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By Clint Willis
Three years ago, John Regan and three friends were sinking a combined $30,000 a month into their fledgling business, Parcxsmart. The company develops smart cards for small transactions, with a primary focus on parking meters. “It was a very, very difficult time to say the least,” Regan recalls. Fortunately, help was on the way. One of Regan’s partners had contacted a former employer—George McQuilken—in hopes that he could help them raise money. McQuilken is an entrepreneur himself, and a founder of eCoast Angel Network, whose members invest in early-stage companies in the New Hampshire coastal region. After a series of meetings, the Angels agreed to raise $2 million to invest in the business. “They did a good job of grilling us,” says Regan. “It was six months before we had any money.”
The firm began generating revenues in November of 2005, and Regan estimates that it will become cash flow positive within the next year or two. Meanwhile, his group of angels has put up another $1 million, and helped the firm land a crucial strategic partnership with another payment systems firm. That partnership will make it easier to raise additional money—and has boosted the valuation of the business. “Hopefully, the next round of financing will be the last time we’ll have to go outside of the company for money,” says Regan.
Translation: We did it!
If stories like that get your pulse racing, you may have some work to do. Small business owners looking for equity capital to grow their firms face an array of obstacles— from finding potential sources of financing to structuring a deal that won’t steal their companies out from under them.
That doesn’t mean raising capital to grow your business is an impossible dream. True, the days are gone when venture capitalists lined up to give money to every geek with a Web-related patent. But venture capitalists during the three years through 2004 funded almost 6,700 deals, for a total investment of more than $62 billion, according to Dow Jones VentureOne, and maintained a similar pace in 2005.
Meanwhile, an army of more than 120,000 wealthy individuals—so called angel investors—funded another 50,000 deals worth some $22 billion in 2005. “We’ve seen steady growth in angel funding since 2000,” says Jeffrey Sohl, executive director of the Center for Venture Research at the University of New Hampshire.
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When Debt Won't Do
The fact remains that raising equity capital for a small business is a difficult challenge. Before you tackle it, ask yourself whether you really need an equity infusion— or have any chance of getting one. Many small businesses can get by on loans, which allow the current owners to maintain their full stake in the companies. Such firms include so-called lifestyle businesses, such as a small law practice or a bookstore, which can provide a living for the owner as well as a career and lifestyle he or she enjoys. Lifestyle businesses are the fixed-income securities of the small business world: they provide steady income, but little prospect for growth.
Lenders may find such firms attractive, especially if the owner can offer some sort of collateral against a loan. Equity investors are a different story. They are interested in companies or startups that offer the potential for dramatic growth and high returns over a relatively short period, typically within four or five years. “If I’m an equity investor I don’t need you to give me my money back,” says Elliot Reiff, chief operating officer of the Venture Alliance, an Irvine, California consulting firm that helps companies raise equity capital. “I already have my money. I’m looking for you to quadruple it.”
Where's The Money?
Let’s say you decide that your firm does need an equity infusion—and has strong enough prospects to interest potential investors. Your next step is to choose what type of investor to target. Friends and family often are sources of capital for small businesses, especially in the earliest stages. Be sure that such investors understand the risk—and use professional standards in structuring and documenting equity arrangements. One reason: When you get to the point where you are ready to approach other investors, they will insist on formalizing those arrangements—and the ensuing trouble and delay could postpone or even deep-six the deal.
Many small businesses turn to angels when they are ready for a larger capital infusion. Angels typically are wealthy individuals willing to back a modest-sized venture or on-going business in hopes of big returns down the road. Many angels set minimum investments that run around $250,000, but others will kick in amounts as small as $50,000, or even less.
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Moreover, angels often provide vital support to the firms they fund. Such support might come in the form of referrals to other investors or to suppliers and potential customers, or advice about how to solve a cash flow crunch or a problem related to your supply chain. “Many angels are former entrepreneurs, so they often know what you’re going through and how to help,” says Jeff Sohl.
