Raising funds for a business concept is a tough issue, because the risks are much greater when investing in an "idea" that is not yet a working company. Numerous things can change the risk exposure of an up-and-running business, so capital for development of a business "concept" becomes even more risky given the lack of validation of the business model as viable in that particular market space.
It's important to do a quick review of the stages in a company's life cycle and understand the use of funds for each stage. (These are covered in detail in my archived column, "What Stage Are You In?") In short, there are four stages: the pre-launch, the launch, the ramp-up and the viability stages. Questions pertaining to the pre-launch cover two unique sub-phases. On the one hand, your interest in raising money could be to allow you to do some "concept feasibility" work. You would be working with prototypes and working models or various versions of the product or service to see if you can get one to actually do what it's supposed to do. You might also be asking for funding so you can do a "market test" among your marketing prospects involving surveys, focus groups and field tests of beta versions.
It's during the concept period that research and development happens for a brand-new product or service to determine all aspects of the ultimate manufacturing, distribution and support processes. Funds invested here have very little substantive expectations because no one can be sure if the feasible solution can be put together and the kinks worked out in a satisfactory manner. And funds used to do market testing are also risky because, while trying to determine price points, potential sales volume and viable buying patterns of targeted customers, results could be very negative and point toward a lack of support for your idea/concept in the industry.
Here are some basic rules to follow when trying to find capital for the pre-launch. First, by definition, you are dealing with higher risk for the investor and lender, because this activity could end without any plan on how to proceed further and actually open for business. So be reasonable in your expectations on the potential investors. If they don't immediately show enthusiasm for your plan, be open to working with them on identifying what kinds of things you could tangibly do to help alleviate some of their risk concerns.
Second, money used for "getting ready" will almost certainly be tied to the likelihood that there will in fact be a business doing business after all the testing and R&D is finished. Investors will want to have a significant stake in that enterprise that follows, because they recognize that without their money now, there can never be a company later. But remember that you have the idea and expertise to make the concept a reality, and that counts for something, too. When deciding on percentage stakes in the ultimate firm, keep in mind that you are very much a mutual company where, almost equally, the money needs the idea and the idea needs the money.
Finally, you'll need to clearly demonstrate an expected path from pre-launch to the launch; otherwise, investors will view their funds as going down a black hole never to be seen again. Product testing, lab research, surveys collected and focus groups polled could all result in no forward momentum. Outline strategic vision at each stage, and show the benchmarks that will define success or failure at each critical juncture. Get agreement that "if we do this and this and that, then we will proceed to do these nest steps."
What complicates this type of funding is that during this pre-launch stage, there is no revenue coming in--only development costs going out. My advice can be summarized in this idea: Would you provide funds for your idea in its current state? If the answer is no, then what things do you need to tighten up before you ask real investors? If the answer is yes, get two or three other people to provide an objective opinion as to whether you're ready to ask for money. If a clear path to a launch date and eventual sales is evident, then there are investors who will provide funding to do these pre-launch activities.
David Newton is a professor of entrepreneurial finance and head of the entrepreneurship program, which he founded in 1990, at Westmont College in Santa Barbara, California. The author of four books on both entrepreneurship and finance investments, David was formerly a contributing editor on growth capital for Industry Week Growing Companies magazine and has contributed to such publications as Entrepreneur, Your Money, Success, Red Herring, Business Week, Inc. and Solutions. He's also consulted to nearly 100 emerging, fast-growth entrepreneurial ventures since 1984.
The opinions expressed in this column are those of the author, not of Entrepreneur.com. All answers are intended to be general in nature, without regard to specific geographical areas or circumstances, and should only be relied upon after consulting an appropriate expert, such as an attorney or accountant.