In our 4 part series dedicated to new product developers, innovators and inventors, we explore the 8 top considerations when developing a new product. Whether a seasoned marketing professional or first timer, these eight critical components include aspects related to product design, positioning, manufacturing, distribution and financing.
What You’ll Need to Start: Ample Capital
Beyond personal savings, innovators look to family and friends, explore small business loans and even tap into retirement accounts to raise money for their startup products. The initial outlay of inventory capital—that which could be tied up for months is often the greatest obstacle to overcome. Minimum order requirements (MOQs) by factories usually cause a lump in the throat for the first time product developer. Even if you have the greatest gadget in the world, how do you plan on financing that first big P.O.? You’ve likely invested significantly to develop your innovation—a figure that has hopefully been taken into consideration for ROI and overall budget. While established corporations have ample cash flow for typical starting inventories, this may be the greatest initial hurdle for those new to the process.
Inventory Financing / Purchase Order Funding / Factoring
There are a half dozen inventory financing groups (IFGs) in the U.S. who provide bridge capital, purchasing and taking title to inventory which goes to a third party distribution warehouse. You then pay the IFG as for the cost of goods plus any in and out fees required by the warehouse as you sell merchandise. Purchase order financing is a new twist on Factoring, an older practice in which small businesses sell invoices at a discount for faster recovery of cash, providing the factoring company with a substantial fee. The caveat is that the invoices must be to reputable clients, i.e. Walmart to be considered.
These can be good options that allow you to purchase greater quantities thus commanding volume discounts. Another benefit is that you don’t have to give up equity to outside investors. Many times the factories’ terms require money down at the time of placing the purchase order. IFGs make it possible to abide by these terms. These companies will want to know:
- Your sales and marketing strategy (refer to Part I of the series) and about your team
- The quality of the products produced
- Your margins
- Inventory turns
- Your credit worthiness and track record
Personal guarantees and background checks are almost always standard protocol which usually means demonstrating some form of net worth whether savings, retirement funds, property, creditworthiness and no criminal records. They may also not take a chance on a new client—one who has no real balance sheet to speak of. Another downside is that these lenders charge interest rates that can be as high as 40% annually. Lastly, there is always a time requirement (term) for making good on these loans which are usually around 60 days. If you are unsuccessful in meeting your sales plan, stiff penalties may be imposed.
In just the past few years companies like Kickstarter have created tech based forums which bring creative projects to life and are open to investment by the general public. To date, over five million people have pledged over $800 million and funded more than 50,000 projects to date on Kickstarter in categories such as films, music and the arts, video games and inventions.
Crowdfunding is catching on and becoming more accepted as a means of raising capital. Investors do so at their own risk and there is little to no governance or regulation meaning no reporting or other administrative overhead. Crowdfunding is really an eco-system for philanthropy and those playing in this space have an entrepreneurial spirit. Mostly, investors do not generally require any form of equity or preferred stock so your ownership is not diluted. On April 12, 2013 the JOBS (Jumpstart Our Business) Act, was signed into law and is designed to increase job creation and economic growth. The good news is that it eases fundraising regulations imposed by the SEC enabling more entrepreneurs to raise capital.
Because blocks of investments can be minimal—as low as $1,000 or less, investors may be less motivated to provide insight or contribute to the long term success of a project.
Seed Capital / Angel Investors
The difference between Seed Capital and Venture Capital is that Seed money comes from individuals vs. institutional investors. Most angel (seed) investors have a wider appetite for risk and a savvy track record for assisting startups with building their businesses. These professionals are also versed in providing feedback on pro-formas (financial targets for top line revenues and margins; cash flow models and debt. Generally seed investors are less hands on in the day to day running of the business once they have a sound idea of your business plan. Seed investments are less administratively complex with less formal corporate contracts and governance.
Seed capital usually comes at a cost—Equity. There is risk on both sides. The investor may never recover their investment or you may give away too much ownership. Usually the latter results because it is just so tempting for the inventor to commence their dream.