Finance Anything: Startups, Greenfield or Growth Capital Formation

Sooner or later, anyone starting or growing a business will need to raise money to finance further development or prove that their venture or project can deliver value. Gaining access to such funding can be maker/breaker for any enterprise or project.  Cash to keep the doors open is like oxygen.

Timing is one of the keys — not waiting too long or attempting to raise outside capital too soon — as is securing the right amounts and forms of capital from the right sources.  The degree of fit depends on how long the funding relationship will likely last.  You might not need to see eye-to-eye or require a detailed understanding of their motives with a short-term bridge lender, but you certainly need to make sure there is mutual understanding, and hopefully vast common ground (shared values and vision) with a long-term equity partner.  Most capital providers will fall somewhere in between.

Here is a synopsis of proven strategies and structures, starting with the earliest stage, pre-seed (idea stage) funding, and ending with the later-stage pathways.  If you are still at the idea stage, start at the top of the list.  If seeking funding options for an established venture, skip down to the later-stage options.

Some of the pitfalls — things that can go wrong … serving as “cautionary tales” — and are included here to help guide wise decision making.  We all make mistakes … hopefully most of the bugs can be worked out before the stakes are high.  Otherwise, modeling more experienced professionals serves as a proxy, offering accelerated learning and more assured success.

1. Your own savings — leave any long-term retirement money where it is, and don’t tap your home equity unless you have no better option and are 110% sure you will see a return (slippery slope due to various psychological fallacies such as the fairly famous “confirmation bias”), but do consider using work-related or personal savings.  This is tied to your earning power, so in case you lose your investment, you can learn from the experience and replace your savings in time.  Such is the life of most entrepreneurs.  Why?  Using your own capital as a type of “sweat equity” shows your commitment … a willingness to have some “skin in the game,” which helps send the right message about the founder’s confidence, beliefs, and evidence that a strong opportunity exists, paving the way toward meaningful risk sharing.
   To avoid self-inflicted wounds:  Some skin is good, just be sure not to invest your whole hide!  Test your way in.  Check the water temperature and depth before you dive in.  One way to do that:  run a “lean scenario” to test your assumptions using Lean Startup strategies.
   The worst reason to go “all in” (use up remaining savings) would be if you are already roughly halfway in, and the cost of withdrawal (or a serious pivot) seems too hard to stomach.  Don’t let yourself get caught up in fallacies of judgement, blind to fundamental assumptions about risk, convincing yourself there’s a viable business case without rigorous analysis and strong outside validation.  That said, check out Overcoming Barriers to Innovation and … keep going.  The world needs your innovation now more than ever!
2. Obtain a seed-stage grant —  although a low-probability of success, grants can be secured for a variety of ventures that deliver “breakthrough” social and/or environmental impacts.  They take significant effort, and developing a winning proposal is no small feat.  That said, sometimes, if no better option exists, and you can patiently pursue such business plan development assistance, or other “technical assistance” (TA is grant-speak for labor costs), it can result in a package of reasonably well-vetted and investible materials for subsequent fundraising.  This is either a perfect strategy or a colossal waste of time, depending on your circumstances.  Grantors include philanthropic Family Office foundations, multilateral finance institutions (such as World Bank or regional development banks), or various government agencies.
   Do not confuse this approach with a loan guarantee — loan guarantees or bank guarantees are not actually capital, grants or otherwise.  They ensure, via a legal backstop, the capital invested by others.  They often come in handy later as part of de-risking.  In3 uses financial guarantees during construction of projects as a form of completion surety.  More on how to obtain such a guarantee here.
3. Use Crowdfunding — a lot of hype and interest surrounds the various forms of crowdfunding, which applies to some industries and not as much to others, from the E-commerce “bridge” of Kickstarter and Indiegogo (now part of MicroVentures), showing that a project can gain some support, or a product can be pre-sold to an available market, to the small business investment sites that offer equity and loan options.  Equity crowdfunding is worth evaluating and decided if it provides a better option than more traditional pathways, but beware of the tendency to see it as a way of compensating for inadequacies or other issues in your investment pitch.  Much has changed since the new rules were passed in the US by the Obama Administration, and it has become quite competitive.  More at Crowdfunding Success Rates by Industry (2014), this 2016 guide to tools and resources, or In3’s article on Equity Crowdfunding Tips, Rules and Issues.
