Editorial Staff
style='font-size:12.0pt;mso-bidi-font-size:10.0pt'>By:2'> John Kingston, MBA, CFPstyle='font-size:12.0pt;mso-bidi-font-size:10.0pt'>
New entrepreneurs can find capital from an increasing number of small to large size venture capital firms on the Internet, but things can go wrong -- very wrong -- sometimes due to circumstances entirely outside of the entrepreneur’s control.
Most mid-size venture capital firms restrict their funding to areas they understand and know well, while the larger corporate players are more diversified in their funding portfolios. At the other end of the spectrum, individual investors (typically wealthy individuals looking for additional ways to diversify their holdings), called "Angel" investors, will provide up to $2 million or $3 million dollars in venture capital. Angel's may themselves, be successful hands-on type entrepreneurs who only need to be excited about the vision and the management team. Angel investors are often the seed capital that can help the entrepreneur bring his new business to that first level -- survival. Once viable, most will move on to a larger venture capital firm for more money to continue their growth, or they will go directly to the capital markets (issuing stock). At this stage, Angel investor's hope to cash out much of their equity at this stage.
Depending on the venture capital firm, they may be staffed by professionals willing to help the new entrepreneur, bringing experience in general management, finance, technology, communications, marketing and production. They may also have an attorney or two in the mix. However, one thing is certain, when the deal is made and the firm begins funding, it becomes a business partner demanding stock options, warrants and other calls on the future equity of your business.
normal'>What happens when things go wrong?
That depends on the venture capital partner’s level of sophistication and perception of the problem. Some deals unravel due to events entirely outside the entrepreneurs control, while other financings may simply blow-up because of a series of small things that take on a bigger perspective to the venture capitalist. One of the keys is to manage expectations (an issue with all relationships); to understand the level of information the venture capital partner needs in order to feel comfortable. The venture capital partner needs to know the entrepreneur's strengths and weaknesses, so he can determine if intervention is needed along the way.
The cash-flow model used while searching for venture capital may turn out to be flawed when operations actually start -- often the result of reworking the model so many times during the process of negotiating different venture capital opportunities. What you didn't know when you started the path will begin to creep into the equation, and the new venture should rework the budget as new issues or problems are encountered. New technologies may prove to be a greater challenge than originally thought, and solutions may not appear as clear cut under the examination of marketing and cash-flow concerns. Some issues will amount to little more than minutia, but several will turn into distractions that require more time and energy to resolve, and time means spending more of that precious cash-flow.
Fortunately, the larger, well-funded venture capital firm will expect this and provide the extra funding. They know there are no guarantees in this business, only probabilities. However, the Angel investor may not have the stomach for disappointment if the outcome begins to look cloudy, and he may quickly turn into a Devil investor. The Devil investor will begin to question everything and may attempt to force management to make decisions to suit himself and not the new enterprise. He may cease future funding and take steps to recover his investment.
normal'>Factors outside the entrepreneur's control
New technology overtaking the technology being developed will usually cause the professional venture capital firm to drop the project like a hot potato. However, general economic conditions and market behavior should not have a significant or lasting effect on the larger better-capitalized investor. This is not the case for the Angel, as he must feel wealthy enough to risk significant capital investment in a non-diversified venture, and if market conditions change his wealth assessment, he may quickly cut funding to protect capital. Recently, market conditions caused many entrepreneurs from Naples to Seattle, to scramble for cash as their Angel partner developed cold feet (I've talked to Angel-financed technology companies in both locations, with strikingly similar stories). Some Angels abandoned their projects altogether.
normal'>How did problems with Angel investors' become so widespread?
In a word, interest-rates. After six straight interest rate increases from the Federal Reserve the high-flying technology laden NASDAQ market took a tumble. The Federal Reserve stated for months that it saw higher worker productivity and the wealth effect from stock values as being potentially inflationary. You don't fight the tape, and you can't fight the Federal Reserve, the saying goes, as the stock market corrected sharply in late spring. The broad market, as measured by the S&P 500 did not suffer so badly, however, many investor's on margin with NASDAQ stocks were not so fortunate. With many NASDAQ portfolios down over 50 percent, investor's on margin saw their accounts wiped-out. One week in April alone, $2.1 trillion of net wealth was removed from the stock market. That's huge, considering the wealth gains by households in all of 1999 was only $1.7 trillion, and the total U.S. national debt is less than $5.8 trillion. While most Angel's are broadly diversified, it's estimated that many of them were brought below their pain-threshold, turning them into the dreaded Devil investor. As interest-rates moderate and the market resumes, some will ease their choke on funding. But, the more aggressive Angel lost his money and has withdrawn forever.
There are no guarantees, only probabilities. Good Luck.
style='font-size:12.0pt;mso-bidi-font-size:10.0pt'>John Kingston, CFP, is a partner in the Registered Investment Advisory firm of Investment Insight, Inc., offering a full range of money management and financial planning services with a fee-based/no commission compensation structure. He’s the author of a fast-moving novel of foreign intrigue entitled Level Playing Field Financial Planning Association of Southwest Florida.