Dear Consultant,
We’re starting a business that aims to sell a new product that my partner and I developed. The product is novel and we believe that it can make a significant amount of money if we can get it into the hands of the right retailers. We already have working prototypes and some retailers willing to work with us, we also have enough funds to do at least one or two manufacturing runs. We have been told that we should start big, and to do that we need external funding to develop the inventory needed to push our product into retail channels. Is this a good approach, or should we try to fund this ourselves and not tie ourselves down with debt or giving up partial ownership of the company?
You’re in the enviable position of having a viable product and it sounds like you have some good leads with retail partners. Getting funding for the manufacturing of orders already agreed to shouldn’t be such a difficult thing. Some banks would likely be willing to work with you and depending on the nature of your product there are other alternative funding sources such as venture capital funding. However, you’re also in the position to possibly fund your growth organically from your own operations. Let’s look at these options.
1) Take out a loan.
Take on debt to finance your manufacturing. The least complicated way to fund your manufacturing is to take out a loan to pay for your operations. You’ll pay interest on this loan for the duration of the time it takes you to pay it back, and the amount of interest that you pay will depend on how risky your lender thinks that you are. You can get cheaper loans if you have some assets like a building that you can use to secure your loan. Secured debt can sometimes offer significantly better interest rates than unsecured loans where you offer no collateral to back the money that you’ve borrowed in case you are unable to pay the loan back to the lender. Likely candidates of lenders may be some more risk tolerant banks, or a banker who has worked with you in the past with whom you have a good relationship. You could also borrow from friends and family if that option were open and made sense to you.
2) Give up equity.
You can offer equity in your company to an investor in return for the money. That is, you can make them partial owners, affording them rights to part of all of your future profits and the ability to have input into decisions about how the business is operated. Typically venture capital funding works like this, they want a large portion of the ownership of the company in return for money for you to grow your business. In many cases this makes a lot of sense, but you will relinquish some control of your business. There may in the option to negotiate the terms of funding agreements like these where the funder may not have decision making rights and will only share in future profits. Equity ownership partnerships can be made with anyone, not only with traditional venture capital firms. Family members and neighbours could also be given partial ownership in return for funding. It is usually advisable to incorporate in situations like these.
3) Bootstrapping.
If you already have a prototype and enough funding for some manufacturing as well as at least one or two retail partners to sell your product then you may have the ability to remain lean and fund your next round of manufacturing after your first round sells through your retailer. That is, make profit from the sales of your first round of manufacturing and reinvest all of those profits into the manufacturing of the next round of products. The term bootstrapping refers to the proverbial “pulling yourself up by your own bootstraps,” or doing it yourself. The advantage of this is that you maintain complete ownership of your company and you’re not saddled with loan payments. A disadvantage of this is that you may have to turn down large orders that you aren’t able to fill because you won’t have enough cash from your last sale. This type of organic growth can be great, but it can also slow down the growth of your organization. In the case of competitive industries, this could be particularly problematic as your competitors may be able to fulfill large orders that you’re not able to do given your limited funding.
The best decision in your case will depend on the opportunities that come up from retailers and from lenders or funders. It goes without saying that growing organically is the best route until such time that demand from retail partners outstrips your ability to fund manufacturing. At that point you’ll want to re-evaluate that strategy.