Premise:

Technology and growth-oriented startups are the primary sources of job and economic growth. Startup companies, by their nature as new and small companies, must grow to survive. To grow, these companies must find ways to compete in a dynamic and challenging environment. Successful competition often requires external financial resources to fuel the innovation and growth needed to reach financial and operational maturity.  

 

Issue:

Access to external financial resources is limited by geographic, network, and market constraints. These limitations create barriers to business and economic growth, particularly in areas not already leading in technology startup and funding density. Further, investor interest and risk capital can accumulate in select technology and market areas with the highest perceived return:risk ratio. Startup companies outside established markets, trendy technology areas, and at early stages of development without demonstrated customer engagement are often at a considerable disadvantage in realizing their otherwise significant growth potential. 

 

Solution:

Strategic and focused investment in TBED risk capital resources can close gaps and create opportunities for startup companies to succeed financially, operationally, and economically. Developing and effectively managing risk capital resources can create an economic flywheel that leads to long-term local and national economic benefits.  

 

Finance program insights:

  • Effective programs often leverage private sector resources and motivations.

  • Entrepreneurs and investors want to succeed and make money.

  • Incorporating market interest in program design can moderate risk, bring additional insights, and multiply limited resources.

  • Targeted intervention closes clear market gaps and should be linked to clear next steps

  • Resources that establish a set of strategic stepping stones can be more effective. than a well-built bridge that doesn’t connect to what a company needs.

  • TBED programs can generate financial returns on investment.

  • The market expects to make money in its investments, and mission-motivated programs can be structured to participate in those successes.

  • Understanding and communicating company and program risk profiles is key to stakeholder support.

  • Mission-driven programs are less likely to generate top-tier returns than unconstrained funds.

  • Early-stage startups have high failure rates, and supporters should understand what to expect.

  • Develop the support from leadership and internal processes to say “yes” and “no” to companies seeking support.

  • Proactively avoid the opportunity for (perceived) external pressure to influence decision making

  • Establishing program goals and an aligned investment strategy can support difficult decision making.

  • Decision makers should be prepared to pass on and manage backlash from companies with clear barriers to success and those not aligned with program goals.

  • Program structure should account for adverse selection potential.

  • The market will identify and fund companies with the potential to generate financial returns, but not all of them, and investor funding is not necessarily linked to economic outcomes.

  • Programs should not be viewed as “easy/free money.”

  • Programs should not inadvertently select only for companies that are the most under-resourced and unlikely to generate market interest.

  • Adding additional resources to a company demonstrating some initial market interest can be a sound strategy.

  • Funding alone does not address all startup challenges.

  • Technical and entrepreneurial assistance should be integrated with programs or strategically aligned within the ecosystem.

  • Solving information and skill gaps with founding teams can be as valuable as financial support.

  • Networks and relationships are important.

  • Take an affirmative advocacy role with the companies your program supports.

  • Advocating for companies and helping them develop connections is most effective if the selection process is transparent and robust.

  • Managing conflicts of interest is critical to long-term organizational viability.

  • Mission-based investors, particularly those leveraging public resources, should proactively develop and rigorously adhere to policies and procedures that eliminate real and apparent conflicts of interest.

  • Robust processes and procedures support program sustainability.

  • Careful management of public and mission-based resources can drive improved programmatic and financial outcomes.

  • Clear policies and procedures offer defensibility of investment outcomes and operational practices.

  • Measuring and communicating successes are as important as program design and operation.

  • Celebrating successes can drive additional stakeholder support and bring new investment opportunities.

  • Consistent and intentional communication is necessary to reach important audiences not directly engaged in TBED activities. 

 

Program Structures:

  • Grants

  • Structure—Grants provide non-recourse capital to achieve an expected outcome or goal. Grants are typically awarded through a competitive or other selective application process. Recipients use the provided funding as prescribed in the funding agreement and report on progress and final metrics. 

  • Use case—Providing targeted intervention to close identified gaps that lead to downstream opportunities. Particularly effective for organizations seeking to make an impact with limited administrative capacity. Examples include funding to complete early-stage technology development (SBIR) or to facilitate customer discovery and business model development.

