Raising Money For Your Venture is Easy

Introduction

This post is about raising money for your idea or venture. When I first started working in startups in late 1990’s, I was very enamored with the idea of raising outside venture funding. But as I participated in a number of venture backed companies, including my own, I began to question some of the prevailing wisdom at the time. And to this day I am very biased about this. My advice- VCs and Angel investors are dish best served at dessert, after you have everything else done (prototyping, product in the marketplace, paying customers, profits or growing numbers of users).

The net net- raising money is probably the easiest part of starting a company. Managing the investors after you raise the money is the hard part. But further, there are many ways to raise money that don’t involve giving total strangers a dominating say in your company. I’ll talk about some of them here and my specific experiences with different kind of venture investors and sources of funding. I'm not the authority here but I avoid arguments based on exception and focus on what gives YOU the best chance of success to hold on to your idea and control of your company.

Keep in mind that fund raising is intrinsically coupled to the market strategy for your idea. Slow incremental growth will minimize to some degree the cash requirements but dismay venture investors. If the product you are selling is profitable from the start, like my company Tailwater Systems, then you can easily finance the growth of the company without resorting to equity investors. Equity investors will attempt to take a controlling interest in your company right from the start. Selling debt or borrowing money will bring others such as banks or the Small Business Administration into your company. But in general these debt investors won’t have any say over the decisions internal to the company.

The Main Idea

Raising Money is Easy- how you manage that money is the hard part

Raising Money Without Equity Investors

The introduction to this post states it pretty clearly- better to proceed organically than bring in equity investors too soon. So what are the sources of non-equity and sometimes non-debt funding? First on the list should be potential suppliers and customers. Some of the remaining sources, in no particular order of preference are:

a. Research grants from State or Federal Sources such as the SBIR and STTR programs

b. Friends and family

c. Research grants from Industry associations seeking pre-competitive innovative solutions

In this post we will focus on the primary source of early stage funding- your potential customers and suppliers.

Write Down the Goals for your Company

Lets start with your goals- have you written down your goals for this new company? If you are engaging in this venture as a tax write off then this is probably not for you. If you are interested in providing value to customers, then read-on. If you are interested in making stuff that people want to use in their business or everyday life, then you really are in the right place.

In this post we are not talking about millions of dollars in net worth or your inheritance. We are talking about starting and growing a business that can create value for you and your team. As a senior, this business could provide you with extra income that your corporate retirement does not allow. In my case, our frequent moves and change of companies really hurt our family’s ability to build up a retirement nest egg.

You raise outside funds for your idea when you can’t fund it yourself or through your customers. You may react with a “well, duh” at this. But it gets immediately to the heart of the problem of how and why you should try to create a new company from your idea. If you’ve been through the vetting process on your idea and still feel the idea has commercial potential, the next step is not to raise money but think about how much cash the venture might need for the next 3-5 years and how you will fund it and use it. Faster growth means more cash requirements. Think you need to go “big” and grab all the real estate before someone else does? Then think venture investors. Want to self fund and grow more slowly and deliberately? Then your cash demands go down and you should be able to make more deliberate decisions, measure the outcomes yourself, and adjust as necessary. But you also run the risk of enabling potential competitors plenty of time to examine your weaknesses and enter the market against you. There is no guarantee you will succeed but growing your firm carefully at first can put you in a stronger position to make better, more thoroughly thought-out decisions about products and customers.

So perhaps you should get a nice glass of bourbon, sit back, and think about how you can get to proof of concept or a “functional prototype” with the least amount of cash and risk. I met people in the Internet crazy days of 1999 that pulled all the money out of their family’s 401 account to fund their venture. They were so sure that they had nailed down the product and Internet business models were red hot. Countless numbers of these ventures did not succeed, the family lost its savings, the company disappeared, and divorce usually followed.

One key topic you must thinking about during your bourbon time is the exit strategy. Do you plan to run your new company till you retire? Try to sell it at the ideal market time? Turn it over to your children? I would encourage you to write down the conditions that could lead to a sale and those that would keep you or your family firmly in control. I worked for a small very and profitable manufacturing firm in Oregon as VP of manufacturing. While I was there, the founder and 100% owner was fully in control of all aspects of the company. No detail was too small for his scrutiny. He was a bit older than me. But when he was diagnosed with cancer, I asked him if he had a transition plan in place. He basically stated that he was going to run the company until he passed and he did plan to die anytime soon. I was dismayed by his answer because many of the employees had been there for years. What about them? I left in 2009 for my Ph.D. program and lost track of them. Later, I was contacted by one of the top manufacturing people at the company. I was informed that the founder had died a few years later, leaving his spouse to run the firm, but most of best employees had quit. As a senior, running a company, you must be pragmatic- have a plan in place to continue the firm and take care of your employees and customers.

Lets say your exit strategy is to sell to larger firm in your industry. This is probably the best way for you to take care of the employees and your customers. Following this strategy can also lead to a very effective fund raising strategy. For example, lets say that your former employers are still struggling with an unsolved problem. These larger firms can help you out in two ways: they can fund your prototyping without any equity requirements and they can buy the products if they meet the customer’s needs (more on this topic later). But two concepts are really important to understand why this is a good idea, before you make this commitment- adsorptive capacity and real options. Remember, we are still drinking bourbon at this stage- we are essentially figuring out how we plan to play the game.

Key Concept - Adsorptive Capacity

This term was taken by the business organizational science crowd from the field of environmental science. In business we use this term to identify larger firms that have the ability and infrastructure to work with small firms, without crushing them with contracts and demands for all kinds of data and reports. One industry you should probably avoid- the automotive sector This industry has historically (maybe this might be changing with the advent of EV’s) been very averse to working with small firms. But under the right conditions and with the write corporate people involved, it can be possible. My Ph.D. dissertation addressed this exact problem, under the guidance of my dissertation chair. Lets just agree that there are much softer and less cynical potential partners to cultivate.