4. Family & Friends — the most common supplement to an entrepreneur’s own resources.  Your wealthy aunt or uncle.  The former partner that you helped make wealthy in 20xx.  The colleague you met at the political organizing event that kept you out late talking about shared values ….  Turns out that your family and close network of friends can be a great source of capital when you are getting started, and your venture is still in the idea or early stages, which usually means hardly any else would take on the risk and uncertainty.  Also recruiting new founders this way becomes more of an investment in you and your idea, less in a company.  Family & Friends, and sometimes also Founders (thus termed FF&F) usually offer the most lenient terms.
   Common mistake:  Failing to ask “What could possibly go wrong?” Approach FF&F without looking carefully at that — coming to grips with possible downsides without an eyes-open, sober assessment, and you increase the odds that you’ll wind up upside-down.   Solution is to explain that there are risks, perhaps even attempt to “unsell” the idea of an investment in your venture, before you accept the check.  Be more formal and professional to compensate for the “friendly” environment.  Any relationship built on trust and love should be preserved no matter what happens in business.
5. Get a loan: There are four ways to qualify for a loan (also known as “debt finance”):
   1. Asset-based / secured borrowing
   2. Revenue history
   3. Credit-based
   4. Commercial Context-based — a mix of these, ideally, but more about the situation and contracts that can show a lender the risk is reasonably low. Asset-based borrowing is what most project finance provides, and even if a “greenfield” (new) project, the assets that will be built can be pledged as collateral for senior debt. Revenue history, if available, often helps make the case for loan qualification.  The past doesn’t equal the future, but it is a decent indicator when it comes to borrowing power.  Leveraging a good credit score to arrange some debt has many advantages and few drawbacks if used wisely. Borrowing can be secured (such as by pledging something of value as collateral) or unsecured (such as a credit card or other lines of “signature” credit).  Skillful and responsible use of debt finance preserves equity (ownership) and control (voting rights) to help accelerate achieving your mission, investing in your venture, helping manifest your vision.  It is not for everyone or even every situation, but should be part of your evaluation.
      How is your credit rating? Know your credit scores (monitoring services that don’t lower your score when obtaining it — called a “soft” pull of your credit scores — are cheap or free nowadays), to wisely build borrowing capacity, both personally and for your business.  For the later, get a D&B DUNS number and protect it like any business asset.  Types:
      1. 1. Secured debt such as equity home lines of credit (HELOC) allow you to use some of the value in your home.  They can be quite cost effective because the interest rates are on par with mortgages, still quite low for most borrowers.
            Word of caution:  do not gamble with your family home unless your advisor says you can afford to lose some or all of it.   Again, test your way in using lean strategies.
         2. Credit Card lines provide a fast and easy way to get access to cash, but typically are only for relatively short-term purposes (less than 12-18 months), and can become expensive after that.
         3. Commercial Bridge loans — once long-term capital or “takeout” finance has been secured, construction loans or other short-term (less than 3 year) loans can be arranged through our Affiliate network.  Practical minimum is probably $5m.
         4. Government-backed Lending Program – see #8, below.

      Caution:  Extend (leverage), but don’t overextend.  Having access to and using credit wisely is healthy, and smart business, but how much is enough?  Like alcohol consumption, a little (1 glass of beer or wine per day, studies show) is good and healthy, a lot … isn’t.  Affordable debt — often zero APR (no interest) for a period of time — is abundantly available to responsible borrowers from US-based banks and credit unions to help stimulate the private-sector economy.  Use it to invest in revenue-producing activities.  If you can’t predict a pathway to cash flow, use lean strategies to test and verify, and even then be extremely careful. Frankly, using credit responsibly requires emotional restraint and self-accountability (as if someone else is watching); accordingly, some people really should not have credit access at all.  Know thyself.

