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& DESIGN Home Page Architecture Brand Equity Auto Design Game Room SMALLBIZ Smart Answers Success Stories Today's Tip INVESTING Investing: Europe Annual Reports BW 50 S&P Picks & Pans Stock Screeners Free S&P Stock Report SCOREBOARDS Hot Growth 100 Mutual Funds Info Tech 100 S&P 500 B-SCHOOLS Undergrad Programs MBA Blogs MBA Profiles MBA Rankings Who's Hiring Grads | | JULY 31, 2000 BOOK EXCERPT The Manager's Arsenal Workplace Warrior: Insights and Advice for Winning on the Corporate Battlefield (Part 2)
As discussed in chapter 7, most people fantasize about being a great leader followed by an adoring crowd. In actuality, most groups of people in today's culture are hard to interest, much less lead. Consequently, for the manager, particularly the new manager, the following are a number of valuable principles to remember: In any case, just like families, all companies at one point or another need access to more money than they have in order to fund growth. However, while the family and the established company both have access to capital through banks, the small private company usually has to seek funds from investors who specialize in high-risk investments. These professional investors, whether business "angels" or venture capitalists, invest in private companies because they expect them to grow at a sufficiently high rate to yield a return superior to what they could earn in other, less risky investments. Moreover, unless these investors expect the company to buy them out at some minimum predetermined rate at a particular time (in which case the investment is more of a loan), they expect a "liquidity" event -- either the sale of the company or a public offering -- to they can realize their profits and have the opportunity to move on.
It's relatively easy to interest investors in a going concern that has a strong record for growth in profits. It's much harder to raise money to start a company. Occasionally, a no-brainer, a product like Viagra, has such obvious appeal that it is clearly a winner, but in most cases, neither the entrepreneur nor the story is that compelling. As a result, too often the relationship forged between the investors and management is like an uneasy alliance between ethnic groups that have experienced centuries of distrust. Any crack in the structure causes chaos. However, for entrepreneurs who cannot bootstrap their companies and who (in most cases, wisely) choose not to use funds from friends and family, there are two primary sources of professional capital -- business angels and venture capitalists. What Drives the Business Angel. Business angels are wealthy individuals, often self-made or with considerable business background, who allocate some of their resources to invest seed money in new ventures. The advantage of a business angel is that the only person's money at risk is his own. In other words, the business angel has no one to answer to if the company fails. As a result, first-time entrepreneurs just starting a company often find it easier to raise money from angels than from traditional venture capital firms, and depending upon the individual in question, the relationship may be either hands-off or very involved. Business angels rarely consider themselves to be the company's last investor. Their goal is to provide the entrepreneur with enough capital to fund initial product development and sales so that the company can later raise additional capital at a higher valuation than at which they invested. The careful business angel, however, will take pains to ensure that the company is run soundly, or he runs the risk that the company will be unable to raise that additional capital. What Drives the Venture Capitalist. While some business angels consider their investments almost a hobby, venture capitalists are in the business of making and managing high-risk investments on behalf of their limited partners, which can range from wealthy individuals to pension funds. Investors in venture funds understand that the investments made by venture capitalists (VCs) run a higher risk of failing than other more conservative investments, because VC-funded companies rarely have significant assets or revenue history. These investors take this risk because they expect the venture capitalists to be savvy about the marketplace and responsible for the management of the companies in which they invest, and while individual investments may lose money, the overall performance of the sum total of investments will provide good returns. Each VC fund raised has a limited duration, at the end of which the venture capitalists must cash out. If venture capitalists do not provide an above-average return on the sum of the investments, they may not be able to raise their next round of funding. As a result, one of the VC's most important tasks is evaluating a company prior to investment, because once the check has been written, there's no backing out. The term frequently applied to this type of evaluation in the business arena is due diligence and refers to the steps that one party takes to ensure that the representations made by another party are accurate. In the case of evaluating start-up companies, this process involves assessing a number of relatively complex issues discussed below. The Product. If the product has not yet been produced, the merits of the proposed products and the likelihood that the company's team has sufficient skill and experience to produce the product must be evaluated. If the product exists, the VC will want to obtain customer references. Its