Where Does the Money Come From?

Fact: In 2005 over 500,000 new business incorporations were organized in the United States.

Fact: Of these 500,000 new businesses less than 1,000 received venture capital funding.

There are vastly more entrepreneurs seeking start-up funding than there are available funding sources and investment pools. This is a fact. And yet, 499,000 incorporations occurred in 2005 without the cover of an investment funding commitment. Many of these new businesses will fail. Nevertheless, the urge to seek the fulfillment, financial security, freedom and the satisfaction of overcoming the odds still drives us to try.

The lingering doubt, and hurdle each of these new entrepreneurs confront is this, “where does the money come from”? We look at, on average, 600 submissions per year in my consulting business. The absolutely, number one reason, most of these presentations will not ever make it beyond the idea stage is an unrealistic understanding on the role of investment and sources of available start-up funds.

My first assessment of an opportunity is always the idea itself. Assuming the submission passes our layered analysis, the next hurdle is the inventor or prospective entrepreneur. Is he a dreamer, or a doer? And the first disqualifying trip wire for a dreamer is the expectation that they can have someone incur all of the financial risk, 100%, while they commit nothing. When I say nothing, I mean no patent filings, no production quality prototypes, no qualified research, no testing, etc. They have only an idea.

Angel investors do exist, but even they do not very often consider investment in dreams, cocktail napkin designs or untested theory. And yet we eliminate 60% of the product opportunities we view, many with interesting commercial potential, simply because the submitter can not, or will not invest in their own opportunity. If you do not believe in yourself, your opportunity, why would anyone else?

The development monies for patent and trademark filing, design, research, creating working models is what the funding world calls 3-F money. 3-F money comes from friends, families or fools. This is very high risk and usually very small amounts are needed. Most of the products we see require from $12,000 to $20,000 to put in a professional presentation that could be of interest to investors, licensees or partners. Most of the people that submit to firms like ours have jobs, homes, and investments. Many love to chat about their boat, second home or recent safari vacation. But they claim to have no money to invest in a project that they state is an absolute winner, and will make millions for everyone involved.

This is an absolute deal killer, a non-starter. We are constantly solicited to become the inventor’s partner, hundreds of times per year. Investors must see passion, commitment, confidence and an inventor with skin (dollars) in the game. The lack of personal commitment one brings to a project is proof that a dreamer is impersonating an entrepreneur.

Friends, family and fools assist in funding, investing or partnering most of the 499,000 new incorporations filed in 2005. This does not include the huge number of sole proprietorships established each year. Most new businesses do not require the involvement of venture capital funding sources, blind pools or investment banks. Their scale is too small for consideration by firms seeking larger investment opportunities with huge harvest (cash out) potential.

Many entrepreneurs have used credit cards, personal savings, a home equity loan, sell that antique car, tap a retirement account, or utilize an inheritance to fund their new enterprise. Just remember however, this is high risk and more business start-ups fail than succeed. Nevertheless, securing the initial development funds in this way shows commitment and can advance a project to the point where deal placement is a real possibility.

During the 1990’s a gold rush mentality occurred that distorted the financial markets. Money for many investment types was readily available. Due diligence was morphed by theory and new age abstract business models. The sky was the limit.

Well the sky was not the limit. The bubble burst and in the first decade of the 21st century we are now in an investment cycle where cynicism rules. Every deal is thoroughly vetted and re-vetted. Terms are very strident. A submission must be absolutely professionally researched and presented. The market allows for no shortcuts or errors in assumptions made.

With this reality in hand, and the knowledge that self-funding, or 3-F funding are the most prevalent options for startup monies, are there any other options? What are they? There are several, and I will be writing specifically in more detail on each. Consider:

· Bootstrapping
My personal favorite, as I successfully started my first business by bootstrapping. What is bootstrapping? Simply stated, this is an avenue to start your business without borrowing, giving up any equity, total self-reliance on yourself. Sell your product or service before you have inventory. If no one buys you have lost nothing. If you receive orders you know you have a winner. More entrepreneurs successfully can start the road to success by bootstrapping than by any other method.

· Licensing
Since the bubble burst in 2000, we have done far more product licensing campaigns than any other deal style. Licensing requires a thorough foundation of intellectual property protection. First to market advantage, a strong Unique Selling Proposition, lowest possible of goods (while maintaining highest possible quality standards) and verifiable sales model.

· Angel Investors
There are so-called angel funds, so named because like fairies they sprinkle a little dust on potential deals of interest, just seed money basically. Angel funds tend to stick to specific fields (technology, wellness, software, etc.) where they have great experience and contacts.

They typically take an oversized piece of equity, as first money in is most at risk. In addition, angels are few and far between, hard to find. Look at local Chamber of Commerce fairs and regional government incubators as a source for networking angels.

· Mezzanine Finance
Once a deal has shown market potential, sales are growing, the market is responding and the risk factor has been mitigated, mezzanine financing becomes an option. Usually the mezzanine round is for far more investment money than the angel-round, and the equity percentage is not as dear. Many banks now have mezzanine arms to service growing, but not yet mature opportunities.

· Investment Bank
Investment Banks are very difficult to work with unless a project is typically past the angel and mezzanine funding stage. They want to see sales traction, even if in a limited test market. Investment Banks have exceedingly aggressive Harvest Goals, recognizing that even with the most heavily vetted deals, only 2 in 10 or so will succeed and pay-out.

Also, Investment Banks are not interested in small loan amounts. It is a reality that it is easier to secure several million dollars than several thousand for a new project. They will not be interested in a local bakery.
A strong, experienced management team is always a top priority for Investment Banks.

· Small Business Administration
The SBA is an excellent avenue for the first time startup, minorities and women to utilize as a funding source. The SBA is government subsidized. That said; it is very slow, bureaucratic and risk averse. A good source of funds for traditional types of businesses, such as retail, local service and light manufacturing.

· Factoring
Again, this is a personal favorite, as I have used receivable factoring to fund several of my startups. Basically, a factor is a financial institution that will buy the firms purchase orders, if the orders are from top grade companies. For instance, the entrepreneur receives a purchase order for his widgets from Walgreen in the amount of $200,000. The order becomes a form of collateral and a pre-negotiated percentage is advanced to the vendor. This is used for working capital, often for completing inventory production. The open balance, less factoring fees, is credited when Walgreen pays the invoice amount. Virtually every dry goods manufacturer factors invoices.

In summary there are many funding options available depending on the size, scalability and current status of the new business opportunity, no entrepreneur should ever attempt to approach funding sources without a customized business plan, exciting presentation materials and strong financial projections. The most likely source of funding for 99% of all new ventures will be personal resources, friends, family and fools.