Article by William S. Ramsey, P.C.
FINANCING A NEW VENTURE
William S. Ramsey
Attorney At Law
410-740-2225 or email: firstname.lastname@example.org
Not Legal Advice.
The Great American Dream to profit from your creativity. But to succeed in an innovative new venture you need invention, drive, and cash. This article will discuss the cash. Most individual inventors no longer expect they will receive venture capitalist financing within months of starting a new venture. There remains confusion and uncertainty on sources of start-up funds; this is the sort of thing I currently discuss with new venture clients. Generally speaking such ventures are "unbankable", that is, banks are unwilling to make business loans to the venture.
Licensing of a provisional patent application. The inventor files a provisional patent application and then contacts large manufacturing firm licensees with the hope of obtaining a license which provides cash for use in obtaining the nonprovisional patent. Prospective licensees typically require agreement that no confidential relation exists between the parties, and that the inventor will rely only on patent protection for his or her invention. A provisional application is inexpensive and provides priority and "protection" for one year. It expires after one year and there is no patent protection at all unless a nonprovisional patent application is filed before expiration of the year. There is nothing intrinsically wrong with this scheme, and I often recommend filing provisional applications, keeping in mind that protection is limited to that which is clearly described in the application.
The practical limitation of this strategy is that one year is not a long time when searching for a suitable licensee and negotiating the license deal. Unfortunately, approaching a licensee with a provisional application may send two undesirable messages. It may appear that the inventor does not have enough confidence in the invention to invest in a regular nonprovisional patent application. It may suggest to the licensee that the inventor will be unable to make a nonprovisional patent application and soon will have no patent protection at all if no interest in the invention is expressed.
Own Sources. The individual inventor probably will have to face the reality of finding start-up funds from his or her own resources. This is the way inventions traditionally have been financed. Each source of start-up funds has some advantages and disadvantages.
From savings. This is the most desirable source of funds, as it assures the ownership of the invention remains with the inventor. Unfortunately, savings often are not available. The inventor may not have enough confidence to risk his or her own savings. If this is the case, the inventor can hardly expect to convince others to risk their cash, and he or she had better go back to complaining about the insensitivity of the capitalist system to the truly innovative.
From your 401(k) account. This follows the above approach, but it puts at risk not only your present, but your future personal solvency. Not even I can recommend it; but it may be necessary if you are to get your business off the ground.
Borrowing using credit cards. This works, and doesnıt involve annoying discussions with loan officers. The main disadvantage is that credit cards have high interest rates. Search for cards with low rates before starting your venture. If worse comes to worse, personal bankruptcy will discharge credit card debts. (But be sure to see a lawyer before undertaking this strategy, particularly if you own a home).
Borrowing on your house. This provides funds at the lowest interest rate, and the interest may be tax deductible. It may be your best bet. But never forget if you fail to make the monthly payments, the bank will take your house - no ifs, ands, or buts.
Borrowing from your family and friends. Again this is a traditional source of funds. But be sure to consult a lawyer before promising a portion of the company, invention or proceeds to the provider of the money. Be sure all agreements are recorded in writing. Future venture capital will be impossible to obtain if ownership of the company is vague or uncertain. No one wants to buy a lawsuit. "If this works out, youıll get a share of the company" is uncertain. "If you write the software you get 1% of the company" is certain with respect to the ownership of the company.
Grants and contracts. Generally available from government agencies, such as the National Institutes of Health, such contracts are life-saving for many technology start-up companies. One disadvantage is the time and effort required to obtain the grants and contracts. It is of course necessary that the research required by the grant or contract actually be done. Ideally the research will fit the company requirements. Unfortunately, the companyıs greatest needs may be in areas other than research, such as market and product development. Nevertheless, few start-ups can afford to ignore grants and contracts.
Other sources. There are a variety of state and local government programs which can provide needed cash. JREF is a private non-profit foundation is which provides low-interest loans to Howard County companies. Information on these opportunities is available from the Small Business Development Center on Bendix Road.
Outside Investors. All the above schemes (with the possible exception of family and friends) do not involve transfer stock to outsiders, and certainly allow the inventor to control the business. Financing at the next stage, involving angel investors, venture capitalists, bank loans, and private and public offerings of stock, is beyond this article. These financing arrangements all involve a greater or lesser loss of control by the company founder. Any founder who sells the majority of the company stock should not be surprised when someday he or she is asked to give up control. Thatıs when you know itıs time to start a new venture.