Less than half of new companies survive their first three years in business, and the way startups seek funding has a big role to play in this. For many business types and strategies, traditional funding methods like venture capital and private equity can set startups up to fail by limiting their freedom and flexibility.
Initial License Offerings (ILOs) were created to provide a safer funding method for new companies. ILOs keep entrepreneurs in control of their businesses and help them increase awareness of their brand, building a solid foundation for business growth.
Common Issues With Traditional Investment
Traditional funding methods like venture capital and private equity have several drawbacks that can hinder the success of a new company.
First and foremost, your investors will often have goals for your business that conflict with your strategy and market knowledge. As a result your business may be pushed in directions that benefit their return on investment, at the expense of your company’s sustainability. Simply getting funding from traditional sources can involve agreeing to unrealistic targets and conditions that will eventually punish you for making the right choices for your company.
The slow and steady approach is often the safest way to build a stable business, especially when entering a crowded market. This has little appeal to investors looking for quick returns however, and their influence may prevent you from laying the foundations of long-term success.
Traditional funding methods can put you under pressure in other ways too. A sudden large injection of cash can be a challenge to handle at the best of times. Some startups waste up to 75% of the funds they generate from investment due to inexperience spending large funds wisely.
Depending on your funding method, you may not get any guidance on how to move forward once you have the funds. Worse, you might be getting advice from investors who don’t have the best interests of your business at heart. Furthermore, taking on investors means more time spent in board meetings and less time building your business.
Dangers Of Venture Capital For Startups
While venture capital can raise funds for your business, it often provides little other help when it comes to reaching your market and getting your business off the ground. In theory mentorship, advice and networking are additional benefits of venture capital investment, however this rarely materializes. In reality, most venture capital investors are not interested in helping you create a great product.
Venture capital investors are incentivised by constant growth. This could compromise your vision for your business, affecting your profits, quality of service and long-term sustainability. The pressure to prematurely scale your company can cause major problems, and rapid growth is not a realistic business strategy for companies entering crowded markets.
As a result if you can’t sell the idea that your business is ready to blow up, you might struggle to attract venture capital attention in the first place.
Dangers of Private Equity For Startups
Private equity investors usually want a significant stake in your company, and the active role in business decisions that comes with that. As a result, you may lose control of your business strategy, recruitment and firing decisions. While the right investor’s involvement can be a blessing, the wrong investor could be a curse.
Private equity investors are motivated by relatively short-term growth in order to sell their stake at a profit. When they decide to sell, their exit strategy could involve selling your business, or otherwise creating uncertainty in the future of your company.
Furthermore, private equity investors will receive their minimum returns whether you succeed or not. This limits your cashflow and if you can’t pay, generates spiralling debt. According to a 2019 study, private equity funding increases your chance of bankruptcy by 18%.
Initial License Offerings Are A Safer Alternative
Unlike traditional forms of investment, Initial License Offerings do not involve the sale of equity. Instead ILO buyers get an agreed percentage of your revenue as royalties, in exchange for promotion.
For companies selling an ILO, the funds from a license sale are booked and taxed as revenue. As a result, companies are motivated to create a plan to spend the money on building their business, instead of letting it burn a hole in their pocket. Additionally, a successful first year increases the value of your next round of ILO funding. With proven results behind you and a wider brand awareness, subsequent rounds of license sales are much easier.
This has three major advantages:
1. Stay In Control
When you sell an ILO you will create regular reports for your licensees, but retain control of your business decisions, without giving away a stake in your company. This limits your risk of being pushed away from your business vision.
2. Grass-Roots Marketing
License buyers must promote your business to qualify for royalties, introducing your products to a much wider audience through word-of-mouth marketing. An ILO can also enable sales commission and discount distribution through motivated licensees, further increasing your brand reach and sales.
3. Buyers Share Your Goals
An ILO buyer’s returns are based on your revenue. That means they are motivated to help you succeed through continued promotion, and will back decisions made for the long-term profitability of your company.
In other words, when you win, your license buyers win, and licensees have every reason to help your business succeed.
It is clear that for many startups, traditional funding methods do not offer a reliable way to build a successful business. Giving control of your company to investors can turn your new business from an exciting adventure to a stressful burden, and could take you in a very different direction to the one you wanted.
ILOs let you keep your equity and provide more than just funding, establishing a wide customer base and brand awareness that sets your business up for sustainable, long-term success. More importantly, Initial License Offerings establish more direct accountability between licensees and companies. Businesses need to provide plausible long-term plans to secure funding, and licensees profit from a mutually beneficial structure instead of a relationship defined by targets and small print.
Informative.