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While this is the time of the year for Christmas angels, I’m better acquainted with those earth-dwellers known as angel investors. Angels are affluent individuals who are willing to invest their money in your idea in return for sharing the profits.
Suppose you have an idea and want to make money on it. In a later article, I will talk about developing the idea. In my book, you can learn how to sell the idea. Today, we discuss funding. How do you get funding?
If you question ten people at random, at least two of them will confess to having an idea (invention concept) that could make “lots of money.” There are thousands upon thousands of people with ideas, many good ideas. What makes your idea different? It has to start with you.
You must be able to ignite your idea. You must bring it to life, Doktor Frankenstein. You must build a prototype or develop the concept beyond a pencil drawing on a Big Chief tablet.
How do you get funding for this prototype? How do you get started? It requires money to develop the idea and get it off the ground.
Most ideas require a minimum of $50,000 – $100,000 before they can take on any life of their own. How do you get this kind of money?
Step One: You invest your own money. Period. No substitutes. Forget OPM sales hoopla. It will be virtually impossible to get funding from someone else if you are unwilling to invest your own dough in your own idea.
“But,” you say, “what if I do not have money to invest?”
Well, you are out of luck, plain and simple. Trash your idea and get on with life.
People who sell their ideas eat sandwiches for lunch, drive an older car, take a second job, and do whatever it takes to raise the money. The new Lexus will have to wait until you are successful. If you are unwilling to discipline your own spending, do not expect others to dish out their money for you to waste. There are plenty of other people with ideas just as good as yours who are willing to make the sacrifices required.
I am not speaking of borrowed capital. That is next. This is about creating and investing your own moolah into your idea. This is the money you did not waste on a second iPhone or the unlimited-texting cell phone plan. One thing all investors look for is this: is this inventor committed? Does this inventor have a real plan and can he/she make it happen? Investors require that you have some “skin in the game.” Borrowed money is not your skin. In fact, if you find an investor who does not require skin in the game, run, do not walk, to the nearest exit. That “investor” plans to take your money.
You must be able to save and put a few thousand dollars of your own money into your own invention or idea
Step Two: You must borrow money. You will need another $10,000 – $50,000 to get your prototype built, create a marketing plan, and put together pro forma financials. A pro forma is a time-phased projection of your planned investments, projected sales revenue, expenses, and return on investment. You will also need to create confidentiality agreements and put other legal protection in place so your idea does not get stolen.
You will need to mortgage your house, borrow from a friend, take a note at the bank, or sweet-talk your brother-in-law. Do not borrow from IRA’s or other investments that penalize early withdrawal. Investors want you to have some financial savvy. Thou Shalt Not Do Dumb Things!
By the time you finish step two, you will have exhausted all your personal funds and all your friends. You are in debt, but you still own all the rights in invention. You have a prototype, a marketing plan, maybe some experimental data, drawings, and other artifacts of value. None of your creditors, hopefully, has any rights to your idea. You simply owe them money. In order to take a product to market, though, most ideas will need an additional $50,000 – $2,500,000. How do you get that kind of funding?
Step Three: Angel Investors. Angel investors listen to your idea and determine if they are willing to fund your project to the next step. They are typically willing to invest $50,000 – $1,000,000. The average angel investment today, per start-up idea, is about $340,000. What do the angels get for their investment? A piece of the action. They will own rights to your invention. How much rights is something you negotiate depending upon the size of the investment, how desperate you are, and how quickly you think the “window of opportunity” is closing.
Angels look for a return of about 10 times their investment within the first five years. Very few angels get this return, of course, but every idea they investigate is evaluated against this standard
Some angels pool their funds and network together to reduce their risks. There are about 15,000 investors pooled in a number of such entities. While I am not recommending any particular fund, ARC Angel Fund has such a cute name it has to be included this time of the year.
Step Four: Venture Capital. Venture capitalists are usually not interested in investments less that a million dollars. In my experience, venture capitalists look for investments that double their money in 1-2 years. This is a terribly high hurdle that most inventions cannot scale. Statistics show that across all venture capital money invested, the average return is only about 13%. This is because 40% of the ideas succumb to sudden infant death while 30% linger comatose for about two years before they slowly and painfully die. Only 30% of the funded ideas survive and become self-sustaining. Those kind of statistics plummet the average.
In today’s environment, venture capital is strained. Today, almost three-fourths of venture capitalists expect the total investment dollars to either remain the same in 2012, or decline. That means higher scrutiny for your idea because less money will be available.
If all this sounds formidable, it is. However, if you do nothing, I can assure that no investor will clairvoyantly contact you begging to channel money into your idea. To the Persuasive Wizard, “difficult” and “formidable” are merely joyous stimulants. They doeth good, like a medicine.