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akgold

Dollars From Heaven

Posted by akgold Jul 20, 2007
Borrowing money-from a financial institution or from family or friends-is one way to raise cash for your business. But there is another: equity investment.
By Chris Freeburn

Unlike banks that loan you money expecting repayment with interest, equity investors infuse money into a business in exchange for a share in the ownership of the company. Not every small business is suited for this form of investment. Generally, equity investors are interested in companies or start-ups 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.”

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Equity investors come in two primary forms: angel investors and venture capitalists. Many small businesses turn to angel investors after they have survived the startup-stage and 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. In 2005, 120,000 wealthy individuals—so called angel investors—funded 50,000 deals worth some $22 billion. “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.

Aside from cash, 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 Sohl.

Four 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.

Though the gilded days of the late 1990’s Internet Bubble when venture capitalists lined up to give money to every geek with a Web related patent are long gone, venture capitalists remain a strong force. From 2001 through 2004, VC firms funded almost 6,700 deals, for a total investment of more than $62 billion, according to Dow Jones Venture- One, and maintained a similar pace in 2005.

Venture capitalists can provide not only money, but other forms of assistance, including management guidance, market expertise and business contacts. Since their return only grows if the business does well, they have an interest in shepherding the firm toward growth. 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. However, venture capitalists usually become part owners of the business and usually demand some say in the conduct of daily operations. In short, accepting venture capital can lead to a loss of total control over the firm. Not all small business owners can accept that.

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.

+Chris Freeburn is an Associate Editor/Writer for Business 24/7 Magazine. Additional reporting by Clint Willis+

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