Funding Sources for Inventors

[Note: The below presentation will be delivered to precocious young inventors (under the age of 18) at 5 pm Pacific US time on Saturday, April 23, 2022 who will be gathered together on Zoom through a wonderful program called GIFT. GIFT welcomes clever children tinkerers as well as adult mentors, teachers, and funders. For more information, please see: www.globalinnovationfieldtrip.org]

You are talented inventors who have great inventions. You decide that you want additional money to make more products or to sell them or to create a company around them. Where can you secure financing? What do you have to do?

First, think of this analogy: As an inventor, you saw a hole in the market that you could fill with your creation, right? Your invention addresses an existing need or interest. An app. A gadget. A service. A process. Financiers see holes in the market, too. They are interested in companies and products that can fill those holes and make enough profit to repay them for their investment. They often specialize in certain industries or geographic locations. So as you approach sources for money, be attentive to THEIR interests. You will save time and be more successful in securing money if you contact people whose interests align with yours.

Let me outline three sources of money: (1) donors and grantors, (2) investors, and (3) bootstrapping.

Donors and grantors are people and organizations that have charitable orientations. This can also include government grants. A grant is money that supports you and your efforts without requiring a return of their money, as long as your efforts meet their requirements. For example, let’s say that you have designed an app to teach Spanish or Hindi. What sources of funds would be most interested in this? Well, you might approach people and organizations interested in education or languages or particular populations. If you have created a device that helps people with damaged legs, you could approach organizations that focus on healthcare, veterans, elderly, or physical disabilities. Review their websites or email or call to ask if they offer grants. If they do, you will fill out a long application. You may need a demo and prototype, testimonials of users, perhaps a video. You will need to spell out what you will do with money from them, within a period of time. This application process can take several months. To see if the effort is worthwhile, you might contact prior grantees (the people who received money) to learn of their experience with this grantor. They are usually listed on a grant page.

