Nearly all startups will require capital resources at some point between conception of the opportunity and successfully attaining profitable operations. Even then, additional capital resources may be required for growth. All organizations will benefit from development of a capital strategy as a component of business planning. This capital strategy will serve as a funding road map that can guide founders as they must make multiple decisions on when and where to raise capital.
Two inter-related key factors in creating the capital road map are risk and the price of capital. The higher the risk, the higher will be the price of capital.
Risk represents the threat that a startup organization will fail to succeed and will be unable to payback investment or generate desired rates of return on that investment. At the commencement of any business, the risk is high. If a business is able to attain a number of key milestones, this risk will diminish.
The price of capital represents the interest rate, share of profits or royalties or other compensation given to the investor of the capital for its use in the business. Different sources of capital will charge different prices for the same amount of capital for the same opportunity.
Basic capital management strategy dictates raising as little capital as necessary during the early stages of a new business when risk and the price of capital are high. The business plan will guide the organization into quickly attaining those milestones that clearly demonstrate a reduction in risk, thereby enabling access to capital at lower prices.
Common milestones include:
- Validation of technical efficacy – the product or service works and will convey a benefit to the consumer
- Validation of economic feasibility – the product or service may be produced and delivered at a cost below the price that the consumer is willing to pay
- Establishment of a management team – the opportunity is under the control of a group of individuals with the necessary skills to advance the concept to the point where revenue can be generated from sales
- First Dollar Revenue – an event where the organization first sells a product or service and collects payment
- Breakeven Operations or Positive Cash Flow – an event where the organization has completed sufficient sales that total revenues received match total costs of operations
Starting with a concept or idea, an opportunity progresses through a series of stages: beginning with a concept and progressing to profitability. The common observation is that an idea has no value because it has not yet been tested. Many ideas prove to have value in that they can provide benefit to the consumer when sold as a product or service, but the cost of producing and delivering the product or service to the marketplace is so high that no one can afford the price and therefore the idea is not economically feasible.
An innovation remains only an opportunity until a management team is recruited to operate the organization. The capabilities of the management team are the single greatest factor in reducing risk of bringing an innovation to market. All opportunities remain theoretical until a first sale occurs and revenue begins flowing into the organization. Risk falls dramatically at achievement of this milestone. And, finally, the last major milestone is achieving economic sustainability – breakeven - by generating revenues equal to cash outflows.
Upon achieving each milestone, there is a broader selection of capital sources that are willing to assume the risk of making capital available to the organization. Therefore, like any commodity, the price of capital falls. Between concept and profitability, the price of capital shifts from an immeasurably high percentage of future profits to well established prime lending rates.
The capital strategy should anticipate each change in risk profile of the organization and identify the best sources of capital that are willing to make capital available at that stage at an affordable price.
Capital strategies should recognize that different investors may realize benefits from investing beyond the price charged for the capital. The success of an organization may yield benefits in terms of access to products or services (customers), new business opportunities (vendors, suppliers, distributors and retailers), local economic impact (economic development agencies and neighborhood businesses) or addressing social problems (impact or social causes). Because these investors stand to realize additional gains from the success of the organization, they may provide capital at a lower price than institutional investors (banks, angel investors and venture capitalists) who benefit only from the return on their investments. Access to this community/alternative capital may be easier to gain as well as lower priced.
Capital planning should also incorporate the possibility that capital may take the form of people, buildings, information/knowledge and equipment that can be invested directly (in-kind) without first having to raise money in order to buy these assets.
This technique and other tips on successfully conducting an investment crowdfunding campaign will be presented at a workshop on Customer Crowdfunding presented by the Colorado Capital Congress PBC on Thursday, June 23. More information and to register, go to: http://www.coloradocapitalcongress.com/events
Additional blogs on crowdfunding can be found at http://www.coloradocapitalcongress.com or on LinkedIn posts by Karl Dakin at http://www.linkedin.com/in/karldakin
Karl Dakin, President
Colorado Capital Congress PBC