Tapping the well Featured

9:40am EDT July 22, 2002
You’ve finally put the finishing touches on your company’s Web initiative and decided that it would be best to launch a dot-com version of your brick and mortar operations instead of using it to complement your current ventures.

Or perhaps you’ve devised a brilliant plan for a pure dot-com business, but don’t have all the funds to get it past the start-up stage.

Now that you’ve mortgaged your house, hit up friends and family for a couple hundred thousand and tapped your bank accounts, business and credit cards, it’s time to begin the search for venture capital funds.

VCs are investment companies in which investors pump money into one central firm whose job is to find solid business investments. As a company succeeds, the VC firm’s return on investment grows as well. In recent years, traditional VCs have branched off into Internet investments, sinking millions into start-up dot-coms, lured by the riches many entrepreneurs have realized.

Admittedly, it’s become tougher to find VC financing as the great shakeout on the Internet has begun. The need to show actual profits has replaced consistent revenue streams. But there is still more VC money out there than there are solid projects.

Here are three critical factors venture capitalists take into account when considering whether to fund your dot-com project:

The people

Strong management teams are essentially what peopleinvest in with any large project, whether it is Internet related or traditional brick and mortar. As few would argue, the world is full of good ideas. But it takes the right breed of people to execute those ideas and turn a notion into successful reality.

“Everything is moving so quickly now that we’re really looking for people who either have past experience (in dot-coms) or some way that allows them to strike relationships and acquire early customers,” explains Shanti Mittra, a partner at Primus Venture Partners Inc. “That’s really a make or break factor.”

Sometimes, however, it’s not make or break, especially if a VC firm believes it can help the management team, says Tim Biro, president of the Ohio Innovation Fund. That’s where experience in investing projects can come into play. It’s something a firm such as Primus or Ohio Innovation can bring to the table as a value-added extra.

“We look for management that’s already in place, but also a willingness to bring on additional management to help make the investment as successful as possible,” Biro says.

One reason behind that is that VCs generally are active investors. They’ll take an equity stake in the company of anywhere between 5 and 75 percent, depending on the stage of the company and level of investment. And they’ll take at least one seat on the board of directors to help guide the business and protect their investment.

Another reason is that because of the very nature of venture capital investments, VCs don’t receive many guarantees in return for their investment.

“Think about all the trouble you go through to get a mortgage for your house,” says Mittra. “Contrast that to VCs. There is no collateral, the management team can get up and walk away. We’re generally minority owners, so we don’t have much control. We don’t partake in the day-to-day management, so we don’t know what’s going on on a day-to-day basis.

“With that type of risk profile, the odds of getting money are that much tougher.”

There’s one final reason.

“People are passionate about what they have,” Biro says. “That’s important. You can’t succeed if you don’t believe in what you do. But, you also have to recognize your own limitations as a manager. You have to be realistic.”

Innovative technology

“You try to get an assessment of what are the advantages of this technology relative to what’s already out there,” explains Biro. “You have to figure out how much of a sustainable advantage can be built with what you’re investing in. Can somebody build a better mouse trap and ace you out?”

Mittra agrees.

“The question you have to ask yourself is whether there’s been any innovation with the technology being used besides just moving the information into a new medium. What we look for is real innovation and value add to the Internet to allow something that’s never been done before.”

Biro says the technology becomes a major factor when considering how much the investment will cost.

“Technology helps determine how much capital it’s going to take to get you where you want to be and the length of time it will take to get a return on the investment, and what that return will look like,” he says.

And with the rapid changes in technology, you have to move fast. Mittra says beware of developing an initiative with technology that will be outdated by the time it hits the market.

Strength of the plan

Primus Venture Partners sees nearly 1,000 business plans each year. Of those, Mittra estimates the firm invests in 10 or 12 deals.

“We like to think every one we do is an original,” she says. “It’s tough to find all the elements we want. You want original ideas. You want the management team that can make deals quickly. You want the solid technology. We realize we won’t always get all the parts, but things have to come together in order to make the right investment.”

One of the key elements of the plan is whether it lays out a specific road map of how the company’s owners plan to move the business from Point A to Point Z, says Mittra.

“You don’t want it to show they’re competing in an overcrowded space. The plan must be solid and it must allow the business to move quickly,” she says. “A lot of people approach us saying, ‘This is the way we’ve always done it. We just want to put a dot-com after our name.’ That won’t do it today.”

Biro agrees, pointing out that Ohio Innovation sees about 300 business plans a year and takes only a select few from that group.

“You try to choose the winners,” he says. “On average, it’s less than 1 percent. You want to be on Secretariat. But you also want Secretariat to have the best jockey possible. A lot of people tell you to get the best jockey, but if he’s riding a jackass, he’s not going to be a race in the force.

“And you want a good betting office to place your bets because you have to get a return on your investment as well. When it comes to a business plan, it must have all the elements that tell you how that company is going to get where they want to go from here.”

How to reach: Ohio Innovation Fund, (216) 830-1172; Primus Venture Partners, (440) 684-7300

Dustin Klein (dsklein@sbnnet.com) is editor of SBN.