Capital Financing
(It’s All in the Planning)
Today's start-ups need serious funding to get off the ground, and many are turning to venture capitalists to get it.
Susan Mason
Amit Shaw recently cashed out of his 2-year-old start-up, Pipelinks, which was acquired by Cisco for $126 million. Ravi Sethi, founder of the recent start-up FORE Systems, purchased Berkeley Networks and added more than $20 million to his net worth. What do these two entrepreneurs have in common, besides wealth and success?
They started their communications companies after 1996. When the Telecom Act passed that year, it caused a veritable explosion of opportunity for entrepreneurs. Venture capitalists funded more than 100 communications companies in the first quarter of 1998 alone, resulting in nearly $800 million in investments. They also invested $140 million on 20 communications start-ups in that same time frame (see Figure 1).
Even with such abundant opportunity, prospective entrepreneurs still have to find the initial financing necessary to launch their new enterprises. There are two types of financing: equity and debt. Debt is a bank loan. Equity is a cash investment in exchange for stock in a company. If you choose equity financing as your initial capital, then you may want to approach a venture capitalist (VC). Before you do, you’ll need to know what VCs look for when they fund a company.
Venture capital is a risky business. It’s based upon the premise that the initial investment will grow to much larger sums as the company matures. VCs focus on building sustainable companies and then exiting, either when the company is acquired or when the company is taken public through an initial public offering (IPO). At that time, VCs realize the return on their investments. If you take venture money from VCs, you must have already decided that your company will be sold or go public.
What are VCs looking for? If you plan to start your own business, three things are essential: the team, the opportunity and the technology. The team is the “horse” a VC bets on. The industry experience of the group of people you choose, your “gut level” understanding of the nuances and drivers of your target market, and your overall intellectual and emotional capability are critical to your company’s success. If the company’s assembled team lacks management experience, or if there is only one person with a good idea, that’s typically not a deterrent to early-stage VCs. They excel at recruiting key management individuals to join the technical founders.
The opportunity is as critical as the team. There is nothing worse than having a team of first-rate players in a so-so market. The factors for the company’s success relate to the overall opportunity size, the ability to penetrate that opportunity, barriers to entry, how interested customers are in the idea, profit margins of the business, and how the business model is leveraged. The VC, which judges the company’s ability to succeed and become a dominant player in an emerging arena, closely examines these factors.
Finally, the technology or business concept is the coup de grace of the opportunity. You must have a great idea that can work in the current communications market. The uniqueness and defensibility of the technology, its development risk and the ultimate product portfolio are essential issues.
Here’s an example of a successful entrepreneur who had strong abilities in all three areas: Royce Holland, the cofounder, chairman and CEO of Allegiance Telecom. Holland previously founded another successful start-up, MFS, which merged with WorldCom in 1996. He and Tom Lord, a veteran of the financial world, were the “horses” that Battery Ventures and others backed with an initial $5-million investment. This minor investment proved itself many times over as the VC firm made more than $39 million in return value after the company had been in operation for only 13 months. Holland walked away with more than $72 million, while Lord earned $33 million.
Another example of a strong VC-backed success story is Carrier Access Corp., founded in 1992. The company was formed to provide multiservice digital access equipment to CLECs, ISPs and wireless carriers. Its cofounders came from an equipment systems integration and consulting firm, where they became highly knowledgeable about the problems their customers were facing. Using this domain knowledge, they identified a market opportunity and a unique technology position. They hit the wave at the optimum time. Since Carrier Access went public last August, the two founders have added more than $400 million in company market value to their net worth.
For more information on Susan contact Andrew K. Adams
| Start-Up to IPO: When Looking for a VC, Do Your Homework Entrepreneurs deluge venture capitalists with start-up opportunities. On average, venture capital firms receive more than 1500 business plans each year. Of these, VCs invite roughly 25 percent of the authors to discuss the opportunity with an investing professional. Out of these hundreds of presentations, sometimes only 10 to 12 investments are made per year. Thus, chances of success depend on an entrepreneur’s ability to do his homework before meeting with a VC. First, venture firms that would be interested in your start-up’s area should be identified. By examining the investments VCs make, you’ll gain insight into their philosophies. Today, most VC firms have Web sites where their investing criteria, their partners and their portfolio companies can be reviewed. Once several VCs that might be interested in your concept or company have been identified, it’s time to contact them. It’s best to work through a “friend of the firm” or someone who understands the firm’s criteria and can make a personal introduction. These people can include CEOs or founders of the companies the firm has invested in and people who do business with the VC, such as lawyers and accountants. If this kind of contact can be found, VCs will be much more likely to review the plan, compared to one submitted without solicitation. After gaining a VC’s interest, there is still a lot of hard work ahead. Raising funds for a start-up can take up to six months. It’s a long and arduous task with many presentations and meetings. If the path is successful, you’ll have a partner who will help grow the company and help position you and your organization for financial success. |