S01 EP01 How To Fund A Growing Drone Startup: Max Tubman, BFD Systems

Max Tubman BFD Systems

Max Tubman is co-founder of BFD Systems, an industrial drone company in Philadelphia. The company bootstrapped a very successful, profitable first year. Now he needs to figure out how to fund improvements in manufacturing and marketing which he estimates will run $160,000. Should he pursue more bootstrapping through big customer deposits? Raise equity now, or later when his valuation is much higher? He ends up with two new ideas: convertible notes, and connecting to investors through the right lawyer.

  • The company used classic bootstrapping to launch: a customer order in hand even before they formed their LLC. This is how Don Gooding’s grandfather launched his business, also from Philadelphia.
  • With less than $10,000 in cash, Max and his business partner have generated revenue of $900,000 in the first nine months, and a profit.
  • To scale up the manufacturing process and drive down production costs he needs about $150,000 in tooling.
  • He also wants to attend a few more trade shows, and build two drones to demonstrate their systems at the trade shows.
  • He may be able to get a large customer to provide a deposit large enough to solve some of the funding problems.
  • He’s concerned about his company valuation rising quickly in the next year, so he doesn’t want to sell equity too soon.

Links and Resources

BFD Systems

Investment Structure: Convertible Notes vs. Equity

Philly Tech Guide

Transcript

Don: Max Tubman of BFD Systems, welcome to The Funding Coach!

Max: Thanks for having me.

Don: Let’s start off with a little bit of background on yourself. What were you doing before you started BFD Systems?

Max: Yes so in the past I’ve done a lot of kind of freelance contractor work in the drone or UAV space before starting BFD Systems. I was the director of operations for a composite material company based in South Korea. And that company made carbon fiber components for manned and unmanned aerial vehicles. And it was in this role I got to go around and meet a lot of different customers and I just noticed that there was a large gap in the market for people who wanted a turnkey solution for heavy lift unmanned aerial vehicles. And that’s kind of how I ended up starting BFD. After leaving the other company.

Don: Well that’s kind of interesting. Just on a personal note my grandfather was in Philadelphia right after World War II. He was selling industrial roofing components for another company saw a gap in the market and built his industrial roofing company out in Lancaster Pennsylvania and that’s still being run by my cousins. It’s a great way to get started in a business.

So let’s talk about the company now. What are your products or services, who are your customers and how far along are you in terms of those products as well as revenue and customers.

Max: So we started about 9 months ago and really we kind of hit the ground running. We had customers lined up before we even got the LLC set up. So really the way that we worked in the beginning was definitely bootstrapping method where we had a customer who put down a deposit. We had already the design of the aircraft that we were going to make and we kind of just went from that one and started building the business from that first sale actually.

In the first year or first nine months rather we were making two or three different types of aircraft that were kind of constantly being updated or upgraded and improved upon as far as the aircraft itself. And then also like the workflow. So we’re doing the manufacturing and whatnot as well so that both of those things have been improving which I’ve kind of been calling Phase 1.

And now in 2018 we’ve got a lot of those systems kind of hashed out and we’re scaling our production. So right now we only make about four or five systems a month and in the next phase I’ll say we’re trying to do something closer to 10 to 20 units a month. And we have the customer base but really one of our issues now is just being able to keep up with the demand for making these systems fast enough and also being able to do good customer support for the existing systems that are out there.

Don: Both of those are really you know they’re kind of high quality problems to have. I want to come to your funding needs now in just a minute. But… So when you were able to bootstrap the company was it necessary for you to put in money or any partners or were you able to basically take a down payment from a customer and launch the business with that?

Max: Yeah great question. So I had to put down some money. It was not much it’s probably less than 10 grand. And then a lot of the infrastructure I kind of already had in place with a partner. And in that space was kind of like the work area and the tools that we needed to build these systems. Because we are already doing a lot of aircraft maintenance and some development for another company. So a lot of this kind of infrastructure already existed from our contracting work as well as working with the composites company in Korea. So that was really something that made it possible you know without seeking more funding.