You may also identify organizations or individuals interested in your area of expertise who do not provide grants, but their industry knowledge can be very useful to you. Email and then call to schedule an appointment to speak with someone so you can demonstrate your invention. Many non-profits have someone called a Development Officer who writes grants and approaches donors to secure funds for their organization. They can lead you to others in your industry. Ask for referrals to entities that can provide funding. Also ask if the organization would consider beta testing your device or app. Even if they do not provide you with money, this testing is very valuable. Work with them to have lots of people try it out, give you feedback, write testimonials. These users may suggest that you tweak your invention a bit so it is easier to use or more effective. Collect all this information. At the end of that period, you may have not only a better product, but also the endorsement of a relevant organization and initial, paying clients! This will be impressive when you fill out a future grant or loan application. A second source of funding is from investors. Investors have a different interest. Theirs is to make MORE money by investing SOME money. So they scrutinize many options. If they share your interest in a certain market need, they may be looking at other inventions and companies in that space, too. They do a risk calculation. Which invention looks most likely to earn me money? Which invention is further developed? Which can be sold or licensed for more money than others? Do I know anyone to sell it to? There are basically two types of investment: debt and equity. Debt investment means a loan that you repay with interest. This works best for inventors who have cash flow. Let’s say that you are currently selling 10 widgets per month at a local store. It is very popular. People are asking for more. You estimate that if could get a loan, you could buy more parts, produce more product, and hire a sales person to visit other stores. You calculate that if you can sell 100 per month, these sales will generate enough profit to cover the cost of additional inventory, and the sales person, and the interest payment AND make more money for you to expand further. In such a case, a loan could be a good idea. Just make sure that you do the math first. If with the loan, you hire a bad sales person who cannot sell more than 100 or if you are unable to produce that many products, you will owe money to the lender that you already spent. Not good. Inventors who do not have cash flow can still secure loans with collateral. Collateral is when the inventor owns something of financial value that the investor can take if not repaid on time. For example, the loan amount might be the value of the inventor’s car or jewelry or home. You can see how taking loans requires you to be careful about being sure that you can pay them back on time. Equity investment is when the financiers become partners with you. Inventors or companies that lack cash flow may seek this sort of funding. In exchange for their money, you trade a portion of the company or of future revenues from the invention. In some contracts, they join you as decision makers in the future of the company or the invention. This can be wonderful if they have expertise you need, in, say, finance or sales or marketing. The term for such investors is often “smart money” because they understand what you are doing and how to help that business grow. You gain both money and a team with other resources. Early stage financiers who take a stake in unproven inventions and businesses take a financial risk. Therefore, to offset that risk, they often negotiate a larger portion of the company or future revenues than later stage financiers. Inventors and entrepreneurs often hate this. They are SO SURE that their idea will make money that they resent “giving up” part of the business to others who pay so that the business can go forward. However, look at this from the point of those with the money. They know that a high proportion of startup businesses fail. One investor may put money into 10 small companies, expecting 6 to fail, 2-3 to break even and 1-2 to make money. Without that infusion of early cash, none of those 10 companies could even try to move forward. So early money has value. There are many good, honest people willing to back inventors and small businesses with fair contracts, but there are also others who take advantage. Their target is naïve inventors and entrepreneurs who are so excited that someone offered them money that they do not check the details. If you are early in your career of dealing with financing, make sure of three things: 1) Get the commitment in writing. 2). Read the fine print. 3) Engage some dispassionate and knowledgeable person to review the contract before you sign it. What are the rights of you and the other party? What are your respective responsibilities? Is that what you understood in conversations and emails? The written, signed contract is final. A terrible contract might sneak in provisions that you cannot possibly meet. Two I saw required the companies to meet unrealistic revenue and growth targets within a short period of time in order to get the next cash infusion. If the entrepreneur failed, the financier got the whole company. These financiers are sometimes called “vulture investors.” Another trick is people who pose as investors but they charge you to deliver services before they will, supposedly, finance your business. They are fake. Be as attentive to the money as you are to the details of your invention. The third source of funds for growing your business is bootstrapping. This means that you generate the money yourself. You do not make interest payments to others; you do not share part of your company or revenues with them. Most inventors pursue this route until they have a track record of sales. After that, they have learned a great deal about business, have a better sense of the value of their invention/company, and can negotiate better terms with lenders and equity investors as well as customers. For many business people, whether children or adults, bootstrapping means earning money through some other endeavor, saving that money, and putting it into the invention or new business. This can take years. Let me give you my personal examples. I am not the clever inventor that you all are, but I am a serial entrepreneur. I started money making businesses in Junior High School, when I was 11 years old, saved money to apply to more lucrative businesses that I ran in High School and College. With early money from labor jobs, like cutting yards and shoveling snow, I decided to buy equipment I could own. I chose to buy snow cone and cotton candy machines and supplies to sell those sweets at community and church fairs in the spring/summer/fall. I scrutinized local papers for the dates, contacted the organizers, and split my profits with them. I saved that money. Later, when I could drive, I bought a snow plow to attach to an old truck. In the fall, I went door to door to secure contracts from neighbors to plow their driveways for a certain price every time the snow fell over a certain number of inches. I routinely walked into my 8 am high school math class with lots of money in my pocket after plowing for 4 hours. Now that I could drive, I decided to upgrade from my summer snow cone business. I had a truck. How could I use it? Chicago parking lots suffered from every freeze/ thaw seasonal change. I decided to address that problem. I took the profits from my prior businesses and bought equipment to start an asphalting business. In the fall, I measured cracked parking lots of restaurants and shops. In the winter, I sent out estimates to resurface them. By summer, I had a season of clients lined up to repave their parking lots. Because of the advance contracts, I could estimate how many people to hire. I looked so young that I actually hired a retired sergeant to meet the clients for me and to make sure that they paid. I ran this business through high school and college. In these ways, I bootstrapped several businesses. The money I made as a kid paid the down payment on my first house and started my stock portfolio. Later, I decided that I wanted to learn more about the financial side of business so I earned a MBA degree from Rice University so I could help other business people. As a serial entrepreneur, investment banker, and angel investor, I have enormous respect for inventors and entrepreneurs. All of you are creative and visionary. Those of you who are also practical about money will likely be successful.

Entrepreneurial Baseball: Winners and Losers

Laura Emerson

1100 words

Over the past 20+ years of working with entrepreneurs (and investors), we have worked with both do-ers and dreamers in more than 2 dozen industries.

I recently realized that baseball analogies describe the three personality types that we encounter most.

See if you recognize any entrepreneurs among them.

1) SINGLES: This group hits singles, regularly and reliably. Neither they nor their companies are flashy, but they get the work done, time after time. These companies tend to grow organically rather than with investors, often in traditional industries. These are the “Mom and Pop” businesses that grow vertically or geographically year by year.

2) SWING FOR THE FENCES The second group swings for the fences. They start companies in fast growing fields that may warrant high multiples because of scalability. IT, AI, life science are all “hot” categories. Most companies seeking investment are in this category. Some of these people do indeed hit occasional home runs, but they also generate more fouls and outs than the first group. As one point of reference, fewer than 20% of startups attract angel investment.

The people who tend to be successful at this often made home runs early and then try to repeat it. But this is not simple replication. There are so many variables. In a baseball game, the weather may change so the air is denser, or the ball field is different, or the player is under some physical or emotional strain. In business, the market may have changed, competition may have improved, or the early success for which the entrepreneur took credit was really the result of a team that is no longer working together.

