Raising Equity Capital

Equity capital enjoys only one significant advantage over borrowed capital, but for some this advantage outweighs all the other drawbacks: Equity capital is permanent capital; it need not ever be repaid. However, whenever your company accepts this permanent capital, it will, in effect, also be accepting a partner who will share in the fortunes of the firm from thereon. Therefore, before management decides that the equity market is a good idea, it should first answer a fundamental question: Is the permanent nature of the new capital that will be raised worth the dilution of control that may go with it?
There are four distinct financing methods. Management can (1) seek out a venture capitalist;
(2) raise the money through private investors; (3) try private placement through an institution or investment bankers; or (4) plan a public offering. For the nonfinancial manager who is considering starting a business of her own, the second section is particularly important: Private investment funds have been the source of money for hundreds of successful start-ups.

How to Attract a Venture Capitalist
The first way to raise equity capital is through a venture capitalist, who invests in new companies. The best way to attract a venture capitalist is to have a “friend in court.” If you know someone who has had dealings with a venture capitalist, his introduction will help. Still, a recent survey indicated that well over 80 percent of all venture capital firms have no particular preference on how they are approached.
Holding the attention of a venture capitalist might be another matter, however. Venture capital firms maintain strict investment standards.

They require the same information as a banker would—and more. If you are interested in establishing such a relationship, here are ways to improve the odds:
1. Growth. Be ready to demonstrate how you can increase your revenue by about $15 million and/or your profits by $1 million within the next three to five years. Otherwise, venture capitalists are unlikely to show much interest.
2. Product line. Most venture capital firms concentrate on industries in which they have acquired a certain amount of expertise, or those that promise unusual growth. If you can locate a venture capital firm that knows your industry, your chances will significantly improve.
3. Your management team. Venture capitalists tend to avoid a “one-man show,” no matter how exciting the prospects may be. Firms that can demonstrate management capability in a number of areas, such as finance, marketing, production and administration, generally receive preferential treatment.
4. Long-term planning. It’s essential that you draw up a sound corporate plan for at least five years, including cash-flow and income assumptions, before discussions with a venture capitalist begin. Give some thought to eventual corporate goals, such as public ownership, a merger or other possibilities that will enable the venture capitalist to withdraw from the firm in five to seven years.

➤ Observation: If your firm doesn’t meet the standards discussed above, you will probably be wasting your time trying to court a venture capitalist. Although funding has increased dramatically in the past several years, venture capitalists still accept only about 5 percent of the deals offered to them.

Evaluating a Venture Capitalist
You can avoid an uncomfortable, time-wasting relationship with a venture capitalist by doing a little evaluating on your own. A venture capitalist may ask for up to 60 percent of your company, so the association should have concrete rewards for you. Here are some guidelines to follow in your evaluation:
● Check out how a venture capitalist’s clients fared in the past.
● Determine whether the venture capitalist helps her clients with additional financing if it’s necessary. You will probably need additional financing for your firm in the future if the first one is successful.
● Agree on what role—active participant or passive investor—the venture capitalist will play in your firm. You might prefer that he merely sit on the sidelines after the deal is made, or you might want active involvement in management. Whatever your wishes, make sure they coincide with those of the venture capitalist.
● Find out what kind of reputation the venture capitalist enjoys in the business community. You will want to know whether the reputation will help or hinder you in attracting other financing sources.