But even without that infrastructure the business was started really with no funding. Essentially that first deposit that made it possible.

Don: Well that’s excellent. So I’m guessing that since then you’ve been able to be cash flow positive in these initial nine months of the business?

Max: Yes! So from that first sale we were beginning… It was just me and one other colleague who’s a partner in the company as well. And we’ve been able to hire two full time engineers a full time electronic assembler and we’re bringing on somebody else is going to be a compliance officer to kind of help with the FAA regulations and also military regulations. And then… So that was all in the first nine months and we had a profit of forty thousand dollars last year.

Don: That’s tremendous.

Max: Yes. So we’re pretty happy with that and definitely looking forward to really start to crank things into full year for 2018.

Don: Okay. So you’re looking now at growing the company and a pretty significant step up in your manufacturing capability. As you think about what you might need for funding now in order to fund that growth what are the big uses that you need cash for?

Max: There’s a few different categories of things that we need cash for.

One of which is just development in scaling. So in the drone that we make or the UAV there’s a few parts that are very labor intensive. It really has to do with the motor itself and then also the electronics in the motor. So those are all handmade. What we’re trying to do is machine parts that would kind of reduce the labor time. So right now each arm takes three hours and there’s four arms that’s 12 hours just to make the arms on one of these drones. If we’re able to machine all these parts of these motor mounts that have all the electronics and everything kind of integrated already then we can reduce that time from 12 hours just to do the arms and then reduce that down to like 2 hours. So we’ll be able to really crank these things out a lot faster. It’s a lot easier for electronic assembler takes less training and whatnot. So part of it is kind of putting the R and D and manufacturing so that we can scale up. It’s way more efficient to make 10 drones at a time or 40 drones at a time than it is to make one at a time. So all our products right now are basically one offs and the tooling and machining to go up from there is pretty costly.

Don: And when you say pretty costly, about how much?

Max: It’s about a hundred and fifty thousand so it’s pretty costly for us I guess. I guess it depends on the company.

Don: It’s all relative. If you don’t have the cash for it, then it’s costly! Okay. Any requirements on scaling up your marketing side of the business?

Max: Absolutely. So right now our sole marketing is essentially going to trade shows and just through our own email chains and social networks. But these trade shows are also pretty expensive. So to do one of these trade shows we’ve done them for really cheap and they’ve had good return on investment but really do it right you need at least you know $50,000 invested in a booth, travel, having the right set up. And from those trade shows you don’t only get customers – companies who want your product – but you also find customers who make components or sensors or anything else like that that then you can really learn or meet new people to collaborate with.

So part of it is trade shows and then also it would be great if we could have a separate marketing director, which I think would be probably selling for 2019. Right now it just kind of being able to scale to our customers needs. And of course we want to get ahead of it and get new customers for this year. But I think that just doing the trade shows, there’s two or three that we would do that I think would be more than sufficient to continue to grow our customer base.

Don: OK. So what I hear is a lot of.. You’ve got kind of a two year plan, it sounds like, in the back of your head. I’m wondering whether you’ve thought about the business that you’re in long term and where you see it might be going in the future. And then what personally you want to get out of the business over the long term.

Max: I’ve been in the drone industry for about eight years now commercially. And every year I say we’re not even really scratching the surface of what these machines are capable of. And I feel like this year we’re really just starting to scratch the surface I guess. There’s a lot of technology in machine learning and artificial intelligence and automation and there’s a lot of companies that are making these software machine learning systems and they are testing them on small drones that are really just meant to fly around a laboratory or out in a test field.

What we do is the hardware side of this integration so we make the aircraft that can integrate with any type of flight computers or off board computers or sensor arrays and we make them ready for real life use, either with mapping or surveying or disaster relief; the military as well. So I think that the long term plan for us is to really start to collaborate with some more of those teams and have American made industrial grade UAS.

And the market right now is completely reliant on Chinese manufacturer DJI which is the juggernaut of the industry. And we certainly don’t intend to try to compete with DJI. But there’s a lot of concern with data security with that particular company. So there’s a lot of our customers now are people who have built a business around a DJI product and now they’re being told that they can’t use them by either their customers or the government or the military.

