THERE’S NO FREE LUNCH!
ALL MONEY HAS STRINGS ATTACHED
Financing Your Start-Up Business
Debunking the Myth of “Free” Grants
[I met Fred Patterson at the National Association of Seed and Venture Funds conference in Oklahoma City last year. He’s back with another rock solid article on business financing. You can also download a PDF of this article, courtesy of Fred.]
By Fred PattersonIt’s the Urban Myth that won’t stay debunked. The Government will give you “free” money to start your business. It’s easy to get! All you have to do is ask them for it! Don’t know where to apply? Buy my book and find out! Only $69.95!
Uh-huh. Sure. That “Free Lunch” you’re looking for? Guess what? It’ll cost you $69.95 (plus shipping and handling)! There is no free lunch, folks. NO ONE is going to give you money without expecting something in return. It’s called the “WIIFM” factor. What’s In It For Me? There’s always a WIIFM. And all WIIFMs come with strings attached.
But there are different kinds of strings. And, guess what? If you can satisfy the WIIFM and are willing to manage the expectations of the string holders, money is available. It’s just never free, and never without those strings.
For perspective, let’s classify the different ways a business can be financed, after the owner has exhausted all personal funds, and bootstrapping (using generated revenues to finance all costs) is premature or insufficient:
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Type of Financing
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From Whom
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WIIFM
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Expectations
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Amateur
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The 3Fs: Family, Friends and Fools
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To support you personally
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Don’t squander the money and embarrass them
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Grant
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Government Agency or Foundation
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Support their Mission by helping solve a problem
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Perform and report your best efforts
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Debt
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Banks (may be SBA guaranteed)
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The Interest you pay them
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Keep current on debt servicing or forfeit your collateral
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Equity
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Angels or Venture Capital Investors
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Build wealth via a significant return on their investment (ROI)
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Take their advice whenever offered and provide that ROI
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Amateur financing strings are the easiest to manage, but can get tangled in a knot you’ll never untie if you’re not careful! All your “3F Investor” wants is to be proud of you. They also can be the most devastatingly impactful on your psyche if things go in directions they don’t approve of. Accept this money carefully.
Debt financing requires putting up collateral equal in value to the money provided, and having the ability to service the debt by making regular payments of principal and interest. It’s unlikely a start-up business (which is usually pre-revenue) can qualify for or want to incur debt! The SBA has been making big headlines recently by making more money available to small businesses by relaxing the qualifying criteria for their loan guarantees to the banks making the loans. This doesn’t help most start-up businesses, however. SBA loans are for established small businesses which can provide evidence of being able to service the debt. Definite strings here, as there’s ALWAYS collateral involved.
Equity financing rarely applies to start-ups. The equity investor is looking for a significant return on investment in a reasonable period of time. According to the SBA, fewer than half of small start-up businesses make it past five years. This means getting an Angel (invests their own money) or a VC (invests someone else’s money) to invest in you is convincing them that you’re a safe bet to not only survive, but that you’re very likely to make LOTS of money. Not only that but they’ll want you to either go public or be sold in some reasonable time frame. Why? Because their equity investment is in your private company’s stock, which is not convertible to cash without doing that! Remember, their WIIFM is to build wealth, not collect paper stock certificates.
Grants for small business
Which brings us back to those “free money” Grants. There are actually some Grants available for start-up businesses, but they’re not really free, and the money is not without strings.
The ONLY grants available for starting a business at the Federal level are those of the Small Business Innovation Research (SBIR) program. The WIIFM of the Federal Agency providing the money is that you solve a technology problem in an area that they identify which is pertinent to their Research and Development mission. Then they get “use rights” or a “royalty-free license” to what you develop. SBIR is intensely competitive, with only approximately 10% of the applications being funded. If you’re selected, you can get over $1M for these projects (over 2-3 years). You’re audited on how you spend the money, so it’s not, by any means, “free”. And they may require you to publish the results and share in the title to any patents you may file. Lots of strings. But the SBIR strings are manageable (with special protections for your ownership rights), as there’s no debt to service, and they don’t own a piece of you as would an equity investor. This small business program is not small potatoes, as close to $2.5 billion of projects are funded annually by eleven major Federal Agencies.
