Raising capital to raise capital

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To quote an attorney at a recent meeting, “The capital market is ugly.”

Talk about being concise and accurate. Everyone agrees capital markets are tough now, and that getting a start-up or expansion deal funded is far more difficult than it was two years ago. That said, deals are still being done. To have a deal join the ranks of those consummated, an entrepreneur must make it so attractive it bucks the ugly market.

It’s common to say businesses can be funded, but ideas cannot. This implies the entrepreneur has a revenue-producing business or has all the ingredients, including an experienced, proven management team already on board. I recently saw a business plan that had executives who collectively founded five successful companies and had significant liquidity events in three others. This is a terrific model to try to emulate, but most start-ups don’t have those credentials.

If you are still an idea company, does that mean all is lost until the capital markets recover? Can a company without profits and even without revenue hope to get funding? Surprisingly, the answer is yes.

The key to funding is validation.

Ideally, validation is previous marketplace results with which you can show success and justify your capital needs with hard numbers. It means your company has great executive talent and the potential for huge returns for investors. As most start-up entrepreneurs will note, “ideally” is the operative word. Their companies have yet to go to market, so market validation is a moot point, and few have an executive team that has been validated by tremendous successes.

So how can opportunities that are less than ideal get funding? How can start-ups with that “killer app” or great idea, but without market validation or deep executive talent, get funding?

An effective way is to get initial funding from sources whose presence as investors add validity to your claims. Consider approaching your business contemporaries or potential customers for funding. They will understand your value proposition with less skepticism than a pure financial investor, who continually hears claims about envisioned market size, acceptance and returns.

People within your profession — as well as potential customers — can appreciate your concept. They know your market, so they won’t need much market education. Conversely, they can see through smoke and mirrors. If they see significant value in your efforts, you have potential early stage investors.

I recently spoke with a medical professional entrepreneur starting his initial round of outside funding. He had shown his technology to other professionals in his field to get reaction and feedback. These contacts were made solely for product development purposes, and the reaction to his technology was universally positive. If he now decides to approach the same group as investors, he’ll be talking to people who know the inherent and commercial value of the technology.

This kind of funding allows for creativity and flexibility. Contemporaries and/or customers who invest can get noncash or non-equity value such as guarantees of first use or reduced product pricing. This does have dangers, such as divulging information to potential competitors, but good planning and good legal counsel can address these issues.

Besides providing needed funds, these early stage investors bring the approval of those in the know. By showing more traditional capital sources that funds have come from sources knowledgeable in your business’s area of expertise, you have a much more compelling argument. You gain the validation that angel or venture investors need to see. Erwin Bruder ([email protected]) is managing director of emerging enterprises for Cleveland-based Prim Capital Corp., where he provides business planning and structuring services to start-up and growing companies.He can be reached at (216) 830-1111.

Prim Capital website