Adsorptive capacity is a qualitative measure of how well a firm can integrate outside ideas, technology, and new capabilities. On one end is the not-invented-here ( NIH) syndrome- we only work with people and ideas from inside the firm. On the other extreme are those that routinely practice something called open innovation (#openinnovation). You can learn about open innovation from any of the wonderful books on the topic. Firms that rank high in adsorptive capacity understand that startups are not “mini-IBMs”. The person that writes the checks in the startup may also be the chief accountant, head of product development, and perhaps even the chief sales person. The lack of infrastructure and formally documented processes can make most larger firms pull away. Firms that are good at working with startups usually assign a “shepherd”- someone that has the trust of the senior management and can buffer the small firm from the demands of the larger firm and brings resources from the larger firm to the smaller firm as required. You might argue that this is what a board of directors is for. Wrong. Many board members of early stage companies simply have no idea of how to help you other than to lend their name and maybe a bit of money to your effort.

What about consultants? This term spans a lot of different jobs and people. Business consultants, as defined by one of my best friends, are and I quote:” know 100 ways to make love to a woman, but don’t know any women”. Sorry if this sounds a bit hetero-normative. I don’t know how to translate stuff that makes me laugh into gender neutral terms. I have hired all kinds of consultants in my career and been hired as one, a few times. But these folks can be very expensive to work with and there is always the issue of moral hazard[1]. You will be left paying their bill and explaining why their advice was not useful. But there are select consultants that are immensely valuable-its just hard to identify them at a distance or simply by reading platitudes on websites.

While working for one small firm, we were contacted by a technology scout, a type of consultant. This person spoke fluent Japanese, had worked with the Japanese for years, and was well respected and trusted by his Japanese clients (all large industrial firms). He was interested in our humidity sensor and wanted to get some of the products tested. We were very short handed so I told the scout that if his client would manufacture some PC boards for us, we could get them products in about 1/4th the time. Well, fully functional PCBs arrived from Japan via FEDEX within a week. And they worked perfectly. This saved me and my team about $10,000. This Japanese firm was very good at working with American startups as they used their “scout” to advise the startups on how to work with the Japanese.

Key Concept- Real Options[2]

Here’s a simple question: why would a large firm give your startup $75,000 just to see what happens? If your answer is- the large firm has dumb management, then you get an F and see me after class. Many engineering managers at large tech firms have discretionary budgets that can easily approach $1M a year. Lets say that your firm wanted to enter a new area of the pump market. Pulling 3 engineers off their current projects off their jobs to go build pump prototypes is going to cost you about 6 months of their time and lots of prototyping costs. At a fully burdened cost of $15,000/month, 18 man-months is at least $250,000, and you may get behind on the product development projects already being tracked inside your firm.

Well if a startup has a prototype that seems to do a majority of what you need, then pay them $75,000 for the “option” to have a look, verify that the startup can really delivery the prototype, and then put in some additional contractual arrangements to insure the large firm can get first rights of refusal or perhaps the ability to purchase the first year or two of production. Many other contingent arrangements could be established. But as the owner of the startup, you just raised $75,000 to build something you were probably already going to build. The big company engineering manager may decide to develop a contract with you. He wins big time as he might get the firm into the new market months or years early by working with a startup. Of course, if your prototype doesn’t work, you may have to downgrade your bourbon from Basil Hayden’s to Cutty Sark. I would not wish that on anyone, except a few politicians that come to mind.

We used this exact technique at #AirAdvice with a large potential customer to install 5 or 6 of our monitors in homes of their employees. They agreed to keep us informed of what was going on in the home that could affect the indoor air quality and we especially wanted to have the monitors in homes if the employees had has asthma or other pulmonary disease. We set it up, and shipped the monitors to the firm. Once they got the monitors, their first reaction was – boy these are really ugly! They were right. They were Radio Shack project boxes with stuff on the inside. They became known as the “butt ugly box” or BUB for short.

But, the BUBs worked really well, a bit too well unfortunately. Apparently one of the senior managers was suspicious that one of their teenagers was smoking weed on the second floor of the house while they were gone (we found this out much later). We were monitoring all the homes and we could immediately tell to the minute, if there were any combustion products in the air (fireplace, cooking, tobacco, weed- all very bad for asthmatics). We gave them daily reports and analysis of what was going on. Then one morning, our staff reported that one of the monitors was showing very high particulate loading in the 2nd floor of the house from the previous day. We sent the data and analysis to the manager and warned them about not smoking in the house anywhere near a family member with asthma. But we accidently busted their teenager. That monitor was promptly unplugged and moved to another location. C’est la vie.

Summary

Some of the lessons that I think might be gained from this very cursory analysis are:

• Planning for your venture must include how much cash you might need and where you are going to get this funding.

• New tech needs to be very aggressively vetted against the key criteria for market success. This means it must be done by a multi-disciplinary team- not the inventors.

• The market decides your success, not the “coolness” of the technology. But the market also defines the parameters or boundaries of where you need to operate.

• Know in advance- what the criteria is for launching a new product and have well established rule for engaging in an advanced technology commercialization.

• Have checkpoints, meetings, or key milestones to guide the release of supplemental funding- no carte blanche.

[1] Moral hazard in this context refers to people who give advice but are not affected by the outcome. There is a slightly different version in the economics literature. We’ll talk more about the economic moral hazard when negotiating contracts with a university or federal labs (failure to disclose known problems etc). [2] Learn a bit more about this from Dr. Rita McGrath at https://hbr.org/2008/03/a-new-approach-to-innovation-i