Startup Capital for Investors

This story appears in the May 2004 issue of Startups. Subscribe »

Raising money has always been a problem for inventors, whether they need funds for a patent, for a prototype, or for production. You need more money than ever to cover the high costs of production and to get into the market with as much momentum as possible. But inventors have an easier time raising money because of manufacturers and marketers' willingness to help fund new projects, and because of new security rules established by the SEC. Inventors can also benefit from community-based funding that rural areas offer to entice business. Of course, all this doesn't mean raising money is easy. You need a good plan, a good product and support from potential customers. If you have these, you'll find that money is available.

That said, don't rush to quit your job. Many inventors use credit cards or personal loans to fund at least the first phase of their inventions, and these loans will be hard to get if you are self-employed with no income. Instead, apply for your loans or credit cards before you quit. You don't want to take on so much debt that you'll go bankrupt, but it helps to have an extra $5,000 to $10,000 in credit. Also, try to keep working for as long as possible to maintain your income until you begin making sales.

Now's a good time to take a close look at your business experience. You aren't going to get money from serious investors unless you have someone on your team with experience in running a company or launching a product. If you don't have that experience, get a mentor or a business partner who can give your venture the business background it needs to succeed.

Early Stages

The money you spend early on will help finalize your idea through the prototype stage. It will also let you make initial contacts with industry insiders. Here's a rundown of typical costs:

1. Initial seed money: $100 to $1,000. This money-self-funded through credit cards, savings or the sale of personal property-is used for a patent search, initial market analysis and verification of your premise. You might also want to attend a trade show to check out products and interview industry people.

This will give you a better understanding of your idea's market potential. Prepare a presentation on why your invention will sell. You'll need it to get funds from family, friends and industry investors.

2. Feeling out the market: $200 to $2,000. Attend trade shows and association meetings to start networking and learning about competitors. You'll use the presentation developed with seed money to explain your product to industry contacts and potential investors. After this period, you should have a better presentation, and you should make a sample brochure. You may need a concept model for the brochure.

Even if you don't need the money, this is a good time to start adding investors because you only need to ask them for small amounts. You could ask for $500 from each of three investors to prepare a concept model and a sample brochure, and visit two trade shows. Your goal is to line up industry contacts as early investors you can rely on during your invention process. You may want to apply for a provisional patent before attending the show so you can say your product is patent pending.

3. Models, prototypes and patents: $500 to $20,000, depending on your patent strategy and the complexity of the prototype. Once you have solid information that your product has true market potential, you need to make a high-quality prototype and implement your patent strategy. Now, your goal is to prepare a product, a brochure and an ad package you can use to conduct the research you need to land a private-label, joint-venture or license agreement. Consider your patent strategy carefully, since you're about to research your idea in the market with end users.

Now's the time to get industry investors and contract manufacturers involved. That's because they only have to invest a small amount now; later, you'll want more money, and the easiest investments to get are ones from people who have already invested. You can also self-fund this stage and get money from family and friends, but those aren't your best investor options.

4. Research results: $300 to $6,000, depending on how close you are to the trade shows and key industry meetings. You have a product, a brochure and an ad. Now you need to interview end users and people in the distribution channel to see what they think. Attend trade shows and association meetings to meet as many industry people as you can to talk about your idea. Some inventors take out a booth at industry trade shows to gauge customer response.

Your goal is to prove your product can sell so you can get investors, companies and industry insiders to help fund preparations for production. That step is expensive, and you'll need investors-probably lots of them. Try to get as many potential investors as possible to attend research events or trade shows. They're more likely to invest if they see end users get excited about the product.

Preparing for Production

The work involved in preparing your product for production can seem intimidating and expensive, but breaking it up step by step will help you get a handle on the process. Here's a look at the steps and costs involved:

1. Finalizing the presentation: $1,500 to $4,000, depending on how many presentations you make and how far you must travel. If you hope to get a private-label contract or a joint-venture agreement, you'll need a prototype, an impressive demonstration and research that shows your product can sell. For this step, you need to prepare a presentation to show to interested parties.

Your best investor here is an industry insider. Having an industry insider on board implies that the product has strong sales potential. If you are proposing private-label sales, your contract manufacturer may also be willing to help fund this step.

2. Finalizing documentation: $10,000 to $200,000, depending on the complexity of the product and whether you've hired salespeople to help presell the product. At this stage, you do the engineering documentation, prepare preproduction models and presell the product to people in the distribution channel. This step is necessary but difficult to get money for because it doesn't do any more to prove the product's sales potential. All you're doing is getting things ready so they can be manufactured correctly. Your contract manufacturer may pick up the costs if you've done a good job researching the market and networking with contacts.

3. Finalizing the marketing plan: $1,000 to $5,000, depending on the extent of the plan and how much help you need to finish it. Here, you prepare a marketing plan for building sales momentum by preselling and quickly penetrating the market once production starts. You write the plan to be sure you are doing all you can to presell and market the product, as well as to create the basis for a business plan, which you may need to get investments to start production.

Use your industry contacts to write the plan. Try to get the help of a large potential industry investor. He or she will have great ideas, and helping write the plan will help persuade him or her to invest in your company.

Introducing Your Product

You will have come a long way by the time you hit this stage. Luckily, you'll be ready for the next few steps. It will cost a lot, but the money you need can be found from many sources, such as:

• Private placements: You hire a broker to sell stock. It's similar to a public offering, except that the stock from a private placement isn't listed on an exchange where it can be readily traded.

• Venture capitalists: These firms invest at least $1 million in companies with high growth potential, experienced management and a sound business plan.

• Angel investors: Angels can be anyone-your neighbor, people at church or local philanthropists. They're nonprofessional investors who invest to help you get started, though they usually won't know much about your business and rarely want any involvement.

• Joint-venture financing: You get this from companies that help you manufacture or market your product.

These are just a few examples of the many available funding sources. However you decide to raise money, you'll most likely be spending it on:

1. Manufacturing startup: $5,000 to $1 million or more for tooling, inventory, packaging and all the other materials and equipment needed to manufacture the product. You need lots of money, and you won't get it unless you have proven the product will sell.

2. Marketing introduction: $5,000 to $500,000 or more, depending on the size of your market. Your expenses include trade shows, advertising and distribution programs; hiring and training manufacturers, sales reps and inside salespeople; and creating a Web site. Don't skimp on your marketing plan, especially if you need lots of money to make your product. Investors will want a big return, and fast. You want a marketing plan that will produce quick sales to jump-start the product.

3. Setting up company operations: $20,000 to $500,000. This includes operating capital, buying computers, hiring an accountant and paying legal fees.

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Don Debelakis author of Entrepreneur's Start-Up Guide #1813, Bringing Your Product to Market.