Business Tips

FINANCING NEW PRODUCTS

Developing new products is inherently risky, and this can make it difficult to get external finance. However, some sources of finance are looking for higher returns and are prepared to take a certain amount of risk where there is the prospect of a high-growth product. These 'venture' sources may include:-

• venture capital companies

• substantial businesses

• wealthy individuals (so-called Business Angels)

In some circumstances it may be possible to get loans to help finance new products. We have taken a look at how to approach each of these different sources.

The European Commission has launched a number of initiatives concerning the financing of innovation, These can be found at:-
http://cordis.europa.eu/finance/home.html

Making a Business Case

If a new product is worth doing, it should be possible to present the case for it in a document. Such business plans form the basis on which financial organisations of all kinds decide whether or not to invest.

In presenting a business case, it is important to make a good impression early on by explaining the whole concept clearly and simply in a few words. This can then be backed up with a logical and detailed description of the proposal. You should ensure a balanced representation of technical, financial, marketing and managerial information. As a guide, a business proposal might be structured like this:-

• Contents

  List the sections and give the page number where they can be found.

• Executive summary

  Explain the whole thing in less than a page, drawing on each of the later sections. It has to be a 'straight-to-the-point' page that will convince the investor or lender to read the whole plan thoroughly.

• The Market

  Explain the demand and show how the demand can be measured.

• The product/service

  Describe what you will be offering and what benefits it will bring to the customers or clients.

• Pricing and costs

  It is often worth showing the logic of your pricing as this can be critical to sales and to competition.

• Financial projections

  Formal profit and loss and cash-flow projections are a must. A balance sheet may be a bonus or a requirement. The endorsement of a respected accountant on this part will help add credibility to the figures.

• Background to the proposer

  To show how you or your team and any advisors have the technical, managerial, marketing, or other skills and experience to make the project successful.

• Long-term prospects

  Talk about your big dreams and ambitions, while showing that they will be firmly founded on the actual success of the early stages.

• Appendices

  Containing detailed information to expand on the main text, and documentation as evidence of key claims made in the main text.

If any aspect of your plan is confidential, it would be worth printing this discreetly but clearly throughout the document, and obtaining a confidentiality agreement from the potential investor. In particular, do not disclose information which you later hope to patent without agreeing and obtaining a confidentiality agreement first.

Venture Capital

It is a mistake to assume that venture capital sources like taking risks, or that they should take risks. The fact is simply that they are prepared to take a certain amount of risk if it has a good chance of producing a very high return. These sources are normally only interested in the business case for their investment. They have no other motives. It is sometimes useful to remember that the investors who make up a venture fund are often pension funds. Would you risk your personal pension on the prospects presented by your new product? Once you understand this it is clear that to approach them successfully you need to make a case for the:

• high return envisaged

• the good chances of success

• the minimisation of the risk involved

The case must be made simply, avoiding both excessive detail, and use of technical language. A well-written and balanced document of 10 - 20 pages is more likely to be successful than either a two pages of unsubstantiated claims, or 50 pages of graphs, tables, and technical jargon.

Venture sources will almost always want to see the business case made out on paper before they will meet you or investigate a proposal. Professional venture capital companies may typically receive, at each of their offices, between 200 and 500 proposals every year. They have to sift through them to find the good ones, and looking at structured business plans is the only way they can get though such a volume of enquiries.

Also, if you imagine yourself looking though several plans every working day, you will appreciate that the ones that make their basic proposition clear right at the start, are more likely to be read in depth, with a degree of sympathy.

Another important point to understand about venture capital companies is that they too have overheads. The return they make on your project has to pay for their staff, offices, and the investments that are lost. They also have to show that they have taken care to invest wisely. All this means that to make an investment can cost tens of thousands of euro before anyone has seen any return. For this reason, venture capital companies often have a minimum which they are able to invest, and are happier making large investments as the costs of a large investment are not much greater than a small one.

Business Angels and Corporate Investors

Private individuals and companies can often have complete discretion over what they do with their cash, how much risk they take, and how long they wait for a return. They are normally hoping to make a return on it just like venture capital companies, but they may have other motivations, and a different way of assessing risk.

