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How Do You Find Private Equity?

Itís a people process. Both on the buy side and the sell side. The entrepreneur needs to network and build relationships to connect with the appropriate investors. Your idea may be good for family and friends, for doctors, a corporation or a venture capital or investment banking firm. But you have to connect with the appropriate investment sources.

Once you get into the loop, you have to pursue relentlessly. Itís a lot of hard work. Pound the phone and the pavement. Getting yourself in front of the right person is largely a matter of effort in turning over a lot of rocks and kissing a lot of frogs.

Generally, sophisticated investment sources will make themselves available if you ask and treat them respectfully. They will hear your story. Maybe not with as much time as youíve wish, but remember, they are quick studies and are experienced at quickly determining if they are interested in your project. You will probably get interrupted while giving your pitch, but itís because they know what questions they need to ask to qualify if they are interested in investing.

You have to have a written business plan that addresses the product or service, the market, competition, and at least three years of projections. Most important, you need a management team with experience in your project's area. If the investor likes your product or service, the next biggest area is the management team. It all boils down to people.

The challenge is getting into the network. There are a lot of good ideas out there and you have to have a good plan and work at getting investors to read it. It will probably take longer then you think, so itís good to start networking early. Even while your working on putting your plan together, there is nothing wrong with making contacts and asking if they are interested in investing in your type of industry or project. If they say yes, tell them that you appreciate the contact and ask if you can get copy of your plan to them when itís finished. Then follow up!

How Do Investors Make the Decision to Invest?

The biggest point is getting excited -- about the idea and the people. Thatís every investors first screening point. Itís the intuition that sparks an interest. Itís creating a spark of interest and enthusiasm for taking the next step. It comes from the investors "gut."

If the interest is piqued, then the potential investor's analytical side kicks in:

This is followed by the first part of the due diligence process. Confirming or not confirming the initial interest. Every investor has a different process for due diligence and the entrepreneur's challenge is to stand at the ready to answer questions and add insightful comments.

There are some easy nos for the investor. One is a plan that turns them off, just no spark or interest. Another is when the investor knows more about the project then the entrepreneur. This happens very frequently. The tough nos for the investor is when the deal just does not pass their smell test. They canít put their finger on why, but it simply doesnít get them excited. This is a major due diligence challenge and frequently today, itís because the entrepreneur hasnít put together a solid, industry knowledgeable and experienced team. The days of the individual hard-driving solo entrepreneur are gone. Our society moves too fast for one person to keep up with all the changes. It takes a team to stay on track. Preferably a team with a successful track record and individuals who have drive and a realistic understand of the challenges that they are going to be faced with.

It takes great enthusiasm and what appears to be a unique idea or approach. No amount of analysis is going to get the investor over the investment decision hump if they canít get excited about the project. Get your investor Excited!

Family and Friends Financing

This is the type of financing most common for "seed or concept" companies and also those categorized as (see Stages of Entrpreneurial Financing). It's not unusual to hear professional investors say that this is the finance source for fools. On the other hand, it is the most dominate source for early stage investment.

According to an Inc. Magazine survey of their Inc. 500 Private Companies, the average amount of seed capital raised was $25,000. Although 54% came from personal savings of the founders, a total of 87% came from "friendly" sources, i.e. personal, friends and family.

Here at Venture Associates, we would estimate that 80% plus comes from the entrepreneur or founding entrepreneurial team members to work out the concept part. This would include the formation of the initial business plan and some seat-of-the-pants market research (also called gut-market feel.) Our experience is that the true family and friends dollars start to roll in after a basic a business plan has been conceptualized and usually put in written form. Commonly, this first version plan is pretty rudimentary, missing a lot of key information that more sophisticated investors require.

However, in truth, most family and friends investors don't do much due diligence on the financial viability of the business. They are investing in the "person" who they know and trust. They have faith in the entrepreneur and their team members. They invest in YOU!

And here comes the rub. If you take in family and friend money, you had best do some real, solid soul searching. If you know in your heart of hearts that the family member or friend which you intend to pitch for funding is not capable of affording a total loss of their investment, you had better think twice before accepting their dollars. Unlike personal or business loans where you are the only person that could be penalized, there are not many things worst than to have to sit across the Thanksgiving table from Aunt Ann and Uncle John when you have lost their hard earned savings. It's tough not feeling right about attending the Wednesday night bowing game if your friends Kathy and Joe will be asking you how their investment (in YOU) is going. "Hey, are we rich yet?" is tough to face when in actuality your facing a payroll deadline the next morning that just might shut down your whole operation.

Family and friend money is easy to get, but can ruin good relationships if not accepted with care. Be sure it won't hurt you at Thanksgiving.