The personality type that succeeds at swinging for fences is one that can weather the shifts between occasionally spectacular success and multiple failures. These are the people willing to accept “no, thanks” from scores of investors until one or two say yes. These entrepreneurs tweak their plans and businesses based on new information, seek out smart money, and surround themselves with experienced management and advisors. They keep their eye on the ball and on both their team and the competition to figure out when to steal a base and when to stay pat to win a game.

Those who are usually unsuccessful are those who have not had a home run in their history, or been recruited by the big leagues. Maybe they were good players in high school or the minor leagues and assume they have what it takes to join the majors. These entrepreneurs offer grossly inflated pre-money valuations and inadequate equity for investment, because they fail to acknowledge the risk reward calculus of a potential financier. They always underrate the competition. They may hire friends rather than people who can do the job needed. They may think, “I have worked for a big company for a long time for a salary. Now I will start my own firm to make big bucks. Surely on my own I can sell services or products to huge school districts or hospital systems or government departments.”

Another group that usually cannot hit the fence is one that did achieve business success in one industry but then pivots dramatically to another where the skill sets are very different. Not every ball player is good at playing piano! One example of this was a couple who ran a successful dry cleaning business and then sought investment to start a resort. Others jump into the new “hot” industry based on only ancillary experience there. We have encountered people who jumped on the bandwagons of cannabis, IT, educational software, financial services, life sciences, and even peony farming with limited experience other than smoking marijuana, going to school, visiting a bank or doctor, or flower arranging. Great athletes make their abilities look easy. Some people think they can jump on the field, and hit a 90 mph ball, too.

3) WHOLE NEW GAME

The third and final group does not even pick up a bat or glove. They may not even buy a ticket to someone else's game! Rather, these guys and gals want to invent a whole new game. They love talking (and talking and talking) about it, frequently describing themselves as a “thought leaders” or “visionaries.” Their concepts are always “game changers.” In all the cases we have encountered, their business ideas are very complex, requiring multiple steps, each of which must be executed perfectly for the game to even start, much less finish. They never have proof of concept to determine if people want to play or pay to watch. They do not put their own money on the line to hire players who can “hit singles” to “get on base.” Nor do they simplify or adjust their “game” in response to feedback. Is this sort of thinking a form of self sabotage? I think it may be, because in several cases, these “Visionaries” come back into our orbit years later with - you guessed it – another new “Vision.”

Over the years I have heard people wax poetic about multi-million and billion dollar international enterprises IF ONLY they had somebody else's money to start them. They want people to work for free based on enthusiasm for the dream. They are uninterested in beginning small, so of course they never launch at all. Others sketch out in great detail complicated org charts and pages of business plans about subsidiaries, partnerships, joint ventures, vertical integration. But – oops – they lack a functioning core business with which anyone can partner or integrate. In numerous cases, these “Game Changers” have not even incorporated their business, but they spend lots of time on brochures, websites, PowerPoint decks and other marketing materials.

When these dreamers attract no serious interest and no money, they invariably use phrases like they are “ahead of their time” or others “don't get it.” To them, the beauty of their vision is that it is complete and finished. They do not seem to perceive business as a process but view it like a perfect photo of a crowd cheering after a team wins the World Series.

Working with entrepreneurs is never boring. They are always interesting people. Over time, working with so many hundreds of them, we have developed an early sense of who has the talent, work ethic, and realistic business plan to be successful. But in my business, just as at the ball park, the thrill of the game is the element of surprise, like the underdog player who catches an impossible ball or the team interaction that results in a triple play.

Entrepreneurs Who Should Not Be

This article (by me) was originally syndicated in 36 city business journals but the essay below has been updated for you with some subsequent eye-openers.

If there isn’t a “Darwin Award”© for entrepreneurs, there should be, for people who would benefit business most by leaving it. I’d like to nominate the speakers of the following, eye-popping quotes in response to logical, due diligence questions. The responses may elicit “you must be pulling my leg” reactions; however, they are all true or abbreviated responses by entrepreneurs or their investment bankers. A single hour’s research per company uncovered most of the underlying issues. Following the quotes are several free and useful research websites and search tools by which investors can research entrepreneurs and by which entrepreneurs can research board members and service providers. If you tend to be trusting by nature, verify, too.

- “Litigation is just a cost of doing business,” said one CEO regarding more than five current suits, judgments and settlements I found against companies in which he was listed as a director or president, including, sadly, a “charity” of his not listed with the IRS.

- “He wasn’t a very involved director,” said a company president, regarding one of his directors, who was indicted for bribery and fraud as a director of another company.

- “I don’t think the IRS tax lien will really discourage investors. People will either love or not love our business.”

- “We don’t think of it as a conflict of interest. We think it is efficient that our major suppliers are also owned by members of our management team and Board of Directors.”

- “No; we don’t want an escrow account with an independent bank and a second signature before releasing investors’ money. Yes, we are raising money to start a bank.”