6. Angel Investors and Boutique VC Funds — Angel capital and “boutique” VC Funds (where those in charge are also the investors, also called a “pledge fund”) fills the gap between start-up financing from “FF&F” — founders, family and friends — and venture capital or project finance.  Angel investors are usually fairly risk averse, but willing to take some risks with management teams and business plans they can relate to.  They’re not as particular as banks or VCs, usually.   An angel investor agrees to provide capital for a business or project in exchange for debt or equity ownership (shares of private stock).  The most common and useful structure for early stage projects or ventures is called a Convertible Debenture or Convertible Note.  This is sometimes synonymous with a Bridge Loan — it “bridges” to a subsequent round of investment at a higher valuation (share price).  Angel-funded ventures tend to have a higher success rate than any other type of startup capital, and typically come in with smaller amounts of capital than VCs.
   What not to do:  Long list of potential pitfalls, actually.  If your investment has social and/or environmental benefits, do not put those ahead of financial fundamentals, unless you know the angel is among the few that believes money is less important that impacts.  In that case, bring measurable impacts, such as carbon capture and or job creation, or improving people’s lives, and emphasize those results as the real goal.  Be sure to focus on WIIFM — “what’s in it for me” [well, them], that is their potential for return on investment, either as dividends (profit sharing or “distributions” in an LLC), increasing the enterprise value (and thus share price) over time, or potential for a profitable exit — relative to risks, always a possibility that they will lose their investment, despite your best efforts to make it work.
   See Learning to Avoid the Pitfalls: Seven Common Fundraising Mistakes for more on this.
7. Impact Investors — a growing asset class that invests for the triple bottom line. For more about this see Impact Investing overview.  Impact investors now cover the entire spectrum from seed-stage grants to first outside round of venture capital (often called “Series A” — when using preferred shares of stock), project finance and later-stage expansion or buyout capital.  Impact investors tend to be highly specialized by industry, country, and cause or type of impacts they want to obtain, and how they wish to track progress, such as helping small farmers through microfinance, climate change mitigation, or poverty alleviation.  For more about this exciting set of new avenues to raising true “Affinity Capital” (check out Next Generation Project Finance — Developer Briefing, a recorded webinar by In3’s Daniel Robin), visit the Global Impact Investment Network (GIIN), or our “Terminology Demystified” (glossary).  If ready for funding, contact us with your project’s current situation and readiness score (RAIN).
8. Government-Backed Lending Programs
   • Within the US, the Small Business Administration (SBA) offers small business loans, as do various the US agencies of Energy, Agriculture, and others.  For the SBA, banks or other institutional lenders to feel comfortable with a loan, the borrower typically must have operating history and/or a guarantor.  The SBA, for example, will guarantee 75% of individual loans from private sources, up to $750,000.  COVID changes all these programs, of course, so check with the SBA about what might be available in your state.
   • Outside the US companies, for US citizen-owned companies or US-involved projects working overseas, DFC (formerly Overseas Private Investment Corp) does provide direct loans into qualified countries.  Note:  In3 is certified by Moody’s Analytics as designated loan originators and political risk insurance providers for DFC.  For non-US-citizens or when a project or venture does not have US involvement, see the previous or next options.
9. Development Finance Institutions — We previously worked as designated loan originators with regional Development Banks and Multilateral Finance Institutions (MFIs), each of which has programs for startups and “greenfield” project finance that deliver social and environmental benefits.  The upside is that such institutions are reliable and affordable sources of capital when qualified, but they also tend to be very careful and extremely slow.  6-18 months leadtime.  See Option 7 above, or the next options, for faster results.
10. Commercial Banks — commercial bank loans are generally the first option entrepreneurs consider because banks don’t take an equity stake or control in exchange for cash.  Banks ordinarily only make loans to companies with long operating histories and strong balance sheets.  The remaining four options are widely-used alternative to bank debt:
11. Revenue- or Royalty-based Financing (RBF) contracts, or other hybrid instruments (sometimes combines debt and equity), long established but now broken into various markets by US State and Sector.  Such contracts exchange a percentage of top-line sales revenue for an infusion of capital that can be used for any working capital purpose.  more
    • How it works:  a company agrees to share a fixed percentage (i.e. royalty rate) of future revenue with an investor in exchange for capital in the form of a loan. The amount of capital is determined by a multiple of monthly revenue (i.e. 3-4x), allowing companies with negative cash flow, or limited assets, to access modest amounts of growth capital. The total obligation is repaid via monthly payments calculated as a percentage of monthly revenue, increasing in strong-revenue months and decreasing in low-revenue months. While this funding instrument has been around for awhile, it’s only recently that revenue-based financing has become a more common funding option in certain sectors, such as tech startups.
      The pros:
      • Provides early-stage companies access to modest growth capital earlier in their life cycle compared to traditional sources such as banks or venture VC funds.
      • Founder-friendly structure, debt only, thus usually no equity dilution, no loss of control, no personal guarantees and no loan covenants.
      • Monthly payments are based on a percentage of monthly revenue, resulting in variable payments that fluctuate with the business.

