funding. Many entrepreneurs have chosen to boot- strap their ventures until they get their business off the ground or the economy returns to a state of relative normalcy. It is best to think long and hard about your capital needs and let that determine how you go about raising money.

Jon Doherty is a manager in Frost & Sullivan's technical insights division.