So we’re really filling this gap of all these customers who have started a drone program and now need to replace it with something that’s more secure for their data and whatever other services they’re providing.

So in the two years I really see that we’re scaling up there and then long term… Ultimately I would like to either sell the company in five years or just be acquired by a larger company that needs to really have an in-house hardware development team. That would be kind of the ideal. I started this company because I just saw this huge gap in the market and I figured hey this is a good way to kind of get this ball rolling but you know for so long I’ve been a contractor, my own boss, and that’s great. But you know I kind of wouldn’t mind selling this company in a couple of years and either working for a larger company or just going on to see what else I can do.

Don: Well that’s really helpful. I’m a firm believer that entrepreneurs ought to be able to fulfill whatever is right for them and, you know, I don’t think there’s any single right answer that applies to all startups. So this is helpful in understanding because your time frame is compatible with equity investors and the outcome of selling the company is also quite compatible with equity investors.

So I’m wondering, now coming back to your short term funding needs, what options have you been starting to look at, either on the debt side or the bootstrapping side? Or have you looked at all yet at the equity side of things?

Max: I’ve been kind of reaching out to different folks to kind of get as many different inputs as I can to try to make the best decision, which is how we got in touch the first place. We do have a few people who are interested in the equity option where they would invest some cash in exchange for equity. And I’m open to that idea. I just feel like it’s a little bit too soon for us to jump to that because I feel like the value of our company is about to go up tremendously in this year of 2018. And if I can hold off a little bit longer they’ll either be putting a lot more money in for equity or the money they put in will get them less equity I guess at the end of this year. So if I can hold off on that I would.

The other thing is, we have a few potentials for large orders in which a deposit for a research project where they need us to develop an aircraft… That one big deposit that comes through one big contract for development might be all we need to make that jump. So those are the kind of the two main options that we’re exploring right now.

We can just sustain with what we’re doing and we’ll be fine – we’ll stay in business and will continue to grow. But what I’d really like to see is a little bit of a leap so that we can increase our efficiency and what we’re producing. If we sustain what we’re doing right now it’s just not quite efficient enough to grow at the rate that I would like to.

So the three options are just kind of wait it out and see how it goes on this current trajectory. Or we might get one of these big research projects which would probably just be enough to help us leap, or sell some equity as well.

Don: Or it could be a combination of all of the above.

Max: Yes, true.

Don: It sounds like there would be good reason to try to get this research down payment because it gets buy-in from the customer over a long term project. Would you agree with that?

Max: Absolutely.

Don: I’m wondering about the total amount that you would need to have available to meet all of your growth trajectory plans. Because what I heard is $150,000 just for the manufacturing side and then on the marketing side I’m guessing another $50,000 would probably be helpful. Does that sound about right in terms of what you’re thinking of?

Max: Yeah I mean the numbers that I looked at… So one of the other options I forgot to mention, because I was looking at small business loans. And the issue I ran into there was we haven’t been in business for quite long enough for them to be eligible for one of them. The numbers I was looking at when I was reaching out to those folks was about $160,000 and that covers the manufacturing – the tooling I guess for making some of these new parts to streamline our manufacturing – as well as the marketing side, which is to go travel and do some of these trade shows.

One of the parts of this trade show aspect is to have working demo units. A lot of our demo units right now are kind of… We have our kind of a Frankenstein of drones cause they have all these different components that we’re testing. So I’d like to have within that $160K that also funds two units that would be all the bells and whistles, real clean and something that we can show to people. Right now every time we have something that is a beautiful drone that works amazing and has all the bells and whistles it sells immediately and we get to take pictures of it and we have some video, but it goes out the door. So we’d like to have one or two of those in-house that we can then go to different companies to show them the functionality and the possibilities what these things can do.

Don: Okay. So let me talk a little bit about the equity side, because there’s a particular kind of equity investment that is very common at your stage of development that actually will help you get past the perception that your valuation of the company is going to go up very fast in the next year.

