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Robert M. Hunter Registered Patent Agent Robert M. Hunter, Ph.D.

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FUNDING YOUR IDEA

by Robert M. Hunter, Registered Patent Agent

Ever hear the old saying, "It takes money to make money?" Itís true. In the U.S., it can cost $100+ million to develop and launch a consumer product like a new mouthwash and $300+ million to develop and launch a new pharmaceutical product. Even fairly straightforward mechanical or software products can cost millions of dollars to develop and commercialize. So, you (or someone else) will need money, and lots of it, to get your idea to the marketplace.

Here's an explanation of where and how to obtain the funding you will need to develop and commercialize your invention from both public- and private-sector funding sources.

U.S. GOVERNMENT FUNDING SOURCES

The U.S. Government invests about $70 billion annually in funding research and development. A variety of programs are available to fund development of new technologies; here's a sampling:

Small Business Innovation Research

Federal agencies and departments that spend $100 million or more on research and development are required by law to set aside 2.5% of the money they spend on extramural R&D. Technology-based small businesses in the U.S. compete with one another to conduct this government funded R&D of new technologies. At present the SBIR programs of ten agencies and departments award over $1 billion annually to U.S. small businesses. While the programs are similar, the program of each agency and department is set up and administered differently from that of the others. Phase I SBIR awards (up to $100,000) are used to assess the technical and economic feasibility of a concept. If Phase I is successful, Phase II SBIR awards (up to $750,000) are used to build and test a laboratory prototype of the concept. These programs are very competitive. Odds of winning a Phase I award are about one-in-ten and about one-in-three for Phase II awards. To remain competitive small businesses must successfully commercialize the results of the funded research.

Small Business Technology Transfer

STTR programs are similar to SBIR programs, but fewer departments and agencies (and less total money - about $100 million) are involved. The win ratios of STTR programs are higher than those of SBIR programs because STTR programs receive fewer proposals. STTR program rules require that a small business team with a research institution, like a U.S. university or federal laboratory, and allow the Principal Investigator (the person responsible for conducting the research) to be employed by an entity other than the small business.

Inventions and Innovation Program

The U.S. Department of Energy's I&I program provides financial and technical support to bring energy-saving inventions to the marketplace. The program provides financial assistance for establishing technical performance and conducting early development of innovative ideas and inventions at two levels: up to $40,000 or up to $100,000. The amount awarded depends on the stage of development. In addition to financial assistance, the I&I program offers technical guidance and commercialization support to successful applicants. The I&I program currently awards about $4 million per year in grants. Although the program has been reorganized lately (it used to be called the Energy Related Inventions Program or ERIP), it appears that the odds of receiving an I&I program award are much lower than SBIR or STTR odds. This program is generally more accessible to independent inventors who are not scientists than are the SBIR and STTR programs.

National Industrial Competitiveness through Energy, Environment, Economics

The NICE3 program, sponsored by the U.S. Department of Energy (DOE), promotes energy efficiency, clean production, and economic competitiveness in U.S. industry by supporting innovative technology deployment. Industry applicants must submit project proposals through a state energy, pollution prevention or business development office. Awardees receive a one-time grant of up to $400,000 to fund up to 50% of total project costs for up to three years.

Advanced Technology Program

The ATP is a partnership between the U.S. Government and private industry sponsored by the National Institute of Standards and Technology (NIST). The purpose of the program is to accelerate the development of high-risk technologies that promise significant commercial payoffs and widespread benefits for the economy. Joint ventures must pay at least half of the project costs. Single companies working on ATP projects must pay all indirect (overhead) costs associated with the project. An estimated $82 million in first year funding was available for new awards for fiscal year 1998.

Cooperative Research and Development Agreements

U.S. federal laboratories are authorized to enter into CRADAs with U.S. companies. In general, the federal laboratory provides access to unique equipment and/or services and, often, no money changes hands during the development phase. Sharing of income from intellectual property developed during the CRADA is often called for.

PRIVATE-SECTOR FUNDING SOURCES

A variety of private-sector funding sources are available. In general, there is less bureaucracy involved in dealing with these sources.

