Most businesses require some form of funding to get started. However, based on what business stage the business is at, the sources of capital will be different. This is where your funding plan comes in, to identify how the business can secure financing for each stage.
A product company goes through five stages groups into three phases to get its product to market.
2. Proof of Concept
3. Product Design
4. Product Development
5. Manufacturing and Distribution
With each stage, the chance of success increases, but so do the capital requirements.
1. Idea Stage
Your primary goal in the idea stage is to validate your business idea. Validating a business idea involves clearly defining your customer and problem hypothesis. Based on your customer and problem hypothesis, list all the assumptions that you have and design tests to see if they are correct. Testing your assumptions in the idea stage is often conducted by interviewing potential customers. During the idea stage, you will also want to verify that customers are willing to pay for your product or service. Just because an idea makes sense to you does not mean that others will feel the same way.
2. Proof of Concept Stage
The primary goal of the proof of concept stage is to explore the feasibility of building a product or service based on your idea. The proof of concept stage involves building Minimally Viable Products and presenting them to customers to get their reactions. MVPs are not finished products. MVPs represent a kind of semi-functional product or mockup to demonstrate concepts and features to test your assumptions with customers in a more physical way.
Early Phase Startup Funding Options
An early phase startup is composed of two stages in the funding plan: the idea and proof of concept. Early phase startups are primarily funded by what is known as bootstrapping. Bootstrapping refers to starting a business without any external investment from sources other than the founder. Early phase startups are not eligible for loans since they have yet to produce revenue that can be used to pay back a loan. Additionally, because early phase startups are still very risky at this point in their journey, the business would have to give away too much equity to attract investors. Therefore, given the early nature of the venture at this phase, there are very few other funding options available other than bootstrapping.
The most popular sources of bootstrapped funds come from:
- Home Equity Line of Credit (HELOC)
- Borrowing money from your 401k
- Personal Savings
- Credit Cards
- Strategic Partners
- Other Founding Partners
3. Product Design
The primary goal of the product design stage is to develop a working prototype and to place it in front of customers to test the usability (UX) and user interface (UI) components of the design. Often, multiple designs are tested in order to perform a kind of A/B testing to see which features users like best.
When the design of a product is solid, you have two choices. You can license your product design to a business that will complete the product development and then manufacture and distribute your product, or you can continue to the product development stage and market it yourself.
4. Product Development
The primary goal of the product development stage is to complete the business analysis and come up with a final design of the product. With a final design in place, pricing is defined as well as the creation of marketing materials, product documentation, and any training programs needed to teach users how to use it. By the end of the product development stage, you have a product that is ready to go to market.
Pre-Revenue Phase Funding Options
The pre-revenue phase is composed of two stages in the funding plan: the product design and product development. Pre-revenue businesses are primarily funded through equity or selling ownership stakes in your business to investors. In some cases, crowdfunding is also available for pre-revenue businesses.
NOTE: With a reward-based crowdfunding campaign, you get to preserve your ownership in the business and validate that people are willing to buy your product before you spend additional time and money trying to manufacture it.
The most popular sources of pre-revenue include:
- Selling stock to friends and family members
- Creating a self-directed IRA and investing in the business
- Selling memberships to customers
- Getting vendors to become partners so they can take a second bite at the apple
- Bringing on business partners
- Selling stock to angel investors
- Running a reward-based and equity-based crowdfunding campaign
5. Manufacturing and Distribution
Most businesses are far better off licensing their new product idea to a manufacturer than raising the capital to manufacture and distribute the product on their own. Licensing your idea to a larger company already in the market of manufacturing and distributing similar products allows you to leverage their capabilities including their existing manufacturing capabilities and distributions channels already in place. However, some businesses will choose to manufacture and distribute their product themselves which is often the most expensive stage of the funding plan.
Revenue Phase Funding Options to Scale a Business
With a functional product that is generating sales revenue, the business has entered the final stage of the funding plan. More traditional options such as debt financing become available to the business where they were not before. In addition to term loans or lines of credit, there are also specialty lenders that become available funding options during the manufacturing and distribution stage. One type of specialty lender is a factoring company that will buy your accounts receivable invoices at a discount. Another type of specialty lender is a sale-leaseback company that will buy your company-owned assets and lease them back to you to enable you to draw equity from your assets.
Since the funding plan for manufacturing and distribution often involves debt financing, a business needs to understand the difference between smart and dumb money. Smart money is money that when contributed to the business, has more value to the business than the actual cash value. Debt financing from an angel investor such as the ones you might find on ABC’s Shark Tank are smart money since they bring both money as well as industry experience and network connections to help out the business. Dumb money just adds to debt or dilution of ownership with no increased value to the business except for the cash. Bank loans or family and friend investors are considered dumb money since they simply loan you money or invest in your business with no added value.
While some businesses can progress through a few or all of the five stages of a funding plan simply through bootstrapping, and thereby preserve equity and maintain full control, many businesses will require additional sources of financing during their funding plan journey.
The founder, followed closely by friends and family, is the most appropriate source of financing for the Idea and Proof of Concept stage. In many cases, bootstrapping is the most adequate source for early phase capital of the funding plan.
As the business progresses to the Product Design and Product Development stages, the business may need additional seed capital. Selling equity to investors is often the most common source of funding for a pre-revenue business. However, more and more businesses are using crowdfunding as a way to raise capital and maintain complete control and ownership of their business during the pre-revenue phase.
If additional funds are still required in the Product Development stage or the Manufacturing and Distribution stage, more traditional sources of funding such as bank loans, and specialty lenders become available to the business.
What is your funding plan?