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Finding Venture Capital in a Time of Crisis

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Scott Caruso, Partner, Flywheel Ventures

Scott Caruso, Partner, Flywheel Ventures

In the wake of a financial crisis that spread quickly from Wall Street to the rest of the world, many small businesses are finding traditional funding sources, including debt financing, harder to secure. Many entrepreneurs are consequently turning to venture capitalists to finance the growth of their businesses.

The decision to seek venture capital is a strategic one that requires thought and planning. Venture capitalists generally invest in high-growth companies that have potential to create a sizable return. Venture capital isn’t for everyone, but it’s ideal for companies aiming to acquire a large market share in their industries until they can be acquired by a bigger player or go public.

When looking for venture capital, it’s critical to target a firm whose mission and goals align with your own and to understand the firm’s economics and investment patterns. Doing this important legwork before seeking venture-capital funding will allow you to be more efficient and successful in achieving your funding goals.

Sizing up the venture-capital alternatives: The first step is to qualify the firms you plan to approach, beginning with fund size, the clearest indicator of a firm’s investment strategy. A firm that operates a $50 million fund might make investments between $2 million and $5 million, while a $500 million fund might make investments in the range of $15 million to $20 million. Understanding the amount of capital a firm is willing to invest helps you determine if it can meet your funding needs.
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Government Backs Loans for the Rural Entrepreneur

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John Woosley, CPA and Director, U.S. Small Business Administration, New Mexico District Office

John Woosley, CPA and U.S. Small Business Administration New Mexico District Director

At a time when banks are loath to lend money to other banks, New Mexico’s rural entrepreneurs may wonder if it’s even worth trying to obtain the credit they need to stay in business.

That’s where the Small Business Administration and its partners come in with programs to help launch and build rural businesses and to help rural innovators overcome the special problems posed by distance from customers, markets and workers and the lack of a telecommunications infrastructure.

SBA’s financial assistance consists of guarantees to banks to share the risk of lending to entrepreneurs. Just this year the agency instituted the Rural Lender Advantage initiative to foster economic development in rural areas by making it easier for smaller community banks to partner with the SBA to finance small businesses. With a maximum loan amount of $350,000, expedited approval, limited documentation requirements and the federal government’s guarantee that the bank won’t lose its entire investment in case of default, this tool makes community banks more willing to help New Mexico’s rural entrepreneurs pursue their business goals.

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Public Funds Back New Mexico Businesses

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Paul Goblet

Paul F. Goblet, Financial Advisor, NM SBIC

There’s no doubt that the foresight of current and past legislatures and governors has attracted equity capital to New Mexico businesses, especially in the technology sector.

While more companies could probably benefit from having additional equity capital on their balance sheets, outside equity investments are not for every business. Investors can be difficult to attract, and dealing with them can be time consuming and expensive.

So how does a small company obtain the capital it needs to grow, even at a modest pace?

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Inside New Mexico’s Private Equity Funds

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Paul Goblet

Paul F. Goblet, Financial Advisor, NM SBIC

Mention professional equity capital in New Mexico, and technology start-ups typically come to mind. That’s because most private equity investments target technology-transfer opportunities emerging from universities and national laboratories based in the state.

With the support of the New Mexico Private Equity Investment Program, more than $350 million in capital has been committed to 22 funds that directly benefit New Mexico businesses, typically in the technology sector in the Albuquerque area. But how do non-technology entrepreneurs or entrepreneurs outside of Albuquerque get their businesses going, especially in an unstable and unpredictable economy?

Help begins at home

Realizing that business ideas exist outside of Albuquerque and the technology sector, the New Mexico legislature in 2000 created the New Mexico Small Business Investment Corporation to focus on financing small businesses. Originally funded with $10 million from the Severance Tax Permanent Fund, it has swelled to more than $87 million thanks to subsequent commitments.

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New Mexico Investment Program Weathering Wall Street Woes

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Paul F. Goblet, Financial Advisor, NMSBIC

Paul F. Goblet, Financial Advisor, NMSBIC

Despite a nationwide financial crisis, New Mexico businesses continue to attract equity investments thanks to commitments made by current and previous legislators and governors.

Both Gov. Bill Richardson and his predecessor, Gov. Gary Johnson, saw potential benefits in supporting New Mexico businesses by providing equity capital for growth.  Using capital that had accumulated in the Severance Tax Permanent Fund, our state launched the New Mexico Private Equity Investment Program in 1994, and it has grown through the infusion of additional capital commitments over the past 14 years.

The state program, which is managed by the State Investment Council, was designed to attract professionally managed equity funds like those operating in California’s Silicon Valley in the 1990s. Its creators believed that out-of-state equity-fund managers had expertise to invest in and develop New Mexico businesses and that their investments would lure additional funds and professionals. They were right.

If you build it, they will come

Chicago-based Arch Ventures was the first to establish a presence in New Mexico, but more than 20 additional funds have followed. Early investors were attracted by the vast amount of technology generated by the state’s research laboratories and universities, but other specialty funds have also been established.

