How much risk is an entrepreneur really taking?

In Mel Brooks' comedy, The Producers, the character Max Bialystock tells young Leo Bloom the two cardinal rules of being a Broadway producer: rule number one, he says, is "never put your own money in the show."

And, for rule number two, he screams: "NEVER PUT YOUR OWN MONEY IN THE SHOW!"

I have met with dozens (well, it feels like dozens) of people who want to start a business.  

But, they won’t put any of their own money into it.

So, while the concept is funny in a Mel Brooks show, what these would-be entrepreneurs are telling the world is that they have this great idea, but they don’t believe in it enough to risk their own savings.

On the face of it, what does that tell you?  Would you invest in a venture in which the owner hasn't put any of his/her own cash?  Or would that send up a red flag?

Some might argue that they have, instead, put in "sweat equity".  In other words, they have worked to get the business going and that constitutes their investment.

I believe that, to most investors, the idea of "sweat equity" is valid.  But, there's an issue here that investors I have spoken with (myself included -- yes, I spoke with myself) see as possibly important and maybe very telling: does the entrepreneur still have his/her day job?

In other words, does the entrepreneur believe in the business enough to take a real risk, quit his or her comfy, secure job and work full time in the venture, for equity, in the belief that the effort and sacrifice will pay huge dividends when the business succeeds?  Or are they working 40 hours a week at the good paying job in case the new business collapses?

Because, if they kept their day job and they have no money in the company, how much have they truly invested?  To an outsider, this scenario may look more like a hobby than a business.

Entrepreneurs should understand that many investors will expect you to take risk.  This is a level of credibility that many private investors look for; they will want to know whether you have risked your own money and livelihood to make your vision succeed.

After all, if you don't believe in your company enough to truly invest in it, why should an outside investor?

There are alternatives for those with great ideas and high levels of risk-aversion.  One is to consider selling the idea to someone else (perhaps in exchange for a royalty of some kind).  My point, however, is simple: generally speaking, if an entrepreneur isn't willing to risk anything, he might have a difficult time getting someone else to do so.

The SBIR program -- one way to get an innovation funded

The US government will, under certain circumstances, send your business some cash.

We are not referring to the websites that pop up if you Google something like “how to get free money from the government”.  You may want to stay away from those.  :-)

The funding that we are referring to is from a successful program started by the federal government over 30 years ago. It’s called "Small Business Innovation Research" (also known as SBIR) and is coordinated by the Small Business Administration.

Under this program, the government will provide funding to turn innovative ideas into commercial products that might help the federal government and the economy at the same time.  The small businesses get the cash and use it to work on the innovations. When the innovations turn into products, the businesses hire people, which helps the economy and brings in tax dollars back to the government.

The process is pretty much as follows: Government agencies (e.g., the Department of Defense, the Department of Energy, the National Science Foundation, etc.) periodically publish topics of interest and proposal guidelines.   Any small business that wishes to apply for SBIR funds must submit a proposal under the relevant topic.  The proposal will be evaluated and either accepted or rejected. 

Funding decisions are based on a number of factors, including the proposal merit, the team and available funds (Congress determines how much the SBIR program is allocated each year).  We know of at least one funding agency that will list the proposals they wish to fund in order of preference.  They will start with the top of the list and go all the way down until they run out of available funds.  Each year, good, intriguing proposals are not funded because the agency simply did not have enough cash available.

The agencies will provide funding in two phases. Phase I awards are typically around $100,000 and Phase II awards (which are granted to a small percentage of Phase I awardees as follow-ons) might amount to $500,000 or sometimes as much as $1,000,000.

If you’ve never received an SBIR award, here are some tips from those of us who have:

-- make sure you follow the proposal guidelines to the letter; you may have the best idea in the world, but if you use an improper font size, wrong margin widths, submit too many pages or otherwise don’t follow the specific steps outlined by the agency, they will almost certainly exclude your proposal (and, most likely, they won’t even read it)

-- make sure you address the topic; if the agency is asking for innovations relating to, say, a light emitting diode, do not respond with an idea relating to halogen.  No matter how much better you think your idea might be, chances are good that the program officer reviewing your proposal will deem it “unresponsive” to the topic and reject it.

-- attend an SBIR conference; the agencies host SBIR conferences periodically all around the nation. If you are serious about getting funding for your idea, they are worth attending. You can learn about the different agencies involved, meet and network with program officers and learn more about the specifics of what they are looking for. We have personnel who have attended these conferences in the past; our opinion is that they are well worth it.

The SBIR program has been extraordinarily successful. If you Google “SBIR success stories” you will find quite a few examples.  An award can give you a financial boost and (if your venture is a little riskier than most) a level of credibility when angel investors and VCs might otherwise be hesitant to give you the time of day.

If you are seeking funding for an innovative idea, we encourage you to check out the programs. Here are a two important links:

http://www.zyn.com – this popular site is called the SBIR Gateway. It is a central source for the agencies that participate in the program and, among other things, provides links to solicitations.

http://www.sbir.gov – the SBIR official website.

There’s a sister program of sorts called Small Business Technology Transfer, or STTR (and yes, the various government agencies are aware that the initials don’t match the name of the program, but no one seems to really care).

We've had a ton of experience with this program.  We've won proposals, lost proposals, attended the conferences and some of our staff have even served as part of review panels for SBIR programs at government agencies.  So, feel free to contact us for help as well.