Beyond venture capital: 5 funding options for start-ups that might not have crossed your mind

America's Network, Dec 1, 2003 by Stephen M. Fredrick

In the recent past, start-up providers of telecom equipment and services enjoyed easy access to venture capital financing and a fast ride to IPO or M&A riches. No more.

Today, the early-stage front-end of the funding pipeline is under pressure because of significant reductions on the back end. IPOs, when they happen, are far fewer, and we see only a mere handful of acquisitions at reduced prices.

But all is not gloom and doom. There is probably more venture capital money on the sidelines than ever before. The problem is that much of it will go to later stage companies because many venture investors have shifted their focus away from pre-revenue, pre-product, "three-PhDs-in-a-garage" start-ups. A handful of early stage venture firms continue to fund great teams with nothing more than a great concept, but much of the industry now prefers to get involved at the commercialization/growth phase versus the early research and development stage (See Figure 1).

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(1) The challenge for today's entrepreneur is how to finance initial R&D activity to complete first product and secure those initial revenues, which then facilitates raising venture capital. For those proven teams fortunate enough to land outside funding at the concept stage, the challenge becomes one of complementing these equity dollars with additional resourceful funding to ensure that you reach customer-validating revenues without the need for more fundraising. There are several options.

BACK TO THE BASICS: BOOTSTRAPPING

While not necessarily true during the bubble years, it's no secret that starting a company today usually requires some financial sacrifice or personal funding. Bootstrapping is a common and venerable way of starting a business, and entrepreneurs should be prepared to weather the early start-up period with a reduced or non-existent income, and in most cases, a cash investment in the business. Make sure your family and personal finances are prepared for this. Sources for this initial funding include savings, credit cards, second mortgages, consulting work and customer advances.

Perhaps the best of all possible funding options is a customer who is willing to pay for R&D work. This type of contract engineering is a great means of starting a business. It not only provides much needed revenue, but it puts you on the front lines with customers to ensure exposure to the opportunities, which will guide your eventual product or service. The basic theme plays out as follows: A startup with a great solution to a problem finds a customer that needs the solution and convinces the customer to pay for development, while ideally retaining rights to the final product. The startup then builds the product, solves the problem, generates revenue, secures a customer reference, and maintain rights to as much of the work as possible to serve as the basis for a commercial product launch.

(2) Other bootstrapping tactics include obtaining prepaid licenses, royalties, or advances from customers, or developing products during off-hours while working elsewhere. Creative entrepreneurs might also obtain free access to development hardware and critical lab facilities--from a current employer, university or a well-placed friend--and thus defer capital equipment costs.

Angel investors continue to be a prime funding source for many startups. These high net worth individuals are often cashed-out entrepreneurs who actively invest in the industry they know best and provide the mentoring expertise of someone who has been there before.

INCUBATORS

Business incubators come in two flavors: assistance from an established company or past employer, and the more formal programs and facilities provided by states, counties and universities.

(3) In the second instance, government- or university-sponsored incubation programs offer reduced rent, furnished offices, access to lab facilities, equipment and communications infrastructure. For many infrastructure-dependent tech startups, acquiring facilities and equipment on a standalone basis otherwise would cost millions of dollars. Moreover, many state-run incubators also provide access to mentors, attorneys, accountants and university research faculty--which all serve to accelerate the company-building process and free the founders to focus on their technical pursuits rather than the logistics of office space and T1 lines.

UNCLE SAM

The federal government is arguably the nation's largest funding source for early stage R&D. Two programs in particular--the Small Business Innovation Research (SBIR) program and the Small Business Technology Transfer (STTR) program--award $1.6 billion annually through participating government agencies. These are often the ideal funding vehicles to validate a concept, prove that the science works and develop a prototype.

SBIR grants fund high-risk, early-stage research. Distinct advantages of the program are that SBIR funding allows researchers to retain ownership of intellectual property and lets companies establish a bid-advantaged sole source position with the world's largest customer--the U.S. government. Participants must be American-owned, independently operated, for-profit businesses with under 500 employees, and the principal researcher must be employed by the business.