This past Monday I talked about convertible notes and the benefits of using them as a funding vehicle in the early stages of your startup. Today I am going to cover the simple agreement for future equity, or SAFE.   As a reminder, a convertible note is a hybrid funding vehicle that combines aspects of debt and equity funding. They are essentially a short-term debt obligation where the investor can convert their investment into shares of the company at a later date. One main benefit of a convertible note is that the valuation of the company is postponed until there is more information available through which to set a fair value.   A truly simple agreement for future equity   The concept of a simple agreement for future equity, or SAFE, was created by one of the most recognized startup incubators in the U.S., or perhaps even in the world. The Y Combinator incubator came up with the SAFE vehicle to take advantage of some of the aspects of a convertible note, but with even simpler terms.   With a convertible note the startup owes debt to the investor. Whereas with a simple agreement for future equity the investor only has a warrant (or right) to purchase equity in the startup at a later date. So, no interest is left to pile up to be paid by the startup.   Also, I didn’t mention this on Monday, a SAFE does not have a maturity date since it isn’t a debt vehicle. A convertible note does eventually come due.   When does a SAFE make since?   Like a convertible note, the simple agreement for future equity makes a lot of since early in the startup’s life when valuations can be tough to assign.    In my mind, the SAFE vehicle is a preferred choice to a convertible note because it does not tie up the startup with debt and interest that accrues.   Next up   This Friday I will talk about yet another type of simplified funding vehicle called a KISS. 

This week on the Funding Simplified series I am moving back to topics around working with investors. One of the funding vehicles that has been gaining in popularity for some time is the idea of a convertible note. Let’s take a look at what a convertible note is, how they work and why they might make sense for your startup.   What is a convertible note and how do they work?   A convertible note is a type of hybrid funding vehicle that combines aspects of both debt and equity funding.   The initial funding phase is considered debt or a loan, typically short-term debt. However, the investor has the ability to convert that debt into equity and usually at a discounted price as compared to future investors.   When does this type of funding make sense?   Typically used in the very early stages of fundraising, convertible notes work great when establishing a startup’s valuation is difficult. Setting the value of a startup can be tough, for example, if the company is pre-revenue or has yet to accomplish many other types of milestones (users, a prototype, etc.).    By using a convertible note the valuation of the business is “kicked down the road” until there is more information that will aid in setting a fair valuation.   Another benefit of using this type of funding is that the founder(s) aren’t likely to give up seats on the company’s Board. With standard equity funding, investors often ask for some level of control by becoming a voting member of the Board that directs the company. Under convertible notes, although it is possible, that is usually not the case.   When doesn’t a convertible note make sense?   The majority of startups don’t need another expense on their books. This type of funding carries interest that is due, at various points in time.   Next up   This Wednesday on the show I will be talking about an even newer funding vehicle that is a cousin to the convertible note. That is the SAFE, or simple agreement for future equity.

Small business loan rates can vary depending on a variety of factors.    Most lenders use something called a “risk grade” to determine the rate they will offer you once approved. That risk grade often takes into account things like your debt-service coverage ratio, credit ratings (both personal and business), and other factors.   Those factors are then weighed and converted into a score (usually on a numeric scale) that the lender then uses to determine your rate.

So, how long does it take to get a loan these days?    Well, even with the advances in technology that are being used to speed up the lending process, you should expect it to take longer than you want.   There is no question that certain types of small business loans take longer than others. But before we get to that, let’s talk about the various stages of the loan process.

 

STTR grants   The STTR grant program is very similar to the SBIR grant program. However, the STTR program was specifically designed to encourage joint venture opportunities between small businesses and non-profit research institutions. In fact, to qualify for an STTR a small business must formally partner with a research institution in both Phase I and Phase II work.   To qualify as an eligible joint venture research institution partner, the institution must be located primarily in the United States or contribute “significantly” to the U.S. economy through taxes or use of American products, materials, labor, etc. and is a non-profit or a federally-funded National Science Foundation center.   The STTR program is also funded by federal agencies whose R&D budgets exceed $1B. Those agencies are required to contribute .45% of their budget toward the program. Currently, that includes five agencies (the Department of Defense, the Department of Energy, the Department of Health and Human Services, the NASA and the National Science Foundation.   Phases of funding   The phases associated with these grants are very similar to that of SBIR grants.   Phase I is where the company is still establishing the feasibility and merit of the solution. This phase has a cap of $150,000 in funding over a one year period.   Phase II is funded based on positive traction accomplished during Phase I and normally do not reach funding amounts over $1M over a two year period.   Finally, Phase III SBIR is strictly for pursuing the commercialization of the solution.   Application standards   Each STTR grant has specific guidelines for the documentation submitted to qualify for such a grant. That documentation should include:  

• Company information
• Customer and competition descriptions
• Analysis of the market
• Explanation of any associated intellectual property
• Financing needs
• Mentoring needs
• Data collection plans

  For more information about funding your business, click here.  

