This story was originally published on June 25, 2009, and is brought to you today as part of our Best of ECT News series.
Lacing a shoestring budget with enough green to get your startup up and running takes some finagling. Still, it can be done. If you can’t find investor backing right now, then turn to alternative funding routes.
You may want to start with your own hidden assets to find the cash you need. One example: Retirement funds can bankroll your future in more ways than one.
“Several entrepreneurs who need seed money for their startup are using the Solo 401(k) program to gain tax and penalty-free access to their retirement accounts,” Andrew Betts, a financial advisor for Bickling Financial Services, told the E-Commerce Times.
A Solo (aka “Individual”) 401(k) is similar to a corporate 401(k), only eligibility is limited to business owners who aren’t covered by a qualified retirement plan and whose business doesn’t employ non-family members for more than 1000 hrs per year, which Betts pointed out “is perfect for a day one startup.”
If you qualify for a Solo 401(k) and roll your corporate 401(k) or IRA (Individual Retirement Account) into it, you can set up a loan and access 50 percent, up to US$50,000, tax and penalty free.
“The money has to be repaid over five years, but you’ll be saving $38,183 at minimum in taxes and penalties, and you will have the benefit of that money continuing to grow tax-deferred in your retirement account,” explained Betts.
“If circumstances change after satisfying the initial eligibility requirements — say, for example, when the owner hires employees and they have worked more than 1,000 hours in a year — the owner may no longer contribute to the Solo 401(k) plan, but existing loans won’t be affected,” added Betts.
If you’re still employed and have a 401(k) through your employer, look for similar loan plans there. Be careful, though; if you quit or are laid off, you can take a big hit in taxes and penalties. Also, take note that IRAs offer no such loan programs.
Life insurance also can be a funding source. Take, for example, life settlement, which is a tool that empowers consumers, usually seniors, to sell their life insurance policies to financial institutions.
This is a method available to policy holders who want an immediate lump sum of cash. Life settlements are often reported to pay policy owners 200 percent to 500 percent more than surrendering the unwanted policy back to the insurance company. Amrita Financial, a startup itself, is launching a Web-based, do-it-yourself life settlement tool, in part to take advantage of the new interest among startups in this funding vehicle.
The Revenue Model
Another surprising source of capital can be found in your customer base. BlitzLocal has reportedly turned down investment offers from venture capitalists and angel investors — and the bureaucracy and owner dilution that comes with it. It chose to use affiliate marketing and SEO / SEM consulting for major chains like Quizno’s and California Pizza Kitchen to fund the development of its local search platform.
It stands to reason that you may be able to similarly identify additional income sources that can help fund your startup, regardless of which stage it is in. There are many other ways to capitalize on your customer base as well.
DNA 11 started with $2,000 and grew it to millions in revenue without any venture capital or financing whatsoever.
“We got our funding from the least-expensive source — our customers and real revenue,” Adrian Salamunovic, cofounder of DNA 11, told the E-Commerce Times.
“What I love about our revenue model is that customers pay up front for their order, and we don’t actually create and ship the art until weeks later. This on-demand model allowed us to get started with minimal costs, and to this day is a great way to control cash flow,” he said.
“In today’s tight venture capital market, many Internet entrepreneurs would be wise to look to their clients and real revenue for funding by encouraging advance payment — prepay for the year, etc. — if their business model can support that,” added Salamunovic.
Your company’s location can also be a surprise money cache. Look for funds backed by regional and state development initiatives. If there are none in your area, consider moving so you can tap this resource.
One example: Toledo, Ohio-based Rocket Ventures is a $22.5 million venture fund focused on attracting early-stage, high-potential technology companies to Northwest Ohio. The fund, run under the guidance of Regional Growth Partnership, seeks business ideas that have the potential to achieve full-scale commercialization, scalable to $30-$50 million in six to eight years.
This means that the business must clearly demonstrate a desire and a way to grow very rapidly, as well as make a commitment to the region by moving operations to Northwest Ohio and signing a lease.
“In these economic times, startups need to look for nontraditional sources of financing,” Rocket Ventures Managing Director Steve Weathers told the E-Commerce Times. “A lot of firms are looking to small venture capital funds like Rocket Ventures, an early-stage, pre-seed fund. Since 2008, Rocket Ventures has already helped start and commercialize more than 50 technology-based companies in northwest Ohio. Rocket Ventures fills the gap between angel investors and large venture capitalists.”
Rocket Ventures also provides $50,000 Ignite Grants to help jump-start a company. So far, 15 companies have received these grants.
Universities can also provide seed money and help in other ways — like free rent or skilled labor. For example, the University of Texas at San Antonio has an incubator to nurture cybersecurity startups nestled in its campus-based Institute for Cyber Security (ICS).
“If the startup is selected, ICS helps with its research and development at an agreed-upon amount of labor for the billing of its chief architects, developers, security analysts and so on, in exchange for equity in the company,” Erhan Kartaltepe, associate director of ICS, told the E-Commerce Times. “The more successful the company becomes, based on its current valuation, the more valuable ICS’s stake is.”
The Acquisition Model
Some startups are helping other startups in unusual ways. There are private companies that have built a successful business and grown their revenues to the $50-$200 million range. These entrepreneurs are now using the venture capital they have raised to acquire other startups with complementary technologies, products or services.
“We’ve seen some acceleration in these types of acquisitions during the current recession as the overall pool of venture capital has shrunk,” Jeff Richards, partner at GGV Capital, told the E-Commerce Times.
“However, even in stronger economic environments, being acquired can be a more attractive option than Series A or Series B funding for a smaller startup,” noted Richards.
The reason, he said, is that the combined company is a stronger, more dominant player in its market, and the combination of complementary solutions can expand the number of prospective customers beyond what either startup could achieve individually.
“Three technology sectors particularly suited to this opportunity are the Internet, software and services,” said Richards. “At a macro level, this should also produce the kinds of companies that are more attractive to the IPO market, as well as potential acquirers in the future.”
In the end, though, most entrepreneurs take more traditional funding routes.
“Most CEOs are going to friends, family, angel networks and individuals as institutional capital sources have raised their bar for funding startups,” said Divya Gugnani, a former venture capitalist who is currently CEO of Behind the Burner. “The best way to get funding is to leverage your personal network.”
The vast majority of venture capitalists and angel investors only take meetings for entrepreneurs that are recommended by their professional network, friends or family.
“As an entrepreneur, you need to attend every industry event, get to know people in your area of domain expertise, meet investors and constantly be pitching you business,” Gugnani told the E-Commerce Times. “It takes one lucky introduction to have a meeting with an institutional investor that wants to invest in your company.”