Articles
Cash Infusion
Savvy Business Owners Make Venture Capital Choices That Don't Demand Too High a Price
By Michelle Valigursky
Photos: Jason Turner
Entrepreneurs gamble on new ideas every day, but professional money managers known as venture capitalists take highly calculated financial risks in exchange for a potentially big payoff. Their investments are an important economic fuel — serving primarily as the equity for promising start-up and emerging companies. The venture capitalist typically receives an ownership interest for the money invested, and expects to cash out in a relatively short amount of time.
“Venture capital is by its very nature a risky investment,” says Tim Smoot, senior vice president and CFO of Baltimore-based Meridian Management Partners, a professional asset manager for private equity funds and economic development. “VCs don’t get paid unless a business is sold or refinanced. Unlike a loan, VC money doesn’t have scheduled payments. If a company goes bad, the venture firm can lose its investment.” Throughout the venture process, a company still requires basic capital funding, and many times, owner investment. “The venture capital firm becomes an equity holder, and they will only invest if they identify an opportunity for three to five times growth. If the company hits a home run, the VCs may get 10 to 15 times their initial investment back.”
In 2007, venture capital investments reached a six-year high at nearly $30 billion nationwide, with nearly $1.3 billion allocated to 214 deals in the Baltimore–Washington, D.C., metro area. Though first quarter 2008 numbers were slightly lower than the same time last year, more than $7 billion in 922 unique deals was recorded across the country, with life sciences and clean technology investments at the forefront. The National Venture Capital Association reports that companies backed by venture capital accounted for nearly 11 million jobs in 2006 and $2.3 trillion in revenue. Regionally, 48 distinct venture deals put $265 million into the economy.
Investing in Business
On a local level, John Laughlin and his team at Ridgecrest Investments Inc. in Frederick have infused more than $37 million into businesses in Frederick and Washington counties in the last three years, plus an additional $10 million in nearby West Virginia. Ridgecrest maintains majority positions in the privately held companies in its portfolio, including Hagerstown’s Laber’s Office Furniture and Beachley Furniture Co. The company’s focus is four-fold, with investments in light manufacturing, retail furniture operations, financial services businesses and education. “We create immediate value with equity,” Laughlin says. “We’re investing in one business at a time, one building at a time.”
While every venture firm specializes, Ridgecrest’s model is unique, focusing on revitalizing central business districts. “These towns grew up around large facilities that quickly outgrew their initial utility and went vacant for a potentially long time,” he says. After thorough rehabilitation, the multi-use buildings become private business incubators. Ridgecrest manages 1.4 million square feet of local space, including the former Hagerstown Armory and the Westview Center Building — and companies in which Ridgecrest has an equity holding often relocate to these facilities. One such Ridgecrest adaptive re-use project will debut later this summer, when Frederick’s Tyler-Spite House reopens as a cutting-edge design firm.
Ridgecrest’s business philosophies are unique in many ways, but like most venture capital firms the company seeks investments in businesses with high potential for success. “Ideas are cheap. … For every guy who makes a million dollars, there are a thousand guys who think they have the next Facebook,” says Laughlin, whose firm passes on 70 percent of the proposals it receives. “We want to know how well you can execute.”
Turning Ideas into Capital
For each new business idea, Maryland entrepreneurs can turn to an intricate network of advisors, private investors, institutional lenders, state-funded programs, grants and venture capital firms like Ridgecrest to streamline and finance business operations at every stage. “Seed capital is initial funding given out on a wing and a prayer when an idea is not yet marketable or saleable,” explains Frederick Attorney Jeffrey McEvoy of McEvoy and Dean, which provides legal counsel to clients through all stages of venture funding. “If companies use that funding wisely, they may attract equity funding with convertible debt financing, which is meant to take them through real and tangible development in exchange for partnership or stock in the company.” Successful recipient companies then can convert that debt into additional equity, McEvoy continues. Finally, businesses might seek mezzanine funding to further enhance company services after their technology or product is fully marketable.
Navigating the maze of financing options requires a solid business plan that clearly identifies future revenue potential. “The best technique is one that attains funding with the least amount of cost to the company,” says Chris Marschner, director of the Technical Innovation Center in Hagerstown. “Smart money comes from a connected investor who can advance the business.” Mike Dailey, executive director of the Frederick Innovative Technology Center Inc. (FITCI), agrees. “But at what phase do you need funding, and where do you go? How do you ask for money? Who are the industry players to approach?” he asks. “We bring in accounting professionals to evaluate a firm’s best course of action with respect to current and future financial needs.”
In the beginning, most businesses require at-risk start-up capital to advance product or technology development. Bootstrapping is a term used by many entrepreneurs who finance a business by using home equity loans, personal savings, credit card advances or monetary gifts from family and friends. The founders of AWS Convergence Systems in Germantown, Md. — owner of the WeatherBug brand, which provides weather information services to the National Weather Association and individual consumers from data collected by more than 8,000 tracking stations nationwide — “bootstrapped the growth for seven years until we were able to get the cash flow from neutral to slightly positive,” recalls CEO Bob Marshall.
By 2000, WeatherBug’s corporate infrastructure was well established to provide data services for weather stations at schools and television stations, “but we wanted to accelerate growth and move to consumer space and the Internet,” Marshall says. The situation was complicated by the impending retirement and buyout of one of the company’s founders. Working with a corporate advisor, the partners put together a road show of corporate stats and projections to present to venture capital firms. HarbourVest Partners in Boston saw the company’s potential and invested $15 million in Series A financing to enable AWS to fully develop and launch WeatherBug’s user-friendly desktop application.