I don’t know if you’ve heard of convertible notes or convertible debt? It’s the most common type of “equity investment” in really early stage companies. It’s a loan with the expectation that it’s going to turn into equity in the future at some much larger raise of equity. And the price of the equity is only determined at that much later stage.

So, for example, if you were able to get two angel investors to each put in $50,000 – so $100,000 of a convertible note – the price when that converts to equity won’t be determined until, let’s say, a year or 18 months from now when you say: OK now we’ve got all our ducks in a row and we’re going to go out and raise, let’s call it $2,000,000, the price gets determined then and then the two people that put in $100 , 000 now get that price that’s set in in a year to 18 months less a discount. That discount is usually on the order of 20 percent.

Max: Yeah. That sounds like it would work really well for us. I wasn’t familiar with that practice.

Don: So I think that’s worth looking at alongside the bootstrapping option. And I think it’s still worth talking to some people about the debt option, because in fact some angel investors may be interested in doing just debt at a higher interest rate. It’s always worth asking. You know, say, hey would you be interested in $50,000 at a 15 percent interest rate, or whatever is the maximum you can have charged. There are actually laws regulating the amount of interest.

Well that’s good. So it sounds like you’ve done some reaching out through connections. Have you tried specifically to plug into the emerging Philadelphia tech startup scene?

Max: Very little. I mean, recently there was a UAS integration conference in Philadelphia and I only found out about it at the very last minute. So that was really my first chance to connect with other people who are doing stuff in the tech and UAV space in Philadelphia. And that was great just to kind of start to build a community here for collaboration and, you know, just to kind of see what people are doing.

But no… You know one of the problems that I’m facing now is I am up to my ears in doing design and customer support and new customer outreach, that I feel totally overwhelmed with going to seek out funding options and connecting with people in Philadelphia. So that’s something that is one of my goals, but right now it just seems like at the end of the day I’m here from eight in the morning to nine at night a lot of nights and at the end of the day, there’s not enough hours in the day.

Don: That’s true for pretty much all startups! Here’s one suggestion.

Lawyers are often a connecting point to potential investors. So I don’t know whether you’ve got a lot of need for legal help right now in doing contracts, but you might consider looking at some of the law firms that are connected to the tech scene and working with them on some of the legal work you need to do now. But then using that as a pathway to kind of get the word out. Because there’s nothing lawyers like better than to be able to connect good promising clients to other people on the investment side because it all kind of works together.

Max: That’s great.

Don: I have by the way taken a quick look at the Philly Tech Guide and perhaps off the air I can give you some thoughts on potential investors in the future. One of the challenges that you have being a manufacturing company is that a lot of tech firms like software not manufacturing. So I think it’ll be efficient to just focus on companies that are going to be comfortable with manufacturing and also I think over time again we could talk about this off air is thinking about how you describe your proprietary technology. It’s something that all equity investors are looking for and being able to describe it in a way that an investor can say, “Oh yeah I can see over the next five years that this is totally a protectable kind of thing.” I think that will also be important to help over time.

Max: Excellent.

Don: Well great. So are there any other ways that you think I might be able to be helpful to you in your current situation?

Max: No not at this time. I mean just those two points about the convertible debt and kind of reaching out to law firms to connect with investors. I think that’s a really great start. And then of course just talking this out and hashing it out with somebody who’s much smarter than me also helps a lot too, just to get the gears spinning.

Don: Well I’m not sure about smarter but I’ve been around a long time! And also again, it turns out that in my noodling around, I do have some connections to two of the, actually three of the venture capital firms in the greater Philadelphia area. It sounds like you’ve got your plate full now, but down the road I may be able to help make some warm and friendly introductions, because that’s another thing that investors are looking for, is an introduction to a deal from a trusted source, whether that’s a lawyer or from some other successful entrepreneurs that they know.

Max: Excellent. That would be fantastic.

Don: Great. Well thanks very much for being on The Funding Coach and I look forward to keeping in touch in the future.

Max: I appreciate thank you for having me and thanks for your help.

Don Gooding

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