You may not wish to hear this, but it is more than true. The greater percentage of your own money used, the better, since money equals control. O.P.M. (other people’s money) costs control, often causes strange bedfellows and, often heartaches or misunderstanding as to who is responsible and for what.
I once sold a 20% interest in a potential invention for $20,000. The fellow was nice enough and he could apparently spare the change and the project was capitalized at one hundred thousand. Alas, we were both so naïve. The agreement was drawn by attorneys and we each signed under advice of individual counsel. According to the terms of the agreement I was to continue development of the invention and he was to wait, and offer any help he could when asked. He couldn’t wait, and he started calling me at least once a day. Also, he assumed that everything else I worked on was part of our partnership even though the agreement was quite specific to the one project. On top of that, he developed a domestic problem which changed his financial outlook. Now, if my investor (my accountant, by the way) could not handle backing an inventor, how do you think a neighbor or mother-in-law would handle this same situation?
There is always a need for outside capital to finance inventions and start-up companies, and there are good resources for this type of money from both the private and public sector. These investors prefer deals in the 5-6 figures and they are venture capitalist. They can and do expect losses and this is their business. Often this type of money is called “seed money”.
Happily these investors are too busy to call you every day, but rather prefer monthly progress reports. I have found these people to be great lovers of demonstrations, however. These professionals also have the contacts to aid the investor with additional funding for the next step. (I cannot stress too highly the importance of getting enough funds at your initial financing -- it is very hard to return, hat in hand.) They can also provide accounting backup, marketing and licensing guidance. Here again, the more that you have accomplished on your own, with your own resources, the stronger will be your negotiating position.
The financing example given above -- $20,000 for 20% -- is called equity financing. In other words, you are selling the right to a specific part of your work. This approach has both pluses and minuses. One benefit to the inventor is that he owes nothing back to the investor if the project fails (unless the investor ties up some of your assets in agreement).
Equity financing also offers certain tax advantages to the investor and he can structure the deal so that he can actually lose no money, even if you, the inventor, fail. This does not apply to the smaller investor, and he will pressure you for results. The pros do this often and they can balance your possible loss against a mammoth success. This is a simplification, just suffice it to say that professional equity investors may not be doing you the favor they claim. They are protected either way the deal goes.
One of the problems with equity financing is the dividing of the pot. My simple 20K - 20% situation was predicated upon my licensing the invention straight out, with a proportional sharing of the royalty advance and the continued royalty income. My accountant friend was happy because he took his income as capital gains and he made his money back in two years.
Suppose, however, that you don’t yet know which path you may take to exploit your work. After all, you have several options. Straight royalty is one. But suppose you come across someone who says that he will sell your product if you provide it. This will turn you from the inventor into the manufacturer.
Or maybe you become so sure about the product that you decide to start a company instead. Your investor will protest because he now has (for the sake of this illustration) 20% of a corporation that is ostensibly closed -- you having control. You could, conceivably, take income and use it for salaries, R&D, a fancy office and company cars. Your investor is in the unfortunate position of not being able to force you to declare dividends.
Having done this myself, I can’t say that is wrong, but there is an axiom that a business deal only works if both parties feel good about it. (The deal is, of course, when each party thinks he or she has the best end of the deal.)
I personally prefer equity financing and have helped put together many successful situations along this line. The above pitfalls are just better mentioned now, rather than too late. Use an experienced attorney, buy yourself as much latitude as possible and be honest from the very beginning. Your potential investor has seen it all. Also try to work a stock buy back at some formula. Your investor probably won’t go for it, but it will impress him as to your thoughts about the success of the venture, and that is almost as good.
The other method of obtaining money is by debt financing, or a combination of debt and equity. I have heard of too many inventors that second mortgaged their homes, sadly to be lost because their invention was not marketable, or there was just simply not enough time. Please be cautious. If your product is good there is enough profit to share with equity investors.
Regardless of which way you go to fund the project, your money people will be looking for a dedicated and driven inventor and they will look very carefully at your presentation piece, marketing plan and financial projections. I might add here, again, that your odds of receiving outside funding are also greatly increased with good working models where little imagination is required by outsiders. Remember that your financial partner may also have people to answer to, and even if not, he will most likely have a cadre of trusted advisors.
Finally, once you have your business plan completed, locate your Small Business Administration (SBA), Small Business Investment Corporation (SBIC), your banker, accountant and anyone else that may have contacts. You may find that most real people want to be helpful -- in fact, they enjoy doing it.
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