Potential Market. Because VCs want a high rate of return, two of their biggest concerns are the size of the market for the company's proposed products or services and the company's potential to succeed in capturing a large share of that market. There is considerable art involved in evaluating the potential merits of and markets for a product. As a result, many venture firms specialize and hire associates based on their expertise and experience in a particular area. However, even when VCs have considerable expertise in particular areas, it is often hard for them to assess the potential of a proposal -- in part because the entrepreneurs do such a bad job of articulating why the product is important from a business standpoint. For example, I recall counseling a couple who had not been able to raise money for what they had benchmarks to prove was the best data compression technology available anywhere. They dropped their jaws in unison when I asked why their idea was important and exactly who was spending too much because this technology was not available. To them the answer was obvious -- anyone sending data from one place to another (in short, anyone using the Internet). To the VCs, it was technical jargon. The Current Ownership of the Company. In order to have a legal entity with which the VC can interact, the entrepreneurs must establish some kind of corporation and, in so doing, determine which founders own how much of the company's stock. The cleaner the ownership, the better from the VC's point of view. If the company has funded its initial operations out of the entrepreneurs' savings or an investment from a business angel, the VC is frequently comforted, as this shows the founders' level of commitment and sophistication. If, however, the initial funds have been raised from friends and family, it can pose problems when structuring a deal where decisions need to be made quickly and efficiently. For this reason, VCs are frequently attracted to companies that have already raised funds from other reputable VCs, because they can assume that these issues have already been resolved. The Financial Status of the Company. Determining this status entails understanding the amount of cash on hand and the way that cash is managed and accounted for. In a start-up, the entrepreneur frequently keeps the company's books as if it's a household, with bills and receipts in a shoebox, checks written by hand, and so on. Others are more sophisticated and use a service for payroll, and still others keep a proper set of financials. In any case, VCs need to assure themselves that the company's management is fiscally responsible, for example, with respect to payroll taxes and sales taxes. If a company fails to manage its finances properly, the entrepreneur will find it extremely hard to raise money even if the shortcoming is addressed, because the VC will worry about what other oversights might have occurred. Intellectual Property and Dependence on Key Personnel. If the product development is dependent upon proprietary technology, the VC must verify that the company has protected its intellectual property through patents, license, copyright, or the appropriate treatment of trade secret material. When the utilization or further development of this technology is dependent upon the know-how and skills of one or two people, the VC needs assurance regarding the company's ability to retain those key persons or plan for recovery if that is not possible. The Management. Finally, and probably most important, the VC is concerned with the management team. Building a successful company takes more than simply having a better mousetrap. As one vice president (VP) of sales and marketing says, "If the best product always won, there would be one kind of everything." Being successful in business requires appreciation for the potential pitfalls and complexity of managing expenditures, people, development, customer support, and so forth. Moreover, the processes required to manage these areas effectively change as a company grows. Given that VCs are satisfied with their other areas of due diligence, their biggest risk then is that the people running the company do not have the experience, skills, or character to run the company. With the first-time entrepreneur VCs have even more concern. Reference checks in these cases can uncover a great deal about the entrepreneur's character or particular set of skills, for example, technical or marketing. However, the fact remains that someone who has never run a company poses a bigger risk than someone who has. In my case, for example, I was considered a poor risk for a CEO. I had neither experience nor training in business, and my background was technical. Even worse, my partner and I were both women in our forties in 1991, long before being a woman CEO was fashionable. At any rate, the skills of the management team are one of the most important factors leading to a company's success and one of the hardest for a potential investor to measure. Even if one or more of the investors is local and can regularly visit the company, the company's success will depend on the ability of management to assess the company's progress on a daily basis. To offset this risk, many VCs insist on augmenting the management team as a condition of investing.  By Kay Hammer  | | |
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Excerpted from Workplace Warrior: Insights and Advice for Winning on the Corporate Battlefield, by Kay Hammer. Copyright 2000. Reprinted by permission of the publisher AMACOM, American Management Association Publications, 