Private individuals or 'business angels' as they are often called, may be looking for something interesting to get involved in where they can have an active role. They may also have some specific expertise or contacts to offer to boost the chances of success.

While the size of their investment may be smaller than venture companies, business angels will often back cases on their own 'feel' rather than needing an extensive business case to be made along with detailed long-term projections.

Business angels and corporate investors can often be more astute at assessing risk and be more comfortable with it, because they have specialist knowledge of the technology or the industry sector. Also, if they are going to be more 'hands on' they can help to manage the risks involved, whereas venture capitalists are mostly 'hands off' and don't like to intervene in day-to-day management.

Corporate investors are essentially other businesses. They may be suppliers, customers, a parent company, or simply a company with an interest in making good use of spare capital or assets they can 'loan' to you, such as premises or machinery. Their decision to invest is likely to be motivated by some additional factor to the potential financial return. For example a supplier of materials or components that would be needed in a new product might feel that the 'double bonus' of financial return and a new customer if the project is successful is worth the risk.

Finding corporate investors is thus a matter of networking among contacts, and possibly of researching companies that could have some secondary benefit from the proposed new product. Finding business angels is generally harder, as private individuals tend to keep their investing activities quiet for rear of being flooded with requests. Accountants and lawyers are worth approaching as they often have clients who are private investors. In some parts of Europe there are even clubs springing up for business angels. For smaller projects, even family and friends can be a source of business angel investment, especially if the risk is spread by syndicating the investment among a number of people.

Loans

In general, loan sources do not benefit from your success, no matter how great. They can be thought of as money rental shops, just like you might rent a car or a ladder. They expect their money back at the end of the loan, and they expect a fee (interest) for the service they have provided. As such, their view on a proposition is less concerned with success or failure of the project, and more with your ability to pay the capital and interest whether or not your project succeeds.

Loan sources are not generally a good idea for funding a risk project. Also, their willingness to make a loan is likely to be based on your ability to repay, so that it is really you who are taking the risk. This might be acceptable if you have spare assets that you would be prepared to gamble on your project, but is otherwise a bad idea as project failure can all too often lead to complete financial ruin for company and, if the loan is backed by personal guarantees, ruin for the individual as well.

However, in some circumstances it is beneficial to use loan finance in order to develop a profitable product for which you would otherwise not have had sufficient cash available; perhaps because of demands elsewhere in the business. In this case, rather than short-term overdraft it is better to seek a 'term' loan over a reasonable period of time in order that most of the repayment can be made out of revenue from the product.

Government Grants

It has now been widely recognised that innovation and technology lead to industrial growth, and a wealthy society. However, there is a big gap between scientific discovery and its eventual application as technology. This conversion also tends to be a slow process, and not a very efficient one. Governments across the world are trying to help the process along in the interests of making their industries more competitive, and more profitable. One way of doing this in Europe has been for the European Union to co-finance major projects to advance technology. The aim has been to enable projects to go ahead where the technology is not yet commercial and there are such risks to be overcome that individual enterprises will not invest in the research.

EU member states and regional governments are also keen to encourage better application of technology in areas where there has been decline. For this reason, governments often make available grants and soft loans to enable businesses with growth potential to realise their ideas. Some of these are backed by EU funds, others are purely national or local schemes.

The key consideration when applying for public funding is to understand the purpose of the funding and to see how your project will contribute to that objective. The skill of marrying the public sector desire for economic growth with your need for profitable products should not be too hard. However, the specific details of a funding programme may be out of line with what makes commercial sense for you, in which case the funding should be avoided.

In terms of EU funding, the best place to look is the CORDIS information on the current four-year plan of funding known as the 5th Framework Programme which began in January 1999:-
http://cordis.europa.eu/fp5/home.html

You can also get information on CORDIS via:-

• The Programmes database, which contains policy and implementation information about individual programmes

• The News database which contains current information such as calls for proposals. Beware, however, that unless you have been following a specific programme and understand its ethos and priorities, you are unlikely to be successful simply by responding to a call for proposals.

If you are able to find an existing technology via the Technology Offers or Results service, you may want to look in particular at 'demonstration projects' which bring technologies nearer the marketplace while developing best practice in this difficult process.