Funding your Startup (Head)

Previously I talked about how you may want to start a business, but can get held back by:

• Finding the right idea
• Funding (for the business or for yourself)
• Procrastination, or
• Fear

Today I’m focusing on funding the idea, and the key building blocks involved. As previously highlighted, an entrepreneur is unlike a business manager. Passion and heart are the most important thing. But all heart and no head can lead to disaster. Much like going into battle with no weapons.

Funding Sources

There are five basic ways to fund yourself in the beginning.

1. Unpaid work – done by yourself and maybe others
2. Customer pre-payments
3. Grants / government support
4. Equity investment
5. Debt (generally unadvisable!)

1. Unpaid work

I covered the topic of researching the viability of your business under The Right Idea, and much of this research should be done by you at little or no cost.

If you can recruit other potentially valuable people to give their time for free too, then as well as getting more done for less money, you’ll have demonstrated that you can sell your vision to others. This is usually done in return for future equity, so:

• try to do as much as possible of the initial work yourself to avoid giving away excess equity
• be careful what you promise and who you tie yourself to – this is where you could do with some strong commercial/legal advice.

Sometimes you can get work done on the side while working in a full-time job. This is especially advisable if there are aspects to starting your business that mean waiting for weeks at a time for decisions to be made – such as waiting to hear back on a grant submission.

Investors back entrepreneurs who have tenacity, problem-solving skills and creativity. Driving your business as far forward as possible without spending lots of money is your first chance to demonstrate these characteristics. The first Google Glass prototype – produced in 45 minutes for about $5 – is a great example of what can be done without big investment (this is discussed in more detail in Finding The Right Idea).

2. Customer Pre-payments

In a new business setting, obtaining customer pre-payments is usually only possible where you’re offering a service to clients who’ve worked with you before. If you were to agree to do a 3-month consulting contract, say, you might be able to agree that a portion of the fee gets paid upfront to cover certain costs and to recognize the fact that you’re committing yourself to the project.

This is an ideal situation, rarely possible for most startups, so I won’t spend more time on it here.

3. Grants/Government Supports

When I came up with an idea for an ergonomic electric plug, I put my idea and plan into a coherent format and won €10,000 worth of “engineering vouchers” from Enterprise Ireland (a semi-state body that tries to promotes employment in Ireland). With these vouchers I could pay engineers to convert my ideas into rendered drawings and, ultimately, into 3D-printed prototypes. This enabled me to progress things far enough to entice investors’ interest.

Last time I looked, Horizon2020 (Europe) was offering research grants of €50,000+ for innovative ideas. In the US, the Department of Defence will help fund the research of certain ideas as will the Department of Energy.

Check out the city, regional, governmental and enterprise supports & grants that could be available to research your idea and get it moving. If you’re like me, you’ll find that reading up on these grants and their conditions is a form of slow torture. But it’s worth setting aside a good chunk of time to do this properly. Again, it shows your tenacity and can make the difference between getting an idea started or doing nothing.

With bigger grants, you can look to get some help from people who advise on this for a living, but at the start of your journey in particular, I’d suggest that you do as much as possible of the grant application yourself and try to get most if not all of the fee you pay to advisers to be a success fee. Advisers will only work on projects they believe will succeed when a success fee is involved. If you pay them come what may, they’ll happily advise on any bad idea!

4. Equity

You can grow some businesses to significant scale without ever needing outside equity investment, but this is quite rare. It might happen with a service business that grows slowly over time; or perhaps with a software business where you or your partners invest a small amount of your own money and forego salaries for a time.

In some jurisdictions you can claim tax back paid on previous earnings if investing it into a new business that’s creating jobs. It’s worth investigating before seeking outside investment.

When it comes to finding investors, generally you have 5 potential sources:

1. Friends & family
2. Private investors unknown to you – you can look up networks of private investors near you
3. Government/state-related bodies – they’ll often invest alongside other investors
4. Venture capital – they’ll take their piece of flesh and tie you to stringent targets so don’t seek it out unless you really need it
5. Companies involved in your field – they can offer the most practical help, but be very careful not to limit your exit opportunities and therefore the final payout amount.

There’s a lot that could be written about the different types of investors, and I’ll do that in a future blog.

The trouble with taking in outside investment is that you inevitably lose control of some aspects of the business (you’ll probably need investors’ permission for certain actions, such as changing your target market or hiring a senior executive). And then comes the thorny issue of valuation. It’s very hard to value a new business so I always kicked the can down the road, offering investors convertible preference shares**.

Whether you’re getting into bed with outside investors or with one or two friendly partners, you’ll need a shareholders’ agreement and it’s important that you get good commercial legal advice on this. Everything seems rosy at the start, but it’s inevitable that you’ll face bumpy times and that some parties won’t fulfill everything the other party expected. There needs to be a clear and fair way to resolve these issues, and working that out from the outset can avoid arguments in the future.

This is a big area and I’ll talk about it more in the future.

5. Debt

Taking out debt at this stage rarely makes no sense, so I’m not going to spend any time on it here. There are of course certain businesses that are asset-intensive where debt can come into play from the outset (e.g. property businesses, certain manufacturing or energy businesses), but if you’re in one of those lines of business, it’s likely you know a lot about raising debt already.

Prepare to Win the War

War is an unfortunate analogy for launching a new business, but I’m a fan of Sun Tzu, and however optimistically you start off on the entrepreneurial journey, you will face a series of obstacles, some of which could derail your business entirely. Understanding the resources at your disposal and knowing how best to employ them will give you the best chance of success. This applies 100% to funding your business.

They say that luck happens when opportunity meets preparation. So, yes, you must have heart, you must have passion, but also, to borrow a scouting motto, Be Prepared!

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** Convertible preference shares give the investor comfort that in a worst-case scenario the entrepreneur’s shares will be worth zero until the investor receives their money back plus a return. It’s a way to put your money where your mouth is when you think the business is worth a lot – and will be worth more in the future – while the investor is full of scepticism. Put simply, the convertibles convert at a discount to a future valuation achieved through a future fundraising or exit. Without getting too technical, I always offered convertibles where the discount grew over time (e.g. Yr1 15%; Yr2 30% etc). and there was a set valuation which would never be exceeded by the converting investors.

This enables (i) the valuation conversation to wait till a time when the valuation is clearer (and greater), (ii) the investor to get somewhat protected in scenarios where the business doesn’t go as well as expected, and (iii) the investor to still participate in lots of the upside if the company does very well (but less so than if they’d had ordinary shares from the time they first invested).

© Alan Healy