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    The MBA

    How to fund your next startup

    By David Meister | July 24, 2016

    Screen Shot 2016-07-24 at 1.53.03 PM

    Earlier this year, Intel trimmed its workforce by 12,000 jobs. This will, in my opinion, contribute to the latest round of entrepreneurs to fill up new We Work locations.

    Mainly older employees with longevity will be asked to leave. The job market for them, being 50+ will not be so inviting.

    What will the former Intel employees end up doing? Well, you heard it here, first: The ones not hired back by Intel (perhaps as “temporary” employees, or consultants), or hired by other chip companies, will inevitably entertain entrepreneurial thoughts around their pet technological ideas. Some, with the determination to “get back” at the man fueling their passion, may even attempt to pursue their dreams actively. Yeehaw!, (not Yahoo).

    Also, inevitably, the question they would ask themselves is: How do I fund my start-up?

    Severance and buy-out packages are potential war chests, of course. But don’t be in too much of a rush to cash out deferred income, stock options, 401K’s, and pension plans.

    Instead, look first into tapping into your personal network of Friends and Family (“F&F”). These are people who know you and regard you benignly. They may be easy marks, but they may not have a lot to invest. You wouldn’t, of course, want to put your 90-year old Aunt Bessie’s last dollars at risk, however much she insists on giving you a piece of her nest egg.

    Next, as funding sources, are so-called “Angels.” An angel is an affluent individual who provides capital for a business start-up, usually in exchange for convertible debt or ownership equity. Many angels operate as networks that pool both their investment resources and business acumen. But, since they use their own capital (unlike venture capitalists who raise vast sums from pension funds and the like), an angel investment is a small, early round of funding.

    A new and interesting source of start-up capital is “crowdfunding,” using online platforms that allow you to list your project and request small amounts from many individuals. The platform takes a 5% (or so) cut of the amount that is actually raised. The ability to do this was granted under the JOBS (JumpStart Our Business Startups) Act signed into law in April 2012. The SEC finally published final rules earlier this year regulating this.

    Under the rules, a startup is permitted to raise up to $1mm through crowdfunded offerings in a 12-month period. Individuals investors, over a 12-month period, are permitted to invest, in the aggregate, up to 10% of their income or net worth, if over $100,000; and up to $2,000 or 5% of the lesser of their annual income or net worth. During the 12-month period, the aggregate amount sold to an investor through all crowdfunding offerings may not exceed $100,000.

    So crowdsourcing could be an interesting way to finance your startup. It may seem easy, because you make your case once and reach thousands of potential investors, but the downsides are that you have to keep your investors informed with frequent updates on the crowdfunding site, and you could have lots of small individual investors in your company who you do not know, but who feel free to contact you to ask how “their” business is doing.

    The government can be a conduit for money – as loans that have to be repaid — through the SBA (Small Business Administration). The SBA does not make direct loans to small businesses. Rather, SBA sets the guidelines for loans, which are then made by its partner banks. The SBA guarantees that these loans will be repaid, thus eliminating some of the risks to the lending partner. (In effect, your fellow taxpayers are guaranteeing your loan. Don’t forget that.) So, when a business applies for an SBA loan, it is applying for a commercial loan, structured according to SBA requirements with an SBA guaranty. So it’s a loan that has to be paid back over time (5-10 years) with interest.

    A client of mine recently applied for an SBA loan for his men’s underwear start-up (I kid you not). The SBA wanted him to put his house up as collateral. He declined. No loan for you!

    Once you’ve gotten your start-up off the ground and you have some measure of success, meaning you are generating sales, albeit modest amounts, and you see you are gaining traction, you could seek funding from venture capital and/or private equity firms. These firms are professional investors and require significant due diligence materials and documentation. They often will take a very significant portion of your company’s ownership. But they also can open doors for you and provide strategic guidance. They will require board seats.

    What they will offer you is a certain amount of funding representing a certain percent ownership in return for Convertible Preferred Stock. If the company is successful, the preferred stock (which is actually debt) will be converted into equity. If the company is not successful, they are ahead of equity holders in getting some return when the company is liquidated.

    In my career, I have worked on numerous start-ups and fundings. It’s a wild ride, but can be exhilarating and rewarding: financially and otherwise. Give me a call.