Looking for Angels

Part of the contingent of private financing sources, or informal investors, are persons affectionately referred to as "angels." Along with family and friends, they are the largest providers of early stage financing, both from a dollar standpoint as well as their sheer numbers. They are a homogeneous group that is very difficult to identify and capture. They may be your next door neighbor or a relative of your friends. They may be affiliated in that they have some contact with you or your business, or they could be nonaffiliated in that they currently have no idea you even exist. Case Western Reserve University in Cleveland, estimates that the U.S. has at least 140,000 active angels who collectively invest some $20 billion a year in new businesses. Obviously, it's easier to start with someone who is already familiar with you and has a vested interest in the relationship. Recognizing that there is no typical angel, just like there are no typical Ultrapreneurs, it's still helpful to establish a characteristic profile of angels.

What's an Angel Look Like?

Various surveys and research reports have yielded some interesting characteristics for identifying angels. Although the exceptions probably overrule the norm, the profiles lend some interesting food for thought:

Primary investment motivation is a high rate of return. Secondary motivation is capital appreciation. They learn of investment opportunities from associates and friends. Less than 30 percent of referrals come from attorneys or accountants. They would like to see more opportunities than they currently see and refer investments they make to their investment network. Contrary to venture capitalist, angels don't rank comprehensive business plans on the top of their criteria list. However, they rank management ability the highest, and seek a clear, demonstrated market need, plus a large market potential for the product or service.

How to Find Your Angel

The financial marketing mindset with angels is a little different than that of dealing with venture capitalists. Venture capitalists know what they want and how to go about getting it. Their primary focus is financial; they're investing other people's money and are getting paid to obtain outrageous returns. Angels, on the other hand, react to your proposal by determining in their mind if you're being fair. While they are also looking for a financial return, they frequently are seeking a psychic or intangible reward like helping minorities, creating jobs, revitalizing urban areas, or simply contributing back to society for their success.

Your First Task Is to Locate Them. It's a tough task. They don't advertise, they network quietly. Start with your calling card file; it may contain some hidden angels but most likely will lead you to more angels. Spread the word that you're seeking financing, that you have prepared a business plan, that you're prepared to talk with anybody, any time, any place, and that you're prepared to pay finders' fees. That's right--many times you will have to pay a fee to someone who puts you in touch with someone who writes the check. It's a financial marketing reality.

Professional service providers are always a good place to start attorneys and accountants are very good networkers with a potential vested interest. Suppliers or vendors can be helpful. Sometimes they invest, many times they may furnish leads, but frequently it's a good way to break into the subject of extended credit terms. Try customers and even employees (they may have some home equity to borrow against). Competitors, especially in other parts of the country, may reveal some strategic alliances as well as information that may lead to an angel. Dialing for dollars, also called telemarketing, works when you can obtain a list of wealthy individuals. Don't forget any already successful entrepreneurs, ex entrepreneurs, or dentists and doctors. Not only can they bring in their money, but they can help attract other angels.

Bottom Line It's Networking. Attend local venture capital groups; there are 80 to 100 of these located in almost every larger city in the country. (see our list Venture Capital Clubs. Check the business events listing in local newspapers or regional business magazines. These groups meet specifically to network and exchange business opportunities. Many of them have a forum for presenting prospective business projects and a lot of angels attend or are plugged into the networks surrounding these groups. They are prime hunting grounds for Ultrapreneurs.

A final source is boutique investment banking firms and some business brokers. They focus on financing start ups and matching angels. As intermediaries, they charge fees which can vary considerably. It's suggested that you qualify them and their principals by soliciting advice from your accountant and attorney.

The Best Ways to Approach Angels

Once angels are identified, the common approach is to furnish them with a copy of your business plan; after they have reviewed it, you'll hope to get together with them face to face. I suggest you handle this a little bit differently. If you can't arrange to meet them in person, furnish your Special Executive Summary first Better yet, if you have your company up and operating, invite them to come in for a first hand look.

Assuming your Special Executive Summary captures their interest, then arrange for an in person meeting. This is your opportunity to sell them on what your company has to offer--that is, management and a product/service with a lot of potential. It's just like any other sales job--display the wares and convince them you have something they need.

Initial contact via phone or nonpersonal referrals don't cut it. They're just not enough. The angel has to understand your company and gain a feeling for the enthusiasm that backs it. Your challenge is to get them personally involved, to buy into your determined dedication. If all they have is your business plan, it's too easy for them to refuse. You want to get them emotionally involved.

Keep in mind that you know more about your business than they do. Be cautious about how you present your projections, remembering that you will be expected to achieve them. Be sure they're realistic and achievable. Although angels are a lot more flexible than venture capitalists (and consequently you can close the deal in half the time), you still need to be sure your relationship is established with a strong bond of good faith and that you earnestly attempt to keep all your commitments.

Angels versus Venture Capitalists

Investorís invest more in people than the project or stage of investment. All are looking for a win-win deal with open communication and positive chemistry. The color of the money may look the same, but there is big difference in the price the entrepreneur pays.