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Two Federal Programs Offer Money With Few Strings Attached

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Tatjana Rosev, Los Alamos Natl Lab Communications Office

Tatjana Rosev, Los Alamos Nat'l Lab Communications Office

The next-best thing to free money is available through two federal programs for small businesses involved in technology and innovation.

Small Business Innovation Research (SBIR) is the larger of the two programs, and it will provide about $2.5 billion this year in grants and contracts to small and start-up businesses to develop products, technology or services that solve pressing problems in agriculture, defense, education, energy, transportation, the environment, space exploration, health and other areas. Small Business Technology Transfer (STTR) requires the small or start-up business to team with a nonprofit research entity, such as a university or federal laboratory, and generally involves a transfer of technology, know-how or expertise from that institution to the company’s project.

Eleven federal agencies — including the Department of Defense, Department of Energy, National Institutes of Health, NASA and National Science Foundation — offer SBIR grants, and five offer STTR grants. Both programs provide money that doesn’t have to be repaid, and the business doesn’t have to surrender equity. But, as federal programs, the grants are subject to federal procurement regulations.
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Obtaining Credit – Even When Lenders Are Leery

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Les Mathews, Mesa Capital Partners

Les Mathews, Mesa Capital Partners

The worldwide credit crunch has tightened credit availability for even the largest companies, and that has also made it more difficult for smaller companies to obtain credit for expansion and working capital. Banks, the traditional sources of loans for smaller businesses, have been forced to raise credit standards and make more cautious loans to smaller businesses, which causes a significant reduction in credit availability, higher borrowing costs and more restrictive credit terms.

As a result, smaller companies, the mainstay of New Mexico’s economy, are seeking more innovative ways to finance their operations and growth. This is particularly true for the state’s early-stage businesses: Most have no history of generating positive cash flows, and most have few unencumbered assets and minimal or negative net worth — all of which make them seem too risky in the eyes of loan officers at traditional banks.

Many owners of early-stage businesses have tried to overcome this problem by offering their personal residences as collateral for business loans. But with the mortgage market meltdown and stagnancy in the residential real-estate market, banks are getting more cautious about hedging bets even on this traditionally most stable and secure form of collateral.

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Current Venture Investment Opportunities: The End of the Beginning

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Trevor Loy, Managing Partner, Flywheel Ventures

Trevor Loy, Managing Partner, Flywheel Ventures

With America’s high-tech industries showing signs of maturity, some observers have predicted the demise of the venture-capital economy. Were it true, this would be troubling news, as entrepreneurs funded by venture capital have been the flywheel of the American economy in recent decades, producing 10 percent of all private-sector jobs and 10 percent of gross domestic product from investments of just two-tenths of a percent of GDP in the past 30 years.

Those of us in the business of investing venture capital see maturity in high-tech sectors as the short-term masking of a promising adjustment by entrepreneurs and investors to the changing realities of expanding global market opportunities with a broader base of technology innovations than ever before.

A World of Needs

In recent years, many international markets for innovation-based products — especially energy, physical infrastructure, human health, mobile computing and communications and security — have grown faster than the U.S. market for those products. Because developing economies need to satisfy their needs in more sustainable ways for cost and environmental reasons, a higher level of technological innovation is called for. Given that the venture-capital industry’s core skill is investing in highly innovative technologies to address large, rapidly growing markets, we believe venture-capital investment is more broadly relevant than ever.
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Financing Decisions in the Real World

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Tom Stephenson, Managing General Partner, Verge Fund

Tom Stephenson, Managing General Partner, Verge Fund

Raising equity capital for your business never happens in a vacuum. External forces inevitably affect when and how and where you hunt for investors, just as they affect your decision about how much money you’ll need to support your company for a few years until you start showing a profit.

External forces include the financing market — the universe of people and institutions that constitute funding sources for your company — as well as the larger business market in which you operate. Understanding these forces will help you develop a strategy for fundraising.

Beware the bubble

Pure financial investors are in the game to make the most money they can from their investment in your company. But even they can make mistakes and act impulsively.

Investors have no more insight than you do into how a market or an individual company will evolve. They, too, can misread the economic signs and underestimate or overestimate the market appeal of a particular product or service. Their fallibility is one reason why certain market segments get “hot” and others get “cold.”
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Equity Funding: Milestones That Matter in the Life of Your Businesses

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Tom Stephenson, Managing General Partner, Verge Fund

Tom Stephenson, Managing General Partner, Verge Fund

Creating a road map with meaningful milestones for the development of your business will help you determine how much equity capital to raise and when to raise it in such a way that you maximize ownership of your company over time.

Many entrepreneurs who decide to share ownership in their companies in exchange for capital investment identify goals that substantially increase the value of their business when reached, and they schedule financing rounds to follow these achievements.

If your product requires pre-approval from a federal agency such as the Food and Drug Administration or United States Department of Agriculture, for example, clearing this hurdle represents a success that makes your business more valuable and attractive to investors. If you raise just enough money to accomplish this goal and carry you through another three months — until you can complete your next round of fundraising and deal with unexpected costs — you can increase the amount of equity that you and your earliest investors maintain in the company.

Reaching these milestones also means you’ve reduced the risk for investors and greatly improves your chances of finding new partners and greater amounts of capital.
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