States sometimes get grants from the Federal government to use for economic development programs. Sometimes the States make this money available, in turn, as grants to local businesses or economic development agencies to satisfy their social and economic initiatives. Watch out for the strings, however, as sometimes these are really convertible debt or equity arrangements disguised as grants. If you don’t create the necessary number of jobs, or meet other milestones for (taxable) revenues or future outside investment, you may find you have to give the money back! Do some Google searching and contact your State’s Economic Development Agency to find out what might be available in your State or local community.
Foundations do sometimes provide grants to small businesses, but only when you can directly address their reason for existing with some benefit worthy of being publicized. Their main activity is usually fundraising to support their mission, and if your business can be “revenue positive” (the amount of money they can attract by having you involved is more than they’ll give you) then this type of grant is possible. Pick your Foundation Investor wisely, as these relationships may be public and controversial, and can be somewhat fragile.
Conclusions
So, let’s summarize. Financing your start-up business will not be easy. The high failure rate of small start-up businesses makes it risky for any investor.
Equity investors may take a chance on a proven entrepreneur who has a pre-revenue business idea, but they’re generally risk averse for anything other than a scalable big-marketplace sure-bet business model that can produce an exit with high ROI in a short timeframe. Not usually an option for early-stage start-ups. There is an organization that focuses on the problems of equity funding for start-up ventures: The National Association of Seed and Venture Funds (NASVF – http://nasvf.org).
Debt financing means putting at risk personal property that the bank really doesn’t want to own. They’re also risk averse, and may be very difficult to sign up, even if you’re willing to service the debt. Rarely an option for a start-up. However, once revenues are coming in, receivables line of credit options become available, as the customer invoice becomes the collateral. The SBA’s various loan guarantee programs become viable once the company is established and generating revenues. For information on these, see: http://www.sba.gov/financialassistance/borrowers/guaranteed/.
Grant financing is a very attractive option for technology companies who can respond to a Government need. For information on the Federal SBIR program, see the SBA’s official SBIR website at http://www.sba.gov/aboutsba/sbaprograms/sbir/. And find out what projects the Agencies are looking to fund today and in the near future at The SBIR Gateway (http://www.SBIRgateway.com). For State level grants, a website that does provide some information about this is http://usgovinfo.about.com/od/smallbusiness/a/stategrants.htm.
As difficult to accept as it might be, for many new business start-ups, Amateur financing is their only option. As Walter Cronkite used to say, “That’s the way it is.” But, for many businesses, that’s all that might be needed before revenues can be generated, and the business can be bootstrapped. There’s even a Bootstrapper’s Network (http://www.bootstrapnetwork.com) with information and resources to help you deal with issues in staying afloat without accepting outside funding.
So beware of offers to lead you to “Free Money” for starting a business, especially for a fee. Don’t be taken in by hucksters. There is no free lunch.
And watch out for the strings no matter what financing you take. Always be aware of the WIIFMs, and manage those expectations.
Come to think of it, satisfying WIIFMs and managing expectations is what Customer Service is all about too, but that’s another article!
As President of The Commercialization Funding Coach, Inc. (www.CFcoach.com), and known nationally as The SBIR Coach®, Fred Patterson has been coaching entrepreneurs and their companies with heralded success for over 25 years. Using his proprietary Funding Readiness Level (FRL)®, Fred prepares them for the process of finding and securing funding for growth.
Photo provided by Fred Patterson.
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Financing always causes business owners angst. If you need financing for your business, it is definitely worth a visit to your local Score office. They can help you put together materials that will give you the best chance with potential sources of financing. They really helped us.
ALWAYS avoid these three: FFF – I’ve never tried it, and I wouldn’t even think of it.
Wayne
Wayne, borrowing from friends and family is difficult, even for the most savvy business people. Always lots of potential trouble there.