Tom Keleher, Managing Director, New Mexico Community Capital

When many entrepreneurs think about funding the growth of their business, they think about taking on more debt. That works pretty well when times are good and asset prices are going up.

But what do you do when a loan is not available and your favorite banker says you need to finance growth with cash flow. What happens if there is not enough cash to pursue your growth dream? This is usually when entrepreneurs start thinking seriously about finding an equity investor. You may not call it that in the beginning, but as your investigation proceeds, you will realize that folks who are willing to provide growth capital that is at risk of being entirely lost are called equity investors. Because of this risk, investors will want to own a piece of the rock and will probably also want to exert significant influence on the business.

The tipping point comes when the bank says “no mas” and you must decide whether you want to put the brakes on growth and give up potentially rewarding value creation opportunities, or give up a slice of the pie to obtain the cash to fund continued, rapid growth of the business. Equity investors will invest if they see the opportunity to help you grow the value of the business quickly enough to generate attractive risk-adjusted returns for them. If your planning indicates that selling a portion of the pie will help you create the growth rate and the company value you desire, then it makes sense to pursue equity financing.
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Trevor Loy, Managing Partner, Flywheel Ventures

Influential writer Jim Collins, author of Built to Last and Good to Great, has written that the critical questions in life are who-decisions, not what-decisions. “The primary question is not what mountains to climb but who should be your climbing partner,” he writes. As I mentioned in a previous article, when considering an investment, the entrepreneurial team is of more importance to most venture capital investors than market strategy, technology or financial projections. When evaluating the pros and cons of bringing on an investor as a partner in your business, your considerations should be similarly weighted toward who-decisions.

But how do you objectively evaluate a potential investment partner? Professional investors should provide assistance and value in many areas beyond financial resources. Here are some key areas that can be assessed.

Experienced oversight and strategic guidance are perhaps the most important roles of the professional investor when partnering with entrepreneurs. Typically, venture capitalists are ourselves former entrepreneurs or industry executives with experience and skills to contribute. More importantly, because of our unique perspective, we can often identify key trends, challenges, and lessons learned from other investments that can help our newer companies.   While a venture capital investor will never share the same depth of knowledge about a particular market sector that the entrepreneur holds, our breadth of experience can help add objectivity. Exceptional venture investment professionals regularly provide that data and breadth, acting as a “sounding board,” while respecting that the ultimate judgment about specific decisions and operational matters is best trusted to the entrepreneurs themselves.
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Tom Stephenson, Mangaging General Partner, Verge Fund

Over the course of this series, various columnists have provided insights into equity – how to determine if it’s appropriate for your business, how to prepare your company, how to navigate the evaluation process, and how to identify the right capital partner. Before you embark on the long and sometimes frustrating process of raising equity capital, however, you should heed an old adage: be careful what you wish for. Make sure that you actually want equity investment in your business.

Raising equity capital brings substantial benefits. If you have selected your equity source carefully, you gain far more than just cash – you gain a partner. Good equity partners bring experience, networks of contacts and energy to your enterprise. They should be able to help you think through strategic decisions and introduce you to important business contacts like vendors, customers or even, eventually, acquirers.  They may participate in recruiting candidates and reviewing financial statements. And, lest we forget, they invest cash into the business to help cover operating losses during growth phases, as well as build working capital and make infrastructure investments in the business.
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Les Mathews, Mesa Capital Partners

Not every company is a candidate for venture capital. Outside equity, whether from family, friends, so called “angels,” or institutional investors like venture capitalists, always has strings attached. If your company is a lifestyle business or one in which the main goal is to generate personal income, or if it is a company that you would like to pass along to family members, then outside equity probably isn’t your best choice.

On the other hand, if your business is one that you want to quickly grow and at some point sell, then looking into the pros and cons of outside equity might make real sense.

Providers of most any kind of outside equity want to get repaid over a reasonable period of time and at a very good rate of return. In exchange for receiving equity capital, you are selling a piece of your company to the provider of that equity, so you now have a new business partner. Make sure you know who that partner is, and what their goals are for your company.

For a growing business, the advantages of this kind of capital are numerous. The most important is that equity significantly improves a company’s balance sheet.  This means that the company will have more growth resources for things like hiring marketing or sales staff, developing new products or purchasing capital equipment.
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Tom Stephenson, Managing General Partner, Verge Fund

Entrepreneurs just starting out will often view all sources of capital as identical – money is money, right? However, as we have learned previously in this series, there is great variety in the sources of capital available to entrepreneurs. The primary distinction that has been highlighted so far is the difference between debt – borrowing money – and equity – selling a piece of your company. However, the specialization continues even within the equity world, generally denoted by stage of development and area of focus.

This specialization is not unlike what occurs in the medical field. The cardiologist you might see for heart disease has very different skills and training from the oncologist you might consult to treat cancer. Venture capital has similar specialization, and just as a pediatrician would not be appropriate to treat an adult, a “seed” stage investor is very different from an investor that provides expansion capital. As an entrepreneur, you need to pick the financial partner that fits your stage of development and your particular industry.

For example, the Verge Fund focuses on “seed” stage investing. Some believe this means we invest in agribusiness, but it actually has to do with the stage of development of an opportunity when we make our first investment. “Seed” stage refers to the time when the idea is just germinating and has not yet grown into a full company. Often this means companies that are at the earliest stage of development – sometimes before they are even generating revenue.
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Trevor Loy, Partner, Flywheel Ventures

I am often asked to explain the criteria used at Flywheel Ventures to make our investment decisions.

It may surprise some to learn that our most important consideration is the entrepreneurial team. We care about the character of the individuals on the team and the culture they are creating as a team.

Evaluation of potential market opportunity ranks a close second.   Projections – such as the size of the addressable market, its rate of expected growth and the amount of potential competition – are used by entrepreneurs to indicate market opportunity. In the end, however, entrepreneurs must satisfy us on four key criteria.

First, we must believe that prospective customers in the target market are aware of a financial “pain” arising from an unsolved problem in the market.

Second, we must understand the projected dollar amount that a prospective customer will be willing to pay for a solution to this problem.

Third, we need to see a credible plan for the new venture to not only develop the product that solves the customer’s problem, but to also market, sell, and deliver the solution in an economically viable means.
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Trevor Loy, Partner, Flywheel Ventures

Over the past year, my colleagues and I at Flywheel Ventures have received 494 business proposals from entrepreneurs seeking funding. We followed up with initial inquiries to 98 entrepreneurs; 23 were then invited to an initial meeting with the entire Flywheel investment team.   We then pursued additional “due diligence” research on about half of the presenters. Ultimately, we invested an average of $365,000 in initial funding in each of just four new ventures.

From the initial submissions, then, we invested in just 0.8 percent.   These statistics, while specific to our firm, are typical of the venture capital industry.

In any field of investment, achieving higher returns requires the acceptance of higher risk. Venture capital investors search for high-risk investments based on innovations in information technology, life sciences, and clean technologies such as renewable energy.   Investments in these types of firms require an extreme tolerance for risk, uncertainty, and failure. Continue reading →