Let’s say once you have a few sales of your manufactured product under your belt, you approach an angel investor and ask for an investment: “You haven’t sold a million dollars of product? You don’t have several hundred thousand Instagram followers?” Huh?
Ten years ago, we were in a recession and world banks started a policy of quantitative easing to pump currency into the economy. Yours truly was in college and realized that picking product design as my college degree, which is almost exclusively tied to disposable income, would probably not result in a job or an internship upon graduation, and I was right.
Fast forward to 2018 and lending is dirt cheap. Money seems easy to come by and there is an influx of what I call ‘unicorns’ – start up companies valued at $1 billion or higher. The 90s and the dream of presenting a piece of paper to a room full of VCs and leaving the room with a 7 figure check are gone, however the ability to raise capital, and lots of it, is still there.
When we started Pretty Knotty, I thought we would figure out our idea, have a functional prototype and then go into a room full o’ suits and leave with a wheelbarrow of cash and get to work on hair ties full time. This was not the case.
There are many ways of valuing companies both public and private. Usually the valuation deals with multiplying the yearly income and several other factors. However you value a company, usually the goal is to hyperinflate the value so that down the line, the earlier investors have the best return on investment, hence why so many startups are valued at a billion dollars or more; compound hyperinflation. Although this seems greedy, it makes a lot of sense. Common wisdom suggests that for fifty investments an angel investor makes, one of them will have some success. Because of this, the single winner needs to recoup the cost of the forty-nine losers.
Why does this matter? If you’re in the business of beating the odds, odds are that you’re going to be very selective. You’re going to pick companies that cost the least to fund and have the highest odds of making money. For the most part, software companies fit this mold. You need a human to code the software and a computer to code the software in. Perhaps several humans and computers are required to make a piece of software, but not much more. Manufacturing requires way more capital. On the other end manufacturing requires humans, computers, 3d printers, power tools and liability costs that come along with power tools, along with a decent amount of space and power. There is no way that manufacturing could possibly compete with software in terms of startup costs and although it’s a shame, fiscally I can understand it.
Let’s say you were a manufacturing company, and despite the odds, you still want to pursue an angel investor. With the huge influx of cash angel investors are looking for a higher rate of return. An entrepreneurship professor once explained to me: nowadays angel investors have moved onto higher levels of financing, which require higher levels of responsibilities for companies that are funded. It used to be that angel investors needed only a successful prototype to invest, now they’ve moved up the food chain and want to see revenue before they invest; at that rate you have a better chance of going from the NCAA to the NBA than going from a startup to an IPO!
For software, you do not need molds, tooling, inventory, packaging, space, or even intellectual property (see Google’s lawsuits about IP). To get to revenue on a consumer product, you need all those things, and more. Even with our hair ties that do not require an injection mold there are still many thousands of dollars that are funneled in before the first product is sold, or even ready for sale. This means that manufacturers must put a lot more skin in the game before they’re ready for angel investors, as opposed to software companies.
Let’s say once you have a few sales of your manufactured product under your belt, you approach an angel investor and ask for an investment. You haven’t sold a million dollars of product? You don’t have several hundred thousand Instagram followers? Huh? A deal, if any, won’t have a high valuation and the investor, whether friends and family or angels, will want a decent percentage of the business. I would be inclined to imagine that if we were funded, we would be working for someone else and own very little ourselves. Once again, it’s a shame but I would not blame them.
Pretty Knotty to us definitely has more sentimental value than quantitative value. On paper it’s a small company that makes hair ties for athletes. For Shelly and I, it’s a way to create our future, to give us jobs that we could only dream of. Will our vision of Pretty Knotty and the market’s value of Pretty Knotty intersect? Will we become the next unicorn? Will Goldman Sachs sponsor our IPO? Will Softbank pump and dump us? Only time will tell, but for now we’re glad to be going on our own.
Jacob Eberhart is a DC-based Industrial Designer and the Vice-President of Operations for Pretty Knotty LLC, prettyknotty.com a manufacturer of athletic apparel. He is interested in increasing small-scale manufacturing in the US, 3D printing, bio-based plastics and just-in-time manufacturing. Out of the office, Jacob enjoys Brazilian Jiu Jitsu, learning DIY projects, and attempting to teach an old dog new tricks.