March 1997 - Volume 16, Number 3


Recently, a potential client and friend asked me if I would introduce him to some venture capital sources. He had an option to acquire an existing small business with his own money but would need additional capital funds to expand the business rapidly.

For six months, he had visited banks, SBA lending source agents, cash flow lenders and local business people in his area to see if his business and marketing plans might be worthy of their support. Despite numerous copies handed out and many questions raised in subsequent meetings, all he had to show for his effort was -- “Sorry, we don’t think we can help at this time” or just plain - - “It’s not for us.”


While this should be obvious, it sometimes makes me wonder about the risk/reward parameters the venture capital industry seeks.


Perhaps, a little perspective is in order about the development of today’s venture capital industry. The history of risking capital is almost as old as mankind. But in the lexicon of today’s understanding, the early venture capitalists in the US beginning in the 1950's were people like General Doriot of the first public funded venture capital company (American Research & Development), Royal Little of Textron, and the Sears Roebuck money in Starwood Corporation and the Rockefeller money, and my old mentors on Wall Street.

The common thread in most of the early VC groups was that the people were risking mostly their own money and the people making the investment decisions were also operators and/or former operating managers. These groups were highly successful and in time, most went to the Harvard Business School, Stanford, and/or Wharton and recruited bright students to become analysts of the many proposals that made their way into those offices.


As time moved on, the upper management of these companies became staffed with these analyst types. Most had never had to meet a payroll, make a sale, beg the bank for money when a big customer went bankrupt or decided to delay their delivery schedules. Their actual knowledge of business came from reading financial reports and rarely from day to day interaction with the real world. The view inside New York and the venture capital and financial communities in time became almost as myopic as the view from inside the Beltway.

Just as the banking industry had its fads, so did the venture capital industry. Last year, the lemming nature of the VC’s could be seen quite clearly in their funding of the Internet craze.


A major change in the VC industry occurred when a financial analyst on Wall Street started a fund and invested in Compaq. Sevin Rosen’s success quickly led the lemmings of Wall Street to beget other venture capital funds by raising money from institutions like pension funds, insurance companies, and other sources including the public market. During the early 1980's, almost $25 billion was raised by venture capital funds. Many of these were headquartered in Boston and New York but a large number of these technology based VC funds were to be found in Silicon Valley.

Because of the astonishing success of high technology companies in the late 70's, 80's and 90's many of the partners became extremely wealthy including several whose worth's were over $500 million.

Along with this success came a major turnover in management in the late 80's. As the industry matured and became more professional(?), we began to hear venture capital funds described in a variety of ways --

Early Stage

Seed financing - a small amount of funds provided to an inventor or entrepreneur to prove a concept in exchange for an inordinate amount of the enterprise.

Startup - financing for use in product development and initial marketing of companies less than one year old which have not sold their product commercially. In exchange for a business plan, key management in place, market studies, the venture capitalists will want control of your destiny.

First stage financing occurs when the startup money has run out and the venture capitalists are willing to put up more money for an increased share of your business.


Second stage financing - provides working capital for the initial expansion of a company which is producing and shipping, and has growing accounts receivable and inventories. Although the company has clearly made progress, it may not be showing a profit. Decreases founders percentage ownership further.

Later stage financing - Third stage and bridge financing. Third stage financing is provided for major expansion of a company whose sales volume is increasing, or that is breaking even or is profitable. These funds are for plant expansion, marketing, working capital or and improved product. Bridge financing is for companies expecting to go public within six months to a year.


LBO (Leveraged Buy Out)\ Acquisition - financing provided to acquire a product or business form a public or private company.

Public market purchases - financing provided to acquire stock from unwary, or nervous, investors in the IPO or secondary financing.

Secondary purchases - financing provided to acquire stock from venture capital partners who want to reduce and/or liquidate their position in your company.

Turnaround financing - financing provided to hopefully make your company profitable after you have been fired.

Bankruptcy financing - financing provided to make sure your creditors are “hosed” after your equity position has been destroyed.

In many venture capital firms, their major expertise is raising money to invest whereas their clients really need help in other areas as well.


When these definitions were being proposed by people both within and without the industry, a few mavericks began to wonder who would finance the innovative. As the definitions grew, the need for more due diligence and larger market potential further reduced the pool of prospective ventures that could qualify under the guidelines.

One New Mexico venture capitalist and former university professor stated in 1988 that if a company did not have a potential to show a $10 million profit in three years, he did not want to be bothered. So guess what. Shortly, all he saw were business plans that proved that the prospective company could earn $10 million in three years. Ask and ye shall receive -- an old proverb!

Now I may be old-fashioned but of all the business plans I’ve seen and evaluated, I can’t think of one that was exactly on target in the third year. Business is the art of adapting to change in markets, people, and competition within the world economy. And who has a really good crystal ball, anyway.


The very best money for small to medium sized business opportunities remains personal savings, family, credit cards and in a few states, business incubator programs which provide small amounts of capital ($100,000 - $200,000).

Raising venture capital for startups and/or small businesses remains outside the province of the venture capitalists with a few exceptions. The DDF - Doctors, Dentists, and Friends - market remains the most reliable source.


A recent development has been with high net worth investors that have made money as successful entrepreneurs primarily in high technology companies reinvesting some of these gains in seed, startup and early-stage companies. So we’ve come full circle in a way, if you are looking for startup capital, these “bands of angels” combine their investments and are often more user-friendly than the professional venture capital crowd. As entrepreneurs themselves they have seen the up’s and down’s of the business and product development cycles. Their experience was gained through the college of reality and their contacts can help to build the company.

The good news is that the DDF market including the angels is about $25 billion annually whereas the professional VC market is only $3 - $5 billion currently.


The professional venture capitalist raises money from institutional sources, reviews a wide variety of business plans and invests in a very few opportunities under conditions that limit their exposure using a set of mileposts that often fail to take into account changes in the economy and/or the business itself. They do provide access to a wide range of other professionals who might be useful to the business and often, serve as matchmakers and/or partnering agents which can be helpful to the growing business. In the arena in which they have chosen, the venture capital industry is a viable alternative.

To successfully attract professional venture capital, you must have a unique product in a large growing market with little competition and high profit potential. But hey, Bill Gates was probably turned down by at least 10 venture capitalists before the first one bit.


But, if you are one of the millions of entrepreneurs like my friend, you have a real problem when seeking to raise funds. Your best bet is your own and your family’s funds including in-laws -- its also the most supportive and cheapest money you can find. Your second best bet are the DDF's and the Angels. The DDF’s are probably cheaper but unlike the Angels won’t provide as much actual business help and assistance.

To find the angels try: http://www.sba.gov/ADVO/acenet.html or http://ace-net.unh.edu

So I gave these addresses to my potential client and guess what, it looks as if he will get the money. Will wonders never cease?

But then ‘Tis Only My Opinion!

Fred Richards
March 1997

This issue of 'Tis Only My Opinion was copyrighted by Adrich Corporation in March 1997.

It is intended to provoke thinking, then dialogue among its readers. Quotation with attribution is encouraged.

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