  • Pro—Easy to implement; attractive to companies and investors as a source of risk-free, non-dilutive capital; can efficiently close critical gaps for very early-stage companies. 

  • Con—Can replace private capital if not carefully implemented; adverse selection risk of selecting companies that meet mission objectives but have no real market opportunity; no opportunity to directly share in financial upside if the company succeeds; requires a source of largely unrestricted cash; demonstrating “but for” causation of eventual business success may be challenging.  

  • Debt

  • Structure—Capital is provided by a lender to a borrower who repays the funding over time with interest. The borrower pledges something of value, typically a business asset or personal guarantee of the owner, to secure the loan. The term of business loans is frequently from 3 to 5 years. Payments are made on a regular schedule and may include a lump sum balloon payment. If the borrower misses payments or defaults on other loan terms, the lender may seize collateral which may lead to business failure. 

  • Use case—Providing resources to companies with the opportunity to recover— and recycle funds when prioritizing financial risk management over returns. 

  • Pro—Funds are returned and can be recycled; managed risk profile and collateral position; repayment before equity investors; can include equity conversion opportunity; can leverage resources expecting a return on investment; flexible terms to meet company and market conditions; relatively short time horizon if successful; attractive to investors and companies as “non-dilutive” funding.

  • ConSignificant underwriting and servicing burden; significant compliance and documentation requirements; tech and startup loans are high risk; calibrating portfolio expectations with experienced/traditional business lenders; lender may be forced to “call” a loan and effectively close a company; challenging optics of “bad debt.” 

  • Equity

  • Structure—Cash is provided to the company in exchange for shares of ownership. The company uses equity capital to develop and launch new products, leading to increased valuation. Investments cannot be freely sold, and returns on investment are limited to exit events (company sale) largely outside of investor control. Early-stage equity investments do not have the same reporting and disclosure requirements as publicly traded stocks and are only open to accredited investors. Equity investments bear high risk of loss, as even promising companies may face unforeseen challenges or be outcompeted by rivals. 

  • Use case—Funding high-growth companies where capital needs are high and the significant return potential outweighs the risk of business failure and investment loss. 

  • Pro—Funds can be returned and recycled; highest potential returns on investment; ability to match and follow along with private sector equity investors’ terms and conditions; limited servicing requirements; avoids “bad debt” issue associated with loans; ability to require company board position/oversight.

  • Cons—Limited opportunity to recover investment outside of successful exit; high risk of failure; requires a strong portfolio to realize financial upside; may require active engagement in private company board; requires a strong understanding of investment contracts, terms, and conditions. 

  • Revenue-based financing

  • Structure—Funding is provided to companies who then make payments based on a set percentage of business revenue. Unlike a loan, payment amounts are not established and scale with income levels over the payment period (typically month or quarter). This approach avoids many challenges of early-stage companies with inconsistent revenue streams making regular, fixed loan payments. Funding agreements can establish return on investment minimums and maximums or be open-ended.

  • Use Case—Funding companies with inconsistent revenue and when there are barriers to providing equity investment. 

  • Pro—Does not require structured payments; flexibility and payment following realized revenue benefits early-stage companies; can have a known return; can have collateral provisions. 

  • Con—Requires tracking and verification of revenue and associated payments; may require close management of company relationship; return may be capped even if term is prolonged; requires market traction and sales.

  • SAFE (Simple Agreement for Future Equity)

  • Structure—Funding is provided to the company with the provision that it will automatically convert to equity at the next equity financing. SAFEs are not loans or equity but have elements of each. Once the SAFE converts to equity, it is treated as such. Various provisions outline what happens if the company sells or fails prior to conversion.

  • Use Case—SAFEs are intended to expedite and reduce the legal and administrative costs of the funding process for early-stage companies with high growth potential. SAFEs should be used only by companies credibly seeking equity investment.  

  • Pro—Relatively simple way to provide funding to the company; does not require negotiating valuation; some protection if the company does not raise additional capital; opportunity to realize financial upside of the equity investment. 

  • Con—Success requires subsequent financing; share price set by downstream funding round not subject to negotiation.