Creative Ideas for Capital

stupomitron helmet2.jpgA great side-effect of entrepreneurs’ optimism in tough times is creativity. At our OpenCoffeeDC last week, discussions got lively when talk turned to bootstrapping — not just self-funding, but all sorts of alternatives for producing live-giving capital and conserving what you do have. Time to put on your thinking caps.

Have you gone through the check list of capital sources? Here are several (offroad from the traditional angel and VC route) that popped up in our discussions, plus a few others.

1. Sales! Duh. Number one will always be revenue. It was just February when Wired magazine chief editor Chris Anderson dubbed this the era of ‘Free.’ (Yeah. A lot of good that’s doing us now.) But don’t blame him — he’s just the messenger. Consumer expectations have been set at $0.00 by big dogs like Google, Craigslist, and Yahoo, leaving everyone to figure out creative ways of making money in the new ecosystem. Wired elaborated with a wiki for Making Money Around Free Content that provides some novel notions for doing so. It’s even been suggested (heaven forfend!) that Facebook start charging — something, anyway, for a premium services (the freemium model) of some sort. Careful thought needs to be given to just what it is that paying customers get, above the non-paying. Look into currently working models (Flickr vs. FlickrPro, Mozy free online backups vs. MozyUnlimited and MozyPro, etc.)

2. Corporate Investment Corporate customers and prospective partners can be turned into investors. In pre-Web 2.0 era, it happened all the time — usually to ensure that the product or service would prevail, the corporation made an investment. The terms were often good, with one twist: if the startup were to fail, the corporate investor got rights to IP. So it was interesting to see Martha Stewart Omnimedia lead a $2.85M investment in Evite-clone Pingg. We’ll probably see many more of these in the coming months.

3. Consulting/Contracting Doing work for hire can be extremely morale-robbing for a startup that had its heart set on making a living with a new web application — but many startups have turned pragmatic. The duality approach is simply more conservative . . . but when external funding is in a state of flux (like now), it may be key to survival. What makes it hard is the emotional and cultural schizophrenia (maintaining a solid reputation in contracting, vs. the live-or-die passion for a product and the customers who count on it are two different head sets), but some organizations appear to be making it work (Intridea, SetConsulting), while other have made the full-scale transition from services to products (37 Signals).

4. CIT GAP Fund Not to be overlooked, Virginia’s Center for Innovative Technology (CIT) provides (through its GAP program) loans of up to $100k in the form of an interest-bearing promissory note that converts to preferred stock in a forthcoming round of fundraising. It’s a great, low-pain process that helped mobile-gaming platform Mpowerplayer and a dozen other Virginia-based startups. (Disclosure: I’m a shareholder in Mpowerplayer.)

5. Venture Loans Used to be, firms abounded that provided venture lending — growth capital and equipment financing to startups that had already secured equity investment from top-tier VCs. It was still a But these firms — which were a notch less risk-averse than banks, and usually in solid association with VCs (they only made loans to startups that already boasted top-tier VC investors). But a few entrepreneurs have recently mentioned offers of ‘loans from VCs’ as a recent funding alternative. The exact nature of these isn’t clear — did they mean convertibles, which pop up whenever valuations get shaken up (like now)? But one thing to keep in mind: promissory notes and loans of any kind need to be repaid, even if the business fails. Moreover, they often have covenants that allow them to be called ahead of schedule. And finally, you may be asked to personally guarantee them. (Did you really want to lose your house?). I say, steer clear of them.

6. Bank Financing Banks, wha? Not often on entrepreneurs’ radar, but if you’ve got any stream of revenue underway, financing receivables can be a relatively straightforward process for smoothing cash flow. In fact, whether you have receivables or not, or venture-capital funding or not, banking relationships should be struck up sooner rather than later. Credit lines can buffer slow-paying customers — this economy is certain to increase receivables aging — but everything you’ve heard about credit lines tightening is true. Even established businesses are seeing them dry up.

7. Factoring At one of my service companies, we relied on factoring to keep cash flowing. (Truth be told, we would have missed several payrolls without it.) Factoring firms — which purchase your invoices and collect on them, advance you some portion (up to 90%) of the invoice, depending on the caliber of the customer, and charge a fee (usually 1% – 3%) — can pull revenue that might normally arrive in 30 to 60 days ARO into a week or less. And, unlike banks, the only due diligence is verification of product acceptance; I bet they’re seeing a pick up in activity lately. Of course, you have to be comfortable with you customers knowing that you’re resorting to factoring (not exactly a sign of stability) . . . so better pick only those you have a close relationship with.

8. SBIRs Not too likely a candidate for social-networking startups, but a wide range of technology companies have taken advantage of Small Business Innovation Research (SBIR)and other grants. The Small Business Administration (SBA) Office of Technology administers the SBIR program, as well as the Small Business Technology Transfer (STTR) program. All told, 11 federal departments participate in the SBIR program and five departments participate in the STTR program, together awarding more than $2B annually to small high-tech businesses. Unfortunately, these things take time . . . sometimes more than a year.