Venture capitalists can be tougher to approach than angels, and they’re not worth the trouble for most small companies. Most VCs won’t look at a firm unless it requires a significant investment, often $3 million or more. Like angels, VCs monitor their investments closely, and they can provide various support services to the company—from board nominees to troubleshooting in times of crisis. Some companies start out with angel financing and move on to venture capitalists when they are ready for the next stage of financing.
The Money Hunt
Once you’ve narrowed the field to a certain type of investor, you need to identify specific individuals or firms who are most likely to provide capital for your venture. Chances are, that investor will be someone in your own town or region—and that’s a good thing. Such an investor can provide more hands-on assistance than one who may be thousands of miles away. Moreover, a local investor will probably have better local and regional contacts that can help you find new customers, key employees, and future investors.
Also keep an eye peeled for potential investors who know your industry; they will be most likely to grasp the essentials of your business plan. Such insiders also will provide the most useful advice once they become part of your team.
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Some entrepreneurs hire consultants to help with the search. A consultant might help you decide how much money you need, evaluate your chances of getting that money, and take steps to increase those chances. Some consultants also can help you target the right investors and land audiences with them.
For example, the Venture Alliance in Irvine, CA, works with a variety of clients who are in various stages of the money hunt. Those clients include a small company that makes the only domestic brewed Hispanic labeled beer in the United States; a firm that operates a small group of medical spas where clients can receive a variety of medical treatments (such as cosmetic surgery) along with their mudpacks and massages; and a firm that provides security for mobile devices. All three firms have revenues of less than $2 million.
You probably can find consultants in your area by checking with local investor groups. Your financial advisers—accountants, financial planners and the like— may also help you make contact with such firms, or with people who would know of them. Interview several firms before you make your choice. You may find that some consultants are more eager to collect their fee than to find you capital.
Your network of friends, acquaintances, colleagues, and associates may provide contacts among potential investors. What’s more, regional and national organizations bring together investors who are on the prowl for deals. A quick Internet search should also turn up angel groups in your region. The Angel Capital Association, a professional alliance of angel groups, doesn’t fund ventures but it offers a partial directory of angels on its website (angelcapitalassociation.org), as well as a list of capital source databases and other resources. And check out www.vfinance.com, where you can screen a list of 23,000 angel investors by various factors. Once you have a list of promising candidates, you can send a summary business plan (including financial results and projections) to promising groups or firms.
If you are trolling for larger sums, it makes sense to start with a list of venture capital firms, and screen for ones that might be interested in you. For example, www.vfinance.com lets you screen a list of more than 1400 venture capitalists for those that match your needs. Look for firms that specialize in your line of business, seek deals in your region and invest in companies that are in the same stage of development as your firm.
Be Prepared
With luck, you’ll get one or more invitations to make a pitch in person. Be ready when that happens. Blow your first shot, and you may not get a second one. Your presentation to venture capitalists, angels or other investors should cover these areas:
The people. They’ll want to know what makes you and your management team special, and they’ll ask about your advisers and other investors, too.
The business opportunity. What’s the business model? What are the firm’s competitive advantages? How about market size and potential, actual and potential customers, suppliers, employees and so on? The investors will also want an exit strategy: How soon can everyone cash out for big bucks?
Context. What external factors—from the economy to technological changes— could affect your success?
Finances. Don’t bother showing at all without convincing financial projections.
Documents. Bring the business plan, financial statements, and anything else that backs your presentation.
The deal. What is your business worth, and how much of it are you willing to give up in exchange for funding? Also make sure you understand the role your investors will play in the business— how much control they expect to exercise over strategic and tactical decisions.
Whether you hope to sell out after a few years, or ride your company all the way to an initial public offering and beyond, you can count on one thing: You’re going to be busy for a while, and the outcome of your efforts is far from guaranteed. Then again, building a business can be an awful lot of fun. And who knows? One of these days you might be using your profits to fund someone else’s growth business.
