Funding Decision Criteria Matrix

On funding innovation

Developing a funding plan for your innovation, or funding pipeline for your community, is difficult because it just takes so many varieties of investor personas as you push forward. We should be openly discussing the challenges - and potential solutions - for firms, investors, and communities in an attempt to better bridge what has been referred to across the country as the “Series A Gap.”

Seeding innovation

On your first day of banking school you learn the only four ways in which companies generate cash:

1. Sales, profitable

2. Assets, converted

3. Debt, new or refinanced

4. Equity, sold

At its surface, it is so simple, so elegant. Just do one of these four things, and cash will be generated.

There’s no “lean” in pharmaceuticals.

Except, of course, you are doing something so new that profitable sales may not be an option. Maybe regulation keeps you from selling your product, like with pharmaceuticals and medical devices. Maybe the value of your creation supersedes the needs of profitable early adopters, like Wikipedia or Twitter. Maybe you need to build your key asset to a certain point before a buyer’s value makes itself apparent, like in restaurants, retail, or art.

And if you are doing one of these things, you likely don’t have tradable assets in your business, like receivables, or the capacity to take on additional debt, assuming, of course, you have already capped out your personal capacity.

Everyone, at some point in their life, has done something that is restricted from, was not intended to, or was simply too misunderstood or early to market to generate profitable sales.

Does the possibility of not being accepted by early payoff mean we shouldn't do something?

If you are reading this, I’m assuming your answer is the same as mine… of course not.

However, cash is still important, and equity is the best way to generate that much needed resource.

As human beings, we do this for ourselves all the time. We invest a little now in hopes that whatever we are doing pays off in the long term. College is a great example. So is a gym membership. And when we make these investments, we have absolutely no assurance of what will happen in the future. We don’t know that the investment will pay off. We actually don’t even know that what we expect to happen will happen. We only know that we are investing in ourselves.

Getting others on board, then, is the challenge.

Innately, we are asking someone to bet against themselves and bet on us personally.

And that, my friends, is the first challenge of funding innovation at the seed round. There is a promise of a technology, of a fit in the market, but the real decision is based on one thing alone:

Do I bet that this team has a better shot at hitting a home run than another project, or my own?

Think about how uncomfortable it is to make this decision. Tough. It is counter intuitive. It is not natural.

Yet it happens, and typically because for one or all of the following three reasons:

1. There is an infrastructure that makes seed investment controlled

2. An investor simply wants to see this innovation become a reality

3. The team is just that good

For these reasons, the seed round is unique to other funding rounds. It takes a certain type of investor and a certain type of team. In mass, like when building an entrepreneurial ecosystem, it takes a considerable amount of over-investment in an environment where special teams can flourish with, and in competition with, their peers.

 Investor pitches at seed-stage accelerator fund Gazelle Lab’s Demo Day.

Does this happen? For sure. Software innovation thrives where there are successful accelerator investment programs. Movies get made where there are studios to greenlight pictures. Breakthroughs are generated at Universities where research dollars are plentiful.

When the ecosystem works, there is room to grow and nurture innovations that might take longer to mature. Only a network that took a chance to develop a Seinfeld would also take that same chance on The Office. Neither were an immediate home run, both required enough flexibility and structural support to flourish.

A first round

A startup looking to raise Series A is like looking to hire a new college graduate. All the promise in the world, very little proof. On the upside, someone invested in this grad’s education, and the grad completed the program. On the downside, we haven’t yet translated skills from academia to the real world. Do you offer this person a job?

For most of us, if the stakes were low enough, we would support this graduate. Only a precious few of us would take that graduate, place them in a high stakes position in our firm, and bet a portion of our future on theirs.

Yet that is exactly what a Series A investment is.

Building this type of investment pool is so difficult to nurture because it takes such a unique type of investor. One willing to make large bets based on the early promise of team, technology and traction. One willing to overlook the lack of proof and gamble a bit. One in love with startups and startup culture.

Post-A

I've heard repeatedly, if you build a great company, it will get funded. I generally agree; however, to this point we've only been discussing a team with an innovation.

By the time we are a great company, we are, by definition, no longer startups. We are companies. Commercial businesses. Investment vehicles for our investors and owners.

Companies, particularly great ones, have funding options. Not just equity, but now profitable sales have been demonstrated as reality, assets can be converted, and debt can be leveraged.

Yet to get there, we had to get a seed investor to support our team over theirs. We had to find an investor willing to take a gamble on us, our technology, and our early traction. We had to take that support to build our innovation into a great company.

Startup Weekend is a great place to find early pipeline for investment.

Getting a steady stream of innovations to this point is the goal of building entrepreneurial ecosystems.

So

Today, Series A has been consolidated down to a few key markets - where entrepreneurial ecosystems are thriving - and the rest of us lose our high profile, high potential startups and talent to those markets. This is beginning to change; however, we need a major Series A disruption.

Yes, this is a challenge I am proposing.

This also helps cultivate more seed investing. If there is a promise of bridge investment between seed and post-A rounds, it is likely I will not lose my investment, or watch it leave town. Leading to more overall interest in startups.

Not to mention, the types of folks who actively make Series A investments are cultural touchstones. They have positive, contagious biases *for* entrepreneurs. They change the game.

Every one of us would like to see more aggressive, attractive funding for innovation - either for our own firms or to help develop the communities in which we live. Now that we’ve outlined the challenges, it is time for real solutions.

Let’s continue this discussion on twitter @sparkcatalyst, share with us your thoughts and responses via #a4innovation.