Four years later, AWS sought additional venture funding to continue expansion of the product line. “We wanted a West Coast VC presence to help us establish higher-level relationships in interactive companies. This time when we did the road show, we were the hot property,” Marshall says. “All the biggest names in Silicon Valley were interested, and it was nice to be loved. We chose Michael Moritz of Sequoia because of his phenomenal reputation for successful investment in Yahoo, Google and YouTube.” A strategic partnership with Polaris’s Allan Spoon resulted in another injection of capital. “The company doubled business year after year from that first burst of funding,” Marshall says. “Now we’re the Number 3 Web site every day in the news and information category, ranked above CNN and MSNBC. And we’ve truly become a digital media company with exclusive strategic partnerships to provide high-quality weather data to AOL, Verizon and Nokia.”
Marshall says his company chose their venture partners carefully to ensure a good match. “In our case, HarbourVest, Sequoia and Polaris have been very supportive, and the capital they provided was instrumental to helping us expand our product line, drive innovative technologies, and scale our business globally.” Each venture firm holds at least one WeatherBug board seat.
Weigh the Costs
Marshall’s point about choosing VC partners wisely cannot be understated. In most cases, these investors buy a say in how the recipient company does business. “It is always a huge tradeoff for company owners — how much can they afford to retain vs. how much they can afford to give up,” McEvoy says. “Venture capitalists want a fair degree of control and a large piece of the equity, but they don’t want financial exposure and they don’t want to own the company long term. They lend with the understanding that investment will be paid back with profit after selling the company to a larger industry player or taking the company public.”
Businesses seeking venture capital should do their homework to determine the best VCs to approach for funding. Proposals rejected by numerous VCs garner an “over-shopped reputation” — so it’s critical to be prepared! Experts suggest gathering information on VCs based on five factors:
» Geography: Find a “local lead” investor. The closer the VC is to the investment, the easier it is to “add value” and to “monitor” it.
» Development Stage Preference: Some VCs prefer start-up investments; others focus on later-stage investments.
» Investment Level Parameters: Most VCs have upper and lower limits to the size of an investment.
» Industry Focus: An increasing number of VCs are specializing in certain industries.
» Lead Investment: Identify a lead investor — an active investor willing to lead financing — before approaching passive investors. Venture capital leadership is key to successful financing.
In addition, Laughlin says, the majority of venture capitalists “aren’t prepared to pitch in to make a company work unless they have a specific skill set to offer. This can be troublesome for both buyer and seller without a solid corporate infrastructure.”
Ridgecrest’s core philosophy supports involvement. “Most VCs require great management. Our No. 1 criterion is a business that meshes with our model. It may have a management problem due to death or succession.
We want to salvage these businesses that might otherwise be lost,” Laughlin says. “It’s very satisfying to watch a business that was failing turn itself around. We’re lucky. We get one of those rushes every month.” *
Channel Some Capital
The Following Resources Can Help You Locate Venture Capital
» Frederick Innovative Technology Center Inc.: Focused on information technology and life science companies. 301.694.2999. www.fitci.org.
» Technical Innovation Center at Hagerstown Community College:
Focused on technology-oriented companies in targeted industries
of avionics, information technology, life sciences and software development. 301.790.2800 ext. 399. www.technicalinnovationcenter.com
» United States Small Business Administration: www.sba.gov.
» Small Business Development Center: For a listing of area locations, visit www.sbdc-wmd.com/where.html.
» Frederick County Public Library Business Resource Center: Among other key publications, the
library subscribes to the DowJones Galante’s Venture Capital and Private Equity Directory. www.fcpl.org/information/ brc/small_bus.htm.
» Service Corps of Retired Executives: www.score.org.
» National Venture Capital Association: www.nvca.org.
Investing in Maryland Business
The Maryland Venture Fund Adds Fuel to the Region's Entreprenurial Fire
For emerging companies like Akonni Biosystems in Frederick, the Maryland Venture Fund offers capital that can kick-start success. Launched in 1994, the MVF is a state-funded seed and early-stage equity fund that receives annual allocations from the Maryland State Legislature. The Fund makes direct investments in technology and life science companies and indirect investments in venture capital funds. Through its two investment vehicles — the Challenge Investment Program and the Enterprise Investment Fund — the MVF has invested more than $45 million in more than 175 companies. “We look for viability, credibility, assumptions and potential market, then take a proactive role in ensuring success,” says MVF Managing Director Ray Dizon. The Fund does not take a board seat, but “we want to see companies graduate into escalating investment funding.”
Akonni Biosystems received a $200,000 MVF grant to use toward enhancing manufacturing capabilities and attaining FDA approval for its TruDiagnosis® disease-detection products. Akonni began as a home-based operation fueled by founder assets and angel funds from high net worth individuals. Shortly thereafter, the business moved into the Frederick Innovative Technology Center, Inc. “The support from FITCI allowed the company to focus on refining products, building prototypes, getting customer validation, and raising an additional $6 million in private funding,” says Senior Marketing Advisor Kevin Banks.
Instead of pursuing a relationship with a venture capital firm, Akonni maintained ownership and only accepted funds from angel investors — a decision made in part to maintain Akonni’s corporate mission to solve challenges facing global health.
Like Akonni, local entrepreneurs can bring their vision to reality with help from resources like FITCI and the Maryland Venture Fund. To be considered from MVF funding, a company must submit a full business plan and meet the Fund’s investment criteria.
Maryland Venture Fund
217 E. Redwood St., Suite 2200
Baltimore, MD 21202 • 877.821.0099
mdventurefund@choosemaryland.org
