Outside investors Featured

10:08am EDT July 22, 2002
Do you look at your business and dream of the infusion of cash that will take it from a small niche player to a market leader? The concept works, production costs are low and distribution is in place. All you need is what almost every business needs: more money.

Any major expansion would put a serious strain on your cash flow, but banks don't understand your industry and because the business is young, they categorize you as "high risk."

Maybe it's time to look beyond the banks to tap into the millions that are available in venture capital funds. While different funds and investment groups will have different requirements, most are looking for businesses with proven potential.

"We like to find people who have a track record of success and a vision to build a market-leading company," says Jim Forrest, managing director of Wind Point Partners, a South Field, Mich.-based private equity investment firm. "The most important element of success is a very good sense of what is happening in their markets. If that exists, then we will look to see if the company has some kind of technological edge or barrier to entry that gives them an advantage."

Banks like to back companies that already have the assets or cash flow, while venture capitalists will take bigger risks for a bigger reward. A bank loan might require repayment of the loan amount plus interest, but high risk investors are typically looking for an equity stake in the company.

"Business owners are not giving up equity," notes Forrest. "They always sell it for a price."

Wind Point Partners looks to be actively involved in the business, taking a position on the board. Other firms may require more or less, depending on the risk involved.

"We want to help the entrepreneur by using our networking capabilities to help them find additional staff to make them successful," says Forrest. "With growing firms, they often need to hire people much faster than they can find them. Investors are not the enemy. Entrepreneurs who only want the money but not the partnerships are not good scenarios for us. A company will generally become stronger through our participation."

The application process

If you were applying for a bank loan, you would have a detailed plan along with any relevant financial information. It is much the same way when applying for venture capital, and in some cases, because of the higher risk, you may actually have to provide more detailed information.

"For us, there is no application per se, but the starting point is a business plan with the resumes of the key managers," explains Forrest. "Someone who needs capital should have a plan for who the customers are, who the competitors are and how to beat them. What technology is required? Who are the key vendors?"

There will also be inquiries about the management team and why it is qualified. Expect to provide detailed information on the products and services offered and how they will be priced and how they will be sold.

"We will generally do a lot of reference checking on the management, make customer calls, call some of the vendors and investigate the technological and competitive issues," says Forrest. "After we've done all that, then we'll look at structuring the financing."

A determination is made of how much the company is worth before the infusion of capital, and then the money is added into the equation to determine the equity stake. For example, if a company is worth $1 million, then $1 million in capital is injected [and] the company is now worth $2 million. Therefore, the investors have purchased 50 percent of the company.

"Once they have the money, there needs to be a process or management team in place," says Forrest. "About 40 percent of all venture investments do not return capital. It is a high-risk environment, and if there is anything we can do to limit those risks, then we like to do it."

Keys to success

"The No. 1 thing is to be totally candid," says Forrest. "Don't expect to understand all the questions or have all the answers. The worst thing to do is answer every possible question and try to come across as knowledgeable in an area you are not."

The investment process also takes time. Don't expect to be handed money overnight. Windpoint Partners can take anywhere from four weeks to six months to make a final decision.

The relationship between the investors and the entrepreneur is often the key to success in any deal. Because it is truly a partnership that is being formed, and not just a loan, it is important for both sides to feel comfortable with each other.

"At the end of the day, we should feel comfortable with the entrepreneur," says Forrest. "As we're going through the process, is the person allowing us to develop a partnership approach? If that doesn't result, then we have to wonder if the deal makes any sense. Venture capitalists do a lot of due diligence checking on the management, and the management should also do a lot of due diligence checking on the venture capitalists."

Be prepared to make changes before a deal is complete. The brother-in-law with the fine arts degree serving as the manufacturing company's director of finance is probably going to have to find employment elsewhere.

"The largest complicating factor can be matters of multiple family members in the business," says Forrest. "In some situations it can be fine, but I have seen companies where there are nine nieces and nephews on the payroll, but we can't seem to find them in the company. Most reasonable people are able to solve these problems before they become sticking points."

For more information, go to www.wppartners.com.