(by Marco Vangelisti)
Slow Money projects and businesses are building a restorative economy by improving the livelihood of their communities, by valuing the uniqueness of place and by restoring the fertility of the soil either directly or by supporting activities that do so.
The funding challenges that any business faces are augmented by the focus of most Slow Money projects and business on achieving appropriate scale as opposed to rapid and continued growth necessary to attract traditional early venture and equity capital. This article will provide an overview of a number of funding mechanisms available to Slow Money projects and discuss their relevance and appropriateness based on the business’ developmental stage.
A business goes through many stages from the initial idea to a thriving profitable enterprise.
- Proof of concept
- Product development
- Entering the market
- Approaching profitability
Every business starts with an idea, often created by the recognition of an unmet need or of a problem in need of solution. That idea must be tested to determine if the perceived need or problem can generate enough demand to support a new business. Prototyping has to do with creating an early version or the product or service, let’s call it offering, that can be tested by actual customers willing to provide feedback and allow for the refinement of the offering’s specific features.
The product development stage is entered when the features of the offering have been sufficiently defined and the attention shifts to production of the offering in the quantity and quality required by the market. Towards the end of the product development period, the offering will be made available to the market thought sales channels (directly or through distributors).
At that point, the business will most likely still be operating at a loss and only once sales reach a certain level will the business reach profitability. Once a business is profitable, it might require additional capital for expansion. Capital is needed for all the stages of development of a business until it becomes profitable and therefore self-sufficient.
As a general rule, the earlier the stage of the business, the greater the risk and therefore the harder to obtain capital. Capital for the very early stages typically comes from the entrepreneur’s own financial resources or from friends and family members.
The first “outside” investors are sometimes called angel investors and typically provide early stage equity capital, in other words, they obtain an ownership stake in the enterprise for the capital they provide. They also typically provide specific field and management expertise. Angel investors might invest in a business that is either prototyping or in the product development stage. They tend to be wealthy individuals with extensive experience in finance in general and private equity investing in particular.
Venture capitalists tend to invest when the business is in the late stages of product development or is already generating revenues. Again, venture capitalists obtain an ownership stake in the enterprise for their investment and sometimes require participation in the managing of the business, either by taking key senior management positions or seats on the Board of Directors. Private equity investors tend to invest in businesses that have a track record of success and an established position in the marketplace.
An established business that has reached profitability might be able to obtain loans or lines of credit either from banks, financial institutions or investors.
Here is a brief schematic of the stages of development of a business and the various funding mechanisms with an indication of their appropriateness. This is not intended to be scientific, but just to provide a rough orientation as to the best form of funding for your business.
One could argue that, for the purpose of funding Slow Money projects, all equity capital that is not deeply aligned with the ethos of Slow Money and is primarily focused on financial returns is not a recommended forms of funding. I am assuming in the chart above, that we are talking about Slow Money equity investors that see themselves as social or impact investors and willing to assume the illiquidity risk associated with the lack of a clear exit strategy.
Donations, recoverable grants and forgivable debt
Some might be surprised to learn that for-profit businesses can receive donations. The only catch for the donors is that their donation is not tax deductible. While it is possible for a for-profit to receive a donation from a non-profit entity if its activities are perfectly aligned with the mission of the latter, the safeguards put in place by the IRS to avoid abuses of the tax-exempt status of non-profit organizations make it a very difficult and unlikely source of funding. Sometimes non-profits can provide recoverable grants or forgivable debt to enterprises that are furthering the formers’ mission and goals. Recoverable grants could be returned by the enterprise receiving them, if it becomes successful. Forgivable debts can be defaulted without penalty if the business receiving them does not succeed.
If your project is particularly beneficial to your community and/or possesses a certain “coolness quotient,” it might attract donations through crowfunding platforms like Kickstarter.com, startsomegood.com or Indiegogo.com.