SBIR grants   Monday I talked about grants in general and even mentioned Small Business Innovation Research (SBIR) grants.   The program is designed to encourage small businesses to develop solutions that have the potential to be commercialized. Those solutions are often to meet the needs of the United States government. Therefore, the SBIR grant program is funded by federal agencies. In fact, those that have R&D budgets exceeding $100M are required to allocate a certain percentage of that budget toward SBIR programs. As of right now that means there are 11 agencies that help fund the program.   Companies that receive SBIR funding do some based on the phase their research is in.    Phases of funding   Phase I is where the company is still establishing the feasibility and merit of the solution. This phase has a cap of $150,000 in funding over a six month period.   Phase II is funded based on positive traction accomplished during Phase I and normally do not reach funding amounts over $1M over a two year period.   Finally, Phase III SBIR is strictly for pursuing the commercialization of the solution.   Application standards   Each SBIR grant has specific process for determining the success of the program. That process includes:  

• Engaging stakeholders
• Describing the program
• Focusing on the design pieces
• Gathering additional data
• Establishing conclusions
• Presenting the findings

  This process is important to note because it will give SBIR grant applicants additional insight into the type of information that the programs are looking for.   The application should include an outline that is close to the following:  

• Cover sheet
• Identification of the opportunity
• Technical objectives
• Related work performed by the applicant
• Future research
• Commercialization approach
• Key personnel
• Facilities/equipment involved
• Cost proposal
• References

  While there is some flexibility in this structure, I recommend staying as close to it as possible.   For more information about funding your business, click here.

Small business grants   Where an entrepreneur can get access to small business grants is a common question I receive. Grants come in a variety of shapes. Some are available to any entrepreneur, while others are specific to certain groups (i.e. women, minorities, etc.).   Let’s take a look at some of the various small business grants that are out there.   Federal programs   One of the best resources is the U.S. small business grant database at Grant.gov. Here you can search through all available federal grants, as well as the agencies that offer those grants. The site includes a lot of resources to help entrepreneurs better understand the grant application and approval process. Another nice feature is that the database is also accessible via a mobile app.   Two of the specific federal grant programs that I have had the most experience with are the Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) programs which focus on research and development of technology and scientific research. My exposure to these programs has largely occurred through my time managing my cities incubator and during my time working with the Innovation Crossroads program. One key point is that, like with other grant programs, the application and approval process is very competitive and detail oriented. You need to prove that the research you will be doing is aimed at solving a problem the government is looking for answers to.   Other programs   While the government is the main provider of small business grants, there are other grant resources available. For example, some large corporations provide grants to entrepreneurs as well. Companies like FedEx offer a grant through their annual grant contest.   Keep in mind that while small business grants do exist, a business grant is not always “free money”. Meaning that they can come with various stipulations that the entrepreneur is required to fulfill.   For more information about funding your business, click here.  

What is a factoring loan?   A factoring loan, also known as an asset-based loan, is a type of business loan where the lender is willing to provide credit based on the amount of revenue the borrower is anticipating having in the near future.    When a business allows their clients to pay them over a period of time, otherwise known as “on terms”, they have become a lender themselves. The business makes the sale and then invoices their client requesting payment in the near future. That period of time is often 30-90 days. However, in some circumstances, the client takes their time paying the business.    In situations like these, the business can run short on the cash needed to pay its bills such as payroll and other operating expenses. That is when a factoring loan makes sense for the business.    When your business becomes a lender   Imagine your business makes a product. When buy the components needed to make that product the supplier might let you take some time to pay their invoice. Let’s pretend that time is 15 days.   Now, your business takes those components and spends 5 days producing the product you sell. Then you sell that product, but because your competitors offer “terms” to their clients you do as well. Let’s say that you allow your clients to take 30 days to pay your invoice.    In this example, your business has become a lender. In the above scenario, you have a timeframe of about 20 days where your business out some cash because it has paid for the components to produce your product, paid for the staff to manage the sale of the that product, but you are still waiting for your client to pay for the product they have already received.    It is in situations like this that a factoring loan comes in handy.    Discounting your factoring loan   Lenders that make factoring loans will generally lend you a portion of the total amount of invoices that you are due in order to tide your business over for a period of time. In the above example that would be the 20 days.    One note to think about, however. When you offer your clients terms there is the possibility that some will not pay you within the required timeframe. Lenders that do factoring loans know that and they will discount your line of credit by that amount. This is often true for any invoices that are past 90 days due.   If you’d like to talk about your particular situation and get my input on what type of loan, if any, makes sense for your business just reach out to me here.

Just about every business these days accepts credit/debit as a form of payment. If your business isn’t, then you are missing out on sales opportunities. Also, if you aren’t accepting plastic as a form of payment then you can forget the possibility of qualifying for a merchant cash advance.   What is a merchant cash advance?   A merchant cash advance is a type of business loan where the lender extends you a loan, usually a line of credit, based on the amount of sales you have coming in each month. The lender uses the income from your sales activities to recoup the payment you owe on the loan.    This type of loan is always unsecured, meaning that you don’t have to sign over any sort of collateral like in a hard money loan. Or, do you?   Hand over the keys to the register!   Even though this type of business loan is considered unsecured, or without collateral, there is some level of security put in place by the lender. Most merchant cash advance lenders require you to give them access to your bank account so that they can withdraw your loan payment from that account.    Something to think about with a merchant cash advance is that the lender may take your payment in daily installments. That’s right, I said daily. Meaning that each day, after you have closed out your sales, a merchant cash advance lender may come in and take one day’s worth of the amount owed for the loan.   For some borrowers this could be seen as a positive, as they don’t have to worry about a huge payment being due at the beginning or end of each month. For others, seeing cash leave their account daily could be too much. For example, what happens if you had a slow sales day that included the need to refund some purchases that put you in a tight cash position? Having a merchant cash advance lender take their payment on that day could hurt your ability to order new inventory. This is a bit of an extreme example, but understanding the mechanics of a merchant cash advance are important.   If you’d like to talk about your particular situation and get my input on what type of loan, if any, makes sense for your business just reach out to me here.