Lean times call for creative ways to find your startup money.
By Christine Bockelman
It’s a tough time to be a startup. Although traditional sources of funding do remain, it’s not like the heady days of 2000 and 2001, when there was money for the taking. Banks, for example, are still coming out of the mortgage crisis and facing new capital reserve and other regulations. And family and friends, once a first stop for anyone looking to raise money, are reeling from post-recession economic issues of their own.
Of course, there are some high-profile startups like Facebook and LinkedIn that raised a lot of money just fine. But don’t be fooled—these are the exceptions.
Which brings us to the question, how can startups raise capital these days? The answer is anything but straightforward.
At the top of the list there are angels—wealthy individuals who invest their personal funds (typically in the $10,000 to $15,000 range) into a startup company, and effectively fill the gap between the family/friend investment and the big money that comes from venture capital firms.
If that’s not enough private capital, in the sexy world of tech companies, home to Foursquare, Twitter and Pinterest, capital often comes from “Super Angels,” who typically invest in the region of $500,000 or more.
“Super Angels get involved from the very, very beginning,” says David Diamond, a CPA and managing director at CBIZ. “They will do things like rent out or take over a couple of floors in a building and make them an incubator for startups. They’ll bring in a few, help fund them, help them with their business plans, and if that goes well, bring in more money for the startup.”
Super Angels carefully evaluate sound business models and don’t like to take big risks. They want to nurture and mentor a company, not aggressively push it towards growth in order to get a return on their investment. Typically, Super Angels aren’t “flipping” their investment, to borrow a term from the real estate world.
Another way to raise capital, of course, is to jump into the venture capital pool. It’s a tried-and-true way of injecting big chunks of money into a growing company. However, there are some indications that venture capital firms are being evermore cautious about where they put their money.
“It’s a lot harder to get money from venture capitalists today,” says Diamond. “The public markets have crashed, and venture capital has been putting money into companies that aren’t being sold. They’re called the ‘living dead.’ In other words, some venture capitalists can’t get money out of companies they’ve invested in, and therefore have less money to invest.”
If you’re too small for angel investors or venture capital firms, read up on the Jumpstart Our Business Startups (JOBS) Act.
Signed into law by President Obama in April 2012, the Act is designed to give new funding options to small businesses, especially those outside Silicon Valley and other established angel investor and venture capital hotspots.
In essence, the Act loosens up some securities requirements and increases the number of shareholders a company is allowed to have before going public. Through the Act, companies can raise capital by selling unregistered securities worth up to $1 million in a 12-month period. This is known as “crowdfunding.”
Crowdfunding basically allows the general public to invest money, often a small amount like $25, in a business. It’s not an entirely new concept. Internet companies like Kickstarter.com, which helps to fund projects like a Masala Food Cart based in Missoula, Mont., have been using it for a long time. But the JOBS Act marks the first time these investors will get actual equity in exchange for their money, as opposed to getting a free curry dinner for two people after giving $25 to a project, for example.
Not every business can take advantage of crowdfunding, though. Only emerging growth companies are eligible to participate in the JOBS Act. These are defined as companies having an annual revenue of less than $1 billion during their most recently completed fiscal year. They also must have an IPO after December 8, 2011.
Evanston, Ill.-based ImpactTrader.com, co-founded by John Jordan, has a social enterprise bent and a business plan based entirely on crowdfunding. It plans to sell investors small ownership shares in social and environmental improvement projects around the world.
“We will basically be doing IPOs on a very small scale over and over and over, which would rack up millions of dollars in SEC fees in the current system,” Jordan explains. “The JOBS Act allows us to provide affordable financing for projects that don’t offer profits that would appeal to traditional investors.”
It sounds great, but there are some pretty big concerns surrounding crowdfunding. First, it’s never been done, so there are lots of regulatory, accounting and other issues to work out. Second, there are limits on how much can be invested by any one person.
“Do it cautiously,” Diamond advises. “Hire an attorney who knows a lot about this, because chances are it’s going to get complicated.”
Taking a more creative approach to the search for funding, “I’ve had a lot of clients get money from the government,” says Diamond. Specifically, the Small Business Innovation Research (SBIR) program, which has been around since 1982, awards funds to small, domestic research and research and development businesses.
Another option is to take a company public through a reverse merger. This involves finding a clean, public shell company and merging into it. “This is happening a lot now,” Diamond explains. “It gets a bad rap because of unethical people, but we’ve done this three times in San Diego in the last year.”
Although not a strategy suitable for every company, many countries have economic development agencies that will give you money to set up in their local towns and cities. “This is what [bio-tech] Invitrogen did,” says Diamond. “They kept their headquarters in the United States, but set up a sales office in Holland. They hired a bunch of people, used the economic development money very judiciously and are a huge company now.”
And there are licensing options as well. “This doesn’t happen a lot,” says Diamond, “but sometimes people will be happy with whatever they can sell in the United States and just want the licensing money to grow and develop the product.”
It’s a reality of today’s marketplace that funding is hard to find. Whether the tried-and-true traditional route, or a new, more creative approach, where there’s a will, there’s definitely a way.