Sources of Money (B):

From Outside the Company

By Frank Demmler

Last week I presented the proposition that there are two sources of money: from within the company and from outside the company. Having discussed the sources from within the company, this week we’ll look at the outside-the-company sources: loans, governmental programs, and investment.

Loans

Loans are a possible source of money, but are not likely to be available to a pure start up. First, all loan programs have requirements that start-ups don’t meet by definition. Second, loans require repayment from the cash flow of the company. This is the very same cash flow that we have discussed in the past that is usually running negative during a company’s early stages, so loans, and their required payments, could injure the company, not help it.

Conventional bank debt is rarely available for early stage businesses. The typical requirements are:

• 12 months of profitable operations
• Adequate collateral to secure the loan
• Personal guarantee

The primary workaround, with which I’m familiar, is a loan guarantee from high net worth individual

SBA Loans are most often loans from a bank, with some level of SBA guarantee (60-85%). I believe that the maximum guarantee amount is $500,000, depending on the program, although that may have changed.

The key thing to realize is that these programs are for loans that almost, but don’t quite, qualify for conventional bank debt.

Economic development loan programs focus on job creation and job retention. In most cases, the debt capacity is tied to jobs created or retained by the end of the third year. These programs require bank participation, to the preceding requirements come into play, with some latitude.

The most important component of these programs, from a financing qualification perspective is that the economic development agency will subordinate its debt to the lending institution, thereby increasing the availability of collateral to the bank.

Governmental Funding Programs

Many people mistakenly call such programs “grants”. While grants may exist in particular circumstances, the most well known programs are not among them.

In my experience, two classes of programs exist for early stage companies to consider, federal and local programs. There are state programs, but many of them flow through local agencies, and/or the local agencies are likely to introduce you to those that are managed centrally.

Federal Programs

The most well known of the Federal Programs is the Small Business Innovation Research (SBIR) Program. Others include the Small Business Technology Transfer Research (STTR) Program and the Advanced Technology Program (ATP) sponsored by DARPA, I believe.

Federal programs are typically comprised of three phases:

• Phase I - Feasibility study - up to $100,000
• Phase II - Proof of Concept (Prototype) - up to $750,000
• Phase III – commercialization

Federal program have a number of issues that you need to consider.

The good news is that any monies received for work on contracts received through this program do not need to be repaid. The sponsoring agency will typically have a royalty-free license for use of the technology, but that’s it.

You have to be careful that the contract you pursue is aligned with your company’s objectives. The fact that you can do something, does not mean that you should do it. My rule-of-thumb is that at least 60% of the funding be devoted to infrastructure that you need in any case.

One of the risks of such contracts is that they will increase your burn rate, often in the addition of technical talent. If the core business has not advanced to the point of generating sufficient cash itself, or being able to attract outside capital, more often than not, the company becomes a “funding program junkie.” i.e., the focus of the organization becomes one of covering payroll from any funding source that can be accessed. Once this shift in focus occurs, I don’t think I’ve ever seen such a company recover its entrepreneurial culture and vision.

We are fortunate to have at least three local resources to help companies navigate these processes:

• Paul Petrovich at the Pitt Small Business Development Center
• Tim Deis at Catalyst Connection
• Periodic workshops by the Pittsburgh Life Sciences Greenhouse (obviously with a life sciences focus)

Local Programs

We are fortunate to have several local organizations that can supply both capital and assistance to early stage companies. All of these are primarily focused on technology-based efforts with each of the Greenhouses have an even narrower focus.

InnovationWorks

InnovationWorks is one of four center throughout Pennsylvania supported by the Commonwealth’s Ben Franklin Partnership Program. Begun in 1983, this program was one of the pioneers in state-supported economic development focused on the creation of technology-based companies.

InnovationWorks has a number of funding programs that most often fall in the $100,000 and $300,000 categories. A single company, if it were successful in qualifying for each program available, could receive cumulative funding of $1.1 million.

In addition, its staff of experienced professionals can help you determine if you qualify for their programs; assist you in applying for the programs; work with you as you deploy the funding; and assist in attracting follow on private sector funding.

Idea Foundry

Idea Foundry takes a very proactive role in assisting companies with high potential, but incomplete management teams and limited financial resources. Like all the other programs, core requirements must be met to receive initial funding of $100,000. Idea Foundry works closely with the other organizations in the community to assist its “graduates” in achieving commercial success.

Pittsburgh Digital Greenhouse

The Digital Greenhouse was founded by the Commonwealth of Pennsylvania as a collaborative effort among the University of Pittsburgh, Pennsylvania State University, and Carnegie Mellon University to create the foundation from which a “System On a Chip” industry could emerge. Through the creation of funding programs for both university research and private sector participants attempting to commercialize their own technology, or that of a university, it is hoped that a critical mass of commercial activity will occur and put the Region on the map in this industry.

The efforts are complemented by the creation of educational curricula and the providing of classes that will train professionals, ranging from technicians to potential CTOs, in the industry. Also, industry membership efforts have successfully attracted companies to provide commercial guidance and assistance, and to make sure these efforts are meeting the needs of the emerging industry.

Pittsburgh Life Sciences Greenhouse

The success of the Digital Greenhouse was such that when the money from the tobacco settlement was received, Pennsylvania launched three Life Science Greenhouses modeled after the Digital Greenhouse. Our local organization is the Pittsburgh Life Sciences Greenhouse (PLSG).

PLSG has a number of funding programs ranging from early stage technology development funds through a seed capital fund managed by PA Early Stage and a venture capital fund that will be managed by Birchmere Ventures when it closes.

Investment

Investment ranging from friends and family to institutional venture capital has been discussed in great depth in prior articles, so I won’t repeat them here.

What is important for you to realize is that there are several sources of funding that may be available to your efforts. Further, proactive pursuit of the proper and viable sources at the right time and with the right amount of effort can significantly enhance not only your chances of attracting funding in the near term, but will position you to successfully attract the follow on funding that you will need as your company enters commercialization.

Remember, attracting investment is a function of perceived risk and potential reward. The successful attraction of funding from these programs is likely to have a major positive impact on your institutional investment attraction. The third party confirmation of your business will help. The fact that you can advance the technology of the business with these sources of capital reduces the technical risk and the financial risk. In some cases these programs can be bundled with investment so that all parties can benefit.

Advice to entrepreneurs

• Take the time to learn about and understand the various financial resources that are potentially available to you.
• Meet with the professionals associated with each of the programs to build your knowledge and expand your network. Try to do this well in advance of when you will be trying to get funding so that you already have a coach and an internal advocate within that organization.
• Talk to people who have successfully raised money from these various sources. They either had assistance, or wish they had, and will be very empathetic to your quest.
• You should know some of these people already, but you probably don’t, so this will give you the reason to do something that you know that you should have done already.
• By virtue of the fact that they have successfully raised money from these sources, means that they are likely six-to-24 months ahead of you in the “building a business” process. Perhaps you can draft them to mentor you.
• Surround yourself with professionals, mentors, and advisors who have “been there, done that” and can help you level the playing field.

Frank Demmler is Associate Teaching Professor of Entrepreneurship at the Donald H. Jones Center for Entrepreneurship at the Tepper School of Business at Carnegie Mellon University. (Website) Previously he was president & CEO of the Future Fund, general partner of the Pittsburgh Seed Fund, co-founder & investment advisor to the Western Pennsylvania Adventure Capital Fund, as well as vice president, venture development, for The Enterprise Corporation of Pittsburgh.