A Start-Up Trek – Money Makes the World Go Around

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Photo taken by 401k. Creative Commons license.

I am starting a new prototyping lab in Huntsville, Alabama, based on the fab lab model. I’ve dreamt of becoming an entrepreneur and have done a fair amount of research on the topic. But this is my first attempt at starting a business. Here is where I document weekly my mistakes and successes in creating a business from scratch.

I need financing to make this business a reality. As much as I’d like to launch this project out of my own pocket, I simply don’t have the necessary resources. The four machines that are core to the fab lab concept are pretty expensive and I also need a number of hand tools for doing detail work (like dremels and grinders) and for diagnostics (like oscilloscopes and logic analyzers). Add to that the inventory of raw materials, electronic components, hardware and other sundry items that customers will need in order to create.

That’s a lot of stuff. While I have about a third of the start-up cost saved up that still leaves a lot of money needed to get this place off the ground. I see four different options to raise the necessary capital. First would be to go to my family and ask them if they want to invest. A lot of businesses get off the ground this way. That, unfortunately isn’t an option for me, but I’d encourage anyone else to seriously consider this option. Why? Because the other options have built-in costs.
Venture capital is a very popular option these days. I’ve lightly followed the VC industry the last few years and have learned a few things. As a start-up I would be looking for an angel investor. Sinking money in start-ups is more risky than investing with someone with a proven track record. So angel investors look for a high rate of return – the rule of thumb I’ve heard is a 20 to 1 return. That’s considerably higher than I’m expecting. Also, most angel investors look for something larger, which seems to me to be related to that high rate of return. An investor is going to take a portion of ownership, require frequent meetings with the development team, and want the team to work with his contact list of accountants, attorneys, IT support, office support, etc. I would love to tap into an experienced VC’s Rolodex, but I don’t see that happening here.

The next option is getting a business loan. My hope is to be accepted for an Small Business Administration (SBA) loan. These loans are attractive because the SBA will guarantee the bank receives some percentage of the loan should the borrower default. So absorbing some of the risk frees up capital and makes it easier for banks to assist new businesses in starting. Great idea in principle but from what I’ve heard financing is very tight right now. And the downside is paying interest for the next 5 to 10 years. Paying interest is an obvious downside, but more interesting to me is how putting loans in my financial projections forces me to charge more to the customer.

There is one other option that I’ve been looking at closely, that of crowdsourcing. I’ve talked to many experienced people about financing issues and just about all of them have never heard the term. I’ve found myself again and again explaining the concepts behind Kickstarter or Rockethub. I’ve done some looking into doing a crowdsourcing initiative but really became fascinated during the Order of the Stick reprint drive. I watched for a month as Rich Burlew’s cartoon graphs rapidly shot into the stratosphere, eventually pulling in $1.25 million when he originally asked for $50k. Recently a couple game development teams have pulled investments that dwarf Burlew’s campaign. I’d say crowdsourcing is making quite a splash, even though everyone doesn’t know about it yet. By the way, check out the Kickstarter projects that GeekDad has highlighted.

But I’m not sure if crowdsourcing is for me. Most projects tend to collect thousands of dollars, and I would need funds in the high tens of thousands. While Burlew and the game companies did phenomenally well, they benefited from their hard earned track records of high performance creating beloved comic strips or highly engaging games. Also they can attract contributions from anywhere, where I would be pulling from one mid-sized north Alabama city. What do you think?

Its interesting to compare the two options. An SBA loan is running at about 6-8% interest right now. Pretty low rates, but then all rates are low these days. Kickstarter charges 5% and then 3-5% to process through Amazon payments. Over the course of a multiyear loan you would pay much more with an interest rate of 8% than you would with an 8% fee. Also consider that crowdsourcing is effectively a presale initiative. Most contributors do so because they receive a gift. These gifts are pegged to the amount they’ve contributed. For instance, Burlew ended up with a number of contribution levels that corresponded to a complex set of scenarios of gifts of book compilations, notepads, patches, and refrigerator magnets. Most of which will be delivered within the next year (or less, I’m excitedly awaiting a few things myself). So we can consider a crowdsourcing campaign as a loan for the online community for products to be delivered later. If we assume a delivery date of one year or less for these presales then the $50k scenario above becomes equivalent to a one year loan with an simple interest of 50*8%/(50*(100-8%)) = 8.7%. Maybe Burlew would have done better getting a loan.

But then he would have had to go through the entire loan process, and probably would have had to put together a business plan, or other documentation that spells out exactly how he expected to pay back the loan. Also he have to know ahead of time what sort of sales to expect, how much product to order. Burlew was the first to admit that the response he received was orders of magnitude higher than he expected. I suspect some of the other $1M+ projects saw were surprised at the level of response they received too. Perhaps the market research inherent in crowdsourcing is as valuable as the revenue generation.

Nah, money makes the world go ’round.

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