      The cons:

      • In the current funding landscape, the cost of capital for RBF tends to be higher than traditional sources, such as a bank loan, line of credit, or A/R factoring.
      • Investment requires monthly repayment, reducing operating cash on a month-to-month basis, relative to equity, convertible, or hybrid investment structures.
      • Requires monthly revenue and steady growth, making it a tough fit for pre-revenue companies.

      More companies are turning to funding methods like revenue-based financing when there are no better options available. VC money is not usually in the top 2 or 3 options except when they are willing to use convertible instruments such as Convertible Debentures or Convertible Bridge Notes, per Option 6 above.

      Is RBF basically just Accounts Receivables (A/R) Financing, AKA Factoring, the next option?  No.  RBF offers growth capital in return for a small percentage of monthly revenues. “Factors” or “receivables financiers” basically speed up the cash flow from sales that already happened (or are just about to happen). Factoring provides working capital; revenue-based financing is incremental growth capital. It comes with fewer restrictions and impositions on your workflow, and is paid monthly compared to daily or weekly, as with factoring.

12. Accounts Receivable FinancingAccounts receivable financing, also known as invoice factoring, is an arrangement wherein a company sells their company’s outstanding invoices or receivables at a discount (i.e. 75%-85%) in exchange for an infusion of working capital into the business. As one of the oldest forms of business funding, when used correctly it can be a useful tool when seeking working capital options for an early stage company.The pros:
    • Abundance of factoring options, making the process quick and options numerous.
    • Does not require additional collateral or personal guarantees.
    • Business owners retain complete ownership of their company; no equity arrangement.

    The cons:

    • Not available to all companies, requires minimum levels of current invoices or receivables.
    • Provides access to working capital, while certainly an option it’s not the best tool to fund long-term growth of company.
    • Contract terms vary across finance companies often include onerous or unclear terms including long contract length, excessive termination penalties, special fees, and all-or-nothing contracts.

    With careful research, accounts receivable financing may be an option if you suffer from the classic startup catch–you need capital to complete a project or take on a new customer, but you don’t have a financial history or access to traditional bank loans or other funding options.

13. Alternative (Non-Traditional, Non-Bank) Capital:
    1. In3 offers a project finance solution called the Completion Assurance Program (CAP Funding), a combination of debt and equity, but with minimums of $25 million.  This is not venture funding, as project finance requires a separate holding company and cashflows from the operating project assets on a standalone basis.  More on CAP Funding.
    2. The EB-5 Immigrant Visa Program — encourages foreign “angel” investors to come to the US, obtain a US green card and help financing one or more private enterprises.  Typical minimum investment required to quality for EB-5 visa status is $500,000 per immigrant investor (more)
    3. Equipment lease financing — not considered debt, leasing equipment is an option for many early-stage businesses that will rely on capital equipment for their operations .
14. Venture Capital — like banks, most VCs have stringent investment criteria and tend to specialize in select industries they perceive as offering the greatest potential for strong returns. The reason for this is that they want to be able to take their exit (a “liquidity” event, alias “cash out”) at a substantial multiple of the original investment.  Similar to Impact Investors in several ways, their specialization means do your homework.
    Don’t try this at the office:  Cold-calling a VC usually wastes your time; better to approach with a warm, third party introduction … someone they know and respect.  Second, don’t expect to retain control.  You’ll probably have to give up multiple seats on your Board of Directors and offer shares that have various preferences and rights.  Ask if they are willing to accept a minority stake.  Lastly, be sure there is a strong affinity, shared vision and values — far too many young companies have horror stories about what happens when there are mismatching values.

Don’t know where to start?  Call +1.831-761-0700 Ext 1 or contact us with your company’s fundraising situation or project’s current readiness score (RAIN) — stands for Readiness And Investment Navigator.  This will provide a free financeability report that is both educational and accelerates fundraising.