Last bits of advice:

- Hoard cash — but don’t tie it up; in other words, even if you’ve raised capital, acquire PCs on credit (don’t lease them, if the lease lines need to be secured). And never secure borrowings with cash.

- Barter when you can — services of any sort.

- Co-habitate — during the last downturn, we opened up our oversized space to another company. If you’re looking for space, post on Craigslist and message boards to co-habitate — you may be surprised at the response.

- Crowdsource design work (logos, literature) you may need. Consider GeniusRocket, or Crowdspring, which Frank Gruber recently used to update his logo. Or do the logo your own damn self, until you can afford a professional.

- Pay with stock/stock options, rather than cash. Or a mix of the two. Worth a shot.

- Negotiate everything.

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Monetize . . . or Die?

What we say to dogs.jpgA few months ago, my pitch to Virginia’s Center for Innovative Technology (CIT) for their GAP funding program was turned down. I actually thought I had a fighting chance, having worked with the good folks there before and produced a plan that set the stage for their first $100k GAP disbursement. But my app-in-progress CHALLENJ was turned down, for, among other things, “We are unsure about your ability to monetize the site.” Gee, I thought — I had scoped out several alternatives . . . one of them should surely yield.

What I said was, “The revenue is, of course, dependent on my ability to acquire millions of users.” And what they heard was “I don’t really care about revenue.” Like the classic cartoon, listening, understanding — and in the case of investors, believing — are often completely different things.

I had built a financial model — I love building models — that suggested revenue somewhere between $10M and $20M was achievable in Year 3. (Maybe I should have given them an interactive model or web toolkit, that would let them dial in their own scenario.)

But truth be told, my focus was primarily on getting users. I was willing to bet on our ability to do so, and that’s fine for founders . . . but for CIT (and others), the risk was too high — certainly to place a $100,000 bet.

(Incidentally, I still recommend applying for GAP funding — it’s a relatively easy application, and structured as a convertible note, avoids issues surrounding valuation, which can be very touchy these days.)

The conclusion I soon reached — months before the economy flip-flopped — was to build and launch before resuming the quest for investment. (Now pretty much a fait accompli for any web start-up.)

Launchbox Digital co-founder (and most recently, Thummit co-founder) Sean Greene suggested an alternative at BarCampDC2 last week: sustainability with small numbers: “VCs need things to be big — you don’t. You might be perfectly happy with 10,000 paying customers. And if so, you don’t need a VC.”

Point well taken. For that matter, maybe you don’t even need angel financing.

In a recent BusinessWeek story, New York Angels chairman David Rose — and several others — remarked they’d like to see self-sufficiency on the initial investment. Jeez Louise, how many businesses can get to self-sufficiency on a couple hundred thousand bucks?

Maybe it’s my upbringing. My first venture-funded company was in the computer-chip business. Talk about a leap-of-faith investment — money comes in, and a year or two later, you hope to have a working product, a receptive customer base, and good market conditions. In that world, there are only two qualifications for investment: 1) the pedigree of the team; and 2) the gut of the VC.

Google was a gut investment; the founders were super-smart, but still in school. Twitter had a mix of both — the founders had proven their smarts and ability to execute with Blogger, which was acquired by Google in 2003; but well before the meme had proven itself with the masses (some say it has yet a ways to go) a few VCs — notably Union Square Ventures‘ Fred Wilson and Spark Capital‘s Bijan Sabet, were also trusting their instincts that Twitter was not destined to be another PointCast. They believed instead they were on the very brink of a phenomenon . . . even without a revenue model.

Recently, a bit of tempest in a teapot brewed around a comment USV’s Wilson made about Twitter, as reported in a Wired blog:

“œIt’s like the stupidest question in the world: How’s Twitter going to make money?,” said Union Square Ventures’ Fred Wilson, another investor. “It’s like ‘How was Google going to make money?’

Wilson subsequently apologized for being snippy, but I knew what he meant. Throughout my startup career, I rarely worried about revenue models — the hardware companies of course made products to be sold, so the only concern there was could we sell thingies for more than it cost us to build them. But even in the software and Internet companies, there was a general belief in the notion that if we produce something people use, we’ll figure out a way to make money.

It may all be moot, because most of you are probably thinking more about sustainable revenue models than ever before.

Call me crazy . . . but I’m still a fan of go big, or go home.

In any case, we believe in our ideas, exuberant (if not irrational) as ever. And we remind ourselves that, as David Hornik, of August Capital has said: “One VC’s next Google is another’s wasted hour.”

Which is why I continue talking to VCs. And in fulfilling my personal mission to improve the VC-entrepreneur dialog, I’ve organized my first OpenCoffee, where we’ll have two local VCs in attendance. Join us, if you can, for some stimulating discussion!

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