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.
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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.