- “Those two corporate bankruptcies were not my fault,” said an entrepreneur seeking investment by showcasing his financial management skills. Unfortunately, the state and county also list five recent personal liens and judgments against him by businesses and taxing authorities.

- “I learned my lesson,” shared a serial entrepreneur, questioned about evidence that he had served time as a white collar felon for duping investors. “Different investors.”

- “Yes, there is another company with the same name that owns the IP we are describing in our documents as our company. That is because we want to raise money to buy them.”

- “I know that the money we want to raise now is not enough to fund the business model I have described. Our plan is to raise enough money from individuals to buy a public shell or go public, and then raise money from stock purchases to start the real business.”

- “Oh, I didn’t realize that another company’s website says to report anyone else trying to represent the product our client wants to raise money for, but he plans to sell it in Mexico, not here.”

- “That journalist hates me,” admits a president regarding an article in his hometown business paper that cited lawyers and investors suing him for a prior business deal very similar to one that company press releases were currently touting.

- “Yeah, we’re updating those filings now,” affirmed a CEO of a pink sheet company in 2006 (the most recent filings were from 2000). The company specializes in managing other companies.

- “I haven’t done anything in real estate development before, but I ran a very successful dry-cleaning business,” said a young and enthusiastic entrepreneur.

- “I don’t know why they are suing me. It was my dad’s store,” said a man charged with 65 counts of petty theft and 27 counts of forgery, hoping to find investors for a new business venture. These quotes prompt two questions: How many knuckleheads do these entrepreneurs and investment bankers think are out there? Are people really willing to write a five or six or seven digit check for a well told tale without a bit of research?

Each of these responses resulted from questions after research that took one to three hours per company, from publicly accessible documents, reading the Private Placement Memorandum (PPM), or just attending the investor presentation.

Most entrepreneurs like an audience, and if you ask the right questions, you’ll get an illuminating earful. Then hide your wallet until you hit the Internet.

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Below are extremely useful, free websites and Internet search tools that potential investors, investment bankers, and even employees can use to review a business prospect. Useful Search tools: Internet searches are harder for common personal names, company names with generic phrases like “Beautiful Flowers” and initials, like “ABC Corp.” Researchers would do well to try several combinations, such as name and city or name and industry.

Useful websites:

* www.sec.gov This site is for public companies. One can search for individuals who might be major stockholders or prior directors or managers, or if a company has been sanctioned, has changed names several times, or is a wholly owned subsidiary.

* www.irs.gov www.charitynavigator.org Anyone who donates money to a charity or religious organization should see if it is listed with the IRS as a 501C3, which allows for a tax credit. If the charity is not listed, why not?

* www.finra.com This website (See Broker Check section) lists every currently licensed individual and broker-dealer in a very easy, searchable system, which includes any disciplinary disclosures and prior employers, too. It also lists people who left the industry as long as ten years ago, perhaps under a cloud of sanctions, which are also listed. The website lists the code of ethics and rules regarding most types of investment sales by which all registered people are bound. People not listed here are not registered but call themselves financial service providers.

All three of the above websites have a “wall of shame” section, too.

* www.bbb.com Visitors can search for companies and charities affiliated with the BBB and for company complaints filed with the BBB, by city. This site is less useful for financial industry firms and more useful for companies that sell some kind of inventory or other service.

* www.yahoo.com/finance A number of websites, such as Edgar and Hoovers, require log-in and membership to access information more easily available, for free, through Yahoo. A visitor can search for press releases, and access public filings and stock price histories. Anyone who has served as an officer of a public company should be searchable.

* www.google.com The most highly used search engine is very user friendly. Searches reveal information about individuals as varied as book reviews they have written, blogs they have visited and political candidates and charities they have supported.

The websites of counties and states across the country vary widely in their web-readiness. Some have committed years and millions of dollars to filing documents electronically for the convenient access of the public. Texas and Alaska have very open records policies. California has stricter privacy policies.

http://www.cclerk.hctx.net On the Harris County Civil Court website, visitors can search for incorporated and DBA companies, for civil suit dockets according to plaintiff and defendant (and read the outcome) by company and individual names.

www.hcad.org On the Harris County Appraisal District website, visitors can search for property records, including ownership and tax payments. An investor might want to assess whether the entrepreneur owns property or is a flight risk if a deal goes sour. Similarly, an entrepreneur might want to determine if a potential investor owns or rents that mobile home or a mansion. In both cases, the inquirer can see if tax payments are current.

http://www.nasaa.org All states have a secretary of state website. Although the customer friendliness varies broadly, these are good sources for checking out any licensed professional, many incorporated companies, and other useful information about white collar crime prevention.

www.bizjournals.com This website enables visitors to search through city business journals from Albany to Wichita, which may have articles about an entrepreneur or investor active in that city.