Amount of ownership Angels aren't lloking for control. They want simple ďTerm SheetsĒ offer better valuations, less restrictive on executive roles, dilution, exit options and voting rights. VCís want to control spending and strategic decisions and want a Board seat.

Size of offering Angels are looking for projects from $25k to several Million. VC's are seeking minimum $2 millioninvestments.

Size of opportunity Angels wnat deasl taht will scale to $25 million sales. VC's wnat conmpanie sthat will achive $1 billion in revenues

Financial return 1Angels are happy with 10% to 20% Per annum returns. VC's want a minimum 30% per annum

Number of rounds Angels lookd for usually one Ė sometimes two. VC's want deals of Multiple multi-million round.

Team Experience Angels often have an emotional interest and want to give back, offer experience, and work with the entrepreneur. VCs want a team with a proven track record in the industry.

Help to expect Some angels will share a lot, other sare pasive investors. VCís more handís on, have current industry insight and connections and can bring in experienced team members. Angles will assist, but have limited time and attention.

Cashflow: It's Your Lifeblood

Cash is king for successful entrepreneurs. And cashflow is the bedrock of the kingdom. It's the lifeblood of a growth company. A company without cash is no company. During the startup or concept stage, the founders usually trade off their time for cash. However, once the company is up and running, when full time employees are hired, the entrepreneur has got to have cash to not only continue, but also to fuel the growth.

During the concept stage, it's usually the founders' personal cash or savings that enable them to write the business plan to obtain seed stage financing. Assuming they can then obtain the cash to execute the seed stage plan, their concern becomes conserving the cash to enable them to meet the objectives and benchmarks and still have enough cash while they pursue product development stage financing. This is a critical stage for almost all growth companies. This development stage of financing, almost without exception, takes longer than anticipated; as many entrepreneurs learn, having a commitment is not the same as having the cash in hand. Several months commonly expire between signing an agreement and receiving the actual funds.

Rapid expansion has many cashflow needs, and in each of these there are cashflow traps. The most prominent, and the ones that can be systematically tracked, semi influenced, and controlled, are inventory and receivables.

Here Are Some Cashflow Pointers

Unexperienced entrepreneurs tend to ignore cashflow where successful entrepreneurs prepare for it. They prepare by having a top accounting person on their team who puts superinventory, receivable, and cashflow management systems in place. This is backed up by the knowledge that high-growth companies always need more money than they can generate internally. Inventory and receivable money has to come from outside sources. And the time to line up these sources is prior to a screaming need for them.

The entrepreneurial business plan should forecast this need. It should take into account when and how much extra debt cash is needed between probable equity financings. Financial management will start romancing these sources early on by supplying a continual stream of updated information which keeps these sources in the know. This way there's no surprises, there's a prebuilt familiarity with management and the company's operations, and no delays in obtaining the financing to continue to support fast growth. These sources are familiar:

Inventory and Receivable Control

Uncontrolled inventory really affects a company's growth. Scores of companies have been bitten big time by this. It can come at you from two different angles. One is high growth rates on complicated products where the company has to carry large levels of various parts--all bought in large quantities so as to get discounted price breaks--to enable it to meet increasing customer demand.

The second can happen when sales suddenly take a dive. The company ends up with large amounts of finished product on hand, no sales, and the cash is all invested in the ballooned inventory. This can also happen if the company's marketing program is dependent on it being a significant credit supplier to its customers by "floor planning" product, offering consignment, or extended credit terms. More than one company has found itself in the position of having to let key people go because it wasn't able to meet payrolls because its money was tied up in inventory. You can't eat or pay people with inventory. It's a high price to pay for failing to protect cash reserves for temporary glitches in sales.

Accounts Receivable: Control Them Also A second great cash consumer is accounts receivable. A lot of entrepreneuring companies start out to be manufacturing or service companies and end up, much to their dismay, as banks. The stories are many; the tales of woe may vary in detail, but the substance is the same. The product or service is hot, everyone wants to buy, the entrepreneur wants to sell. Things go along smoothly for the first couple months, dealers buy and pay timely. The company is shipping increasing amounts of product or proving burgeoning amounts of service. All of a sudden, dealers' or customers' payments slow down.

The first month or two, the company, in its high-growth headset, doesn't notice. They're too caught up in the euphoria of their success, and too busy producing, shipping, or delivering. At the first sign of trouble, it's very hard to say no to customers who tell you how much they like your product, how if they just had the next shipment in they can turn it over immediately and send you your receivable payment. First thing you know, six months of this have gone by and the entrepreneur is blindsided by no cashflow. People have to be laid off, payables get extended, and rampant rumors start throughout the industry on how the entrepreneurial star is having money problems. This compounds the situation, in that formerly valued customers now determine to drag out their payments even longer on the chance that the company may not make it. Guess what? The entrepreneur doesn't make it. All because of cashflow.

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Principal Contact - James B. Arkebauer
Venture Associates
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