Your Savings

The first source of money is your savings. Many investors will eventually require that you "put your money where your mouth is" so be prepared to kiss those savings goodbye.

Retirement Accounts

Think twice before you use the money that you have saved for retirement to fund development of your invention. The technology development business is fraught with risk. If you do cash in your IRAís, etcetera, you and your spouse should realize that you may have to live more frugally in retirement than otherwise. Of course, there is a chance that the opposite will be true, but it is important that you admit to yourselves - it is a small chance.

Family and Friends

When you exhaust your personal funds, the next place to seek money is from family and friends. The simplest way to involve family and friends is to borrow money from them. The general rule here is, "Do not borrow more money than you can make payments on indefinitely." Also, make sure that you draw up a written loan agreement that clearly states what the money is going to be used for, how much money is going to be borrowed, what the interest rate is, when it will be paid back, what the monthly/quarterly/annual payments will be, what the collateral is, what happens if you cannot make a payment, etcetera. Business deals have broken up more than one friendship, marriage or relationship - donít let it happen to you. Also, do not borrow from family and friends who cannot afford to lose their investment - in case you "get run over by a truck" or are unable to meet your financial obligations for some other good reason.

A second way to obtain money from family and friends is to sell them a share of the invention itself or stock in the company that owns the invention. In both of these instances, it will be necessary to first prepare a valuation of the asset to be sold (valuation techniques are discussed elsewhere.) If you sell a share of an invention, it is important that the purchase agreement cover such things as the nature of the rights transferred (because any owner of an undivided interest in an invention can license it with no obligation to share revenues with other owners, unless there is an agreement to the contrary), how future development/marketing costs will be shared, how future profits will be shared, etcetera. If you plan to sell shares of stock, compliance with state and federal securities laws will be necessary, as is discussed below.

Angels

Angels are wealthy individuals who invest in new ventures, typically by buying stock in the venture. They are often interested in the technical field in which the company operates, possibly having made their money in that field. In order to protect their investment, they typically want to become involved in the management of the companies in which they invest, e.g., by becoming a member of the board of directors. The best angels bring more than just money to the "table" ó they also bring contacts, expertise, credibility, and power. As is the case with any equity investor in startup ventures, angels expect the companies in which they invest to have experienced management teams and credible business plans that project significant returns (40-100% return on investment compounded annually or "ten times their money in five years".) Because they do not want to be harassed by hungry entrepreneurs, angels typically keep a low profile. Thus, they can be hard to find. Most larger communities and many states have angel networks or clubs, some of which are formally organized, many of which are not.

Venture Capital Firms

Although angels and venture capital firms are both venture capitalists, venture capital firms are typically professionally run operations. Venture capital firms often invest in particular fields, in ventures at a particular stage of development (typically more mature ventures) and in ventures with very large growth potential. Often, venture capital firms are interested in investing in ventures that need tens of millions of dollars of capital to reach their potential. Prattís Guide is an excellent source of information on venture capital firms.

Stock Markets

Offering stock in your venture to the public is another way to raise capital. Public stock offerings must comply with state and federal regulations. Typically, the services of an investment banker are used.

Corporate Partners

Large corporations can be excellent sources of relatively lower-cost capital. Finding an in-house "champion" for your cause and closing a deal with a large corporation can take a lot of time and effort. The apparent fickleness of large organizations can also make obtaining funding from corporate partners a challenge. There are good reasons this approach is called "dancing with elephants."

Banks and Government Loans

Banks loan money to people who have assets that can serve as collateral for the loan. For example, second mortgages can be used to convert the equity available in real estate (e.g., the difference between the value of your house and the debt you already owe on it) into cash. Because banks do not typically make equity investments (e.g., buy stock in startup companies), but rather loan money to people and companies who have assets to back up the loans, it is often said that, "banks loan money to people who do not need money." Often, the owners of startup companies are required to personally guarantee repayment of loans to their companies. Government programs are available that can reduce the effective interest rate of bank loans and make debt available to companies that would otherwise not have access to this source of funding.

Summary

The money you will need to fund your idea can be obtained from a variety of sources. The information and links provided on this page should enable you to find a source of funding that is appropriate for your needs.


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