Personal resources, family and friends
Being an entrepreneur requires physiological qualities that are uncommon including a blend of courage, vision, commitment, optimism, dedication, single-minded focus, initiative and motivation. Sometimes such qualities can interfere with proper risk assessment and with prudent stewardship of one’s own financial resources. Reaching out to family and friends for funding can in the best of circumstances provide financial, moral and technical support, a way to diversify personal financial risk and a way to share the eventual financial success with loved ones. In the worst of circumstances it can create relationship strains and financial hardship for all those involved. Since many “great ideas” will not survive the proof of concept stage, it is not advisable to reach out to friends and family for funding a project before it reaches the prototyping stage, or better, the product development stage.
Angel , Venture and Private Equity Capital
Traditional angel, venture and private equity capital is usually not appropriate for Slow Money projects since they rely on a rapid and sustained growth leading to an “exit strategy” to generate financial returns commensurate with the risk associated with early stage equity investing. (See my article “A New Funding Structure for Slow Money Projects.”)
There is thought a small but growing number of early stage equity investors that are primarily guided in their investing by their personal commitment to building a better world. Some of them might consider themselves socially responsible investors, impact investors or philanthropists. This rare breed of investors is the one Slow Money entrepreneurs would need to seek out as early investors and partners in their ventures. It is best to reach out to angel investors when the project is in the late stages of prototyping, to venture capital investors in the product development stage and to private equity investors when the business is close to profitability.
Advanced sales are an often overlooked source of potential capital for funding a Slow Money venture. Most of the Slow Money ventures are related to food and farming and could offer to their current or future clients to buy in advance their products and services at a discount. The CSA (community supported agriculture) model is a quintessential example of this funding strategy and it could be applied to many types of businesses. Such arrangement is ideally set up when the business has already successfully entered the market with its products or services or when it is very close to doing so. Advanced sales are not suited for the very early stages of the business (idea, proof of concept, prototyping). Some businesses have used the donation platform Kickstarter to effectively fund their enterprise through advanced sales by framing the sales as rewards for “donations”. Another platform currently being tested for funding Slow Money enterprises through advanced sales is Credibles.
Royalty financing is an arrangement whereby investors provide capital to an enterprise with revenues and approaching profitability or already profitable. The investors are repaid via a percentage of the gross revenues until the initial capital plus a premium determined in advance is returned. See my article “A New Funding Structure for Slow Money Projects” for a closer look at royalty financing.
Royalty financing is a funding structure that has great potential for Slow Money projects for a number of reasons. First, royalty financing does not entail ownership and therefore the original owners do not get diluted by raising capital through royalty financing. Second, Investors providing royalty financing have an interest in seeing the business succeed but since they are paid based on a percentage of revenues do not need to have a say in how the business is run or how fast it reaches profitability. Finally, royalty financing is self-liquidating and independent on how fast the business reaches profitability. Both liquidity risk and investment risk are greatly mitigated therefore greatly expanding the pool of potential investors that can participate in such structure.
Entrepreneurs who want to determine the pace of growth of their business based on a healthy balance between work and family life and the ultimate size of their business based on a sense of appropriate scale and a sense of place might find royalty financing a very attractive way to fund their business.
Convertible debt is a very common structure for funding an early stage venture before its valuation can be determined by either the revenue stream or the profitability of the business. There are many variations of a convertible structure including whether the dividends are paid out or accumulated in the investors’ account, whether the option to convert is given to the investors or retained by the entrepreneur and the discount at which the debt is converted into equity shares of the business. A detailed discussion of the options available is beyond the scope of this article. The only important point for Slow Money entrepreneurs is that convertible debt investors will most likely become early equity investors in the business so the same considerations discussed in section above regarding the investors’ primary motivation and their alignment with the values of the entrepreneur apply.
Debt and Lines of Credit
Once the business reaches profitability, traditional forms of debt financing become available. Again, it is worth choosing the financing partners carefully and seeking out financial institutions that share some of the restorative and social values of a Slow Money entrepreneur. RSF Social Finance is an example of such a financial institution and a strong ally of the Slow Money movement.
In summary, it is important to know the various funding option available to a Slow Money entrepreneur and the most appropriate one to pursue based on the stage of development of the business. Even more important is to seek out capital from investors that share with the Slow Money entrepreneur a commitment to building a restorative economy and the future we want.