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I. Introduction - Venture Capital

Funding is a critical element for the establishment and growth of a business venture. Whether it's from a personal savings account or a large corporation's public offering, money is always a concern of the entrepreneur or corporate monarch. A seasoned business person said that, "Entrepreneurs' never fail, they give up!" A lack of money often results in a company's failure.

A venture's resourcefulness locating investment capital is vital for its development. The first place entrepreneurs usually look for funding is FFA - Family, Friends, and Associates. Asking Mom or Dad for $5,000 to buy circuit board components is not unheard of; some notable entrepreneurs have made their start this way. Ted Waitt, the founder of Gateway 2000 Computers, started from a farmhouse workshop with a loan secured by his grandmother. However, there is the added emotional burden to repay the loan because it has come from a relative or friend.

Another funding option is a loan from a financial institution, although they are typically reluctant to finance new ventures. For an established company with a proven track record or an upstart company with tremendous earnings potential, an Initial Public Offering (IPO) may be the answer to their funding needs. An IPO provides an investor an opportunity to buy the initial public issuance of stock in a company. Netscape Communications' IPO was heavily subscribed because of investors belief in the company's Internet technologies and products.

Venture Capital(VC) has grown since the late 1980's as a funding resource for emerging businesses. VC firms are usually private investment organizations that finance new companies. The firms want their investments to have a rate of return commensurate to the high risk. There are a variety of VC firms, each with different investment goals and preferences, for aspiring entrepreneurs to solicit for seed money. Some VC companies focus only on particular industries, while others have diverse holdings. The funding range is from $20 million to $800 million according to this article's expert.

For a new business, arranging a finance deal with a VC firm is as much an art as it is a science. The entrepreneur's concept and business plan are scrutinized by business and financial experts. They also assess the entrepreneur's personality and business savvy. If the VC firm decides to fund the venture, it wants a substantial investment return and usually a seat on the company's board of directors. The EM visited with Bob Crowley, Executive Vice-President of the Massachusetts Technology Development Corporation, to see how this VC firm evaluates a new opportunity and what advice Bob has for the finance seeker.

II. Massachusetts Technology Development Corporations - MTDC

The MTDC is a unique VC corporation because it is owned by the Commonwealth of Massachusetts. According to Bob, the typical VC firm is a privately-held partnership that lasts about ten years. The MTDC was founded in 1978 from an initial grant of $3 million from the Federal Government under the Economic Development Administration Program. An additional $5 million was granted by the Commonwealth. The charter of the MTDC defines its investment criteria and restrictions. The most significant restriction on the MTDC - it can only fund companies within Massachusetts. The reasons for this mandate are as follows: job creation ; nurturing entrepreneurs; fostering long-term economic development; and helping companies become technological leaders within their industries. The firm has made eighty investments since 1978, and today, its fund has a net worth of $20 million.

"The fact that we are a State owned corporation differentiates us from the traditional VC firm in two distinct ways. The first is that since we are a corporation we theoretically have an unlimited life span. Therefore as long as we continue to make investments and earn a return that goes back into the corporation, we can continue to stay in business. The typical VC firm is a limited partnership that lasts about ten years. Although this VC firm may have an aggressive investment philosophy by funding early stage companies that are typically riskier, as the age of the firm approaches its intended life-span they will cease to invest in such opportunities as the return from such an investment will go well beyond the life of the fund. We have the ability to invest in such long-term investments continually." An interesting consideration affecting the decision-making process of a VC firm. Because the MTDC is state-owned, it is not structured to earn a return for private investors.

The MTDC has funded numerous companies that have become commercially successful, and even several that have become publicly-held. Some of its notable alumni includes Powersoft Corporation, Xylogics,Interleaf, Zoom Telephonics, and Aspen Technologies. The current portfolio of thirty-three companies includes Endogen, Voicetek Corporation and PixelVision (featured in the third issue of The EM). Overall, fifteen of the MTDC's companies have gone public, seven were acquired for a profit, seven were acquired for no profit, and twelve have gone out of business with no return to the firm.

Bob's functions as the Chief Investment Officer which means he reviews all of the plans submitted to the firm. All deals must be approved by the Board of Directors that meets every five weeks. Bob and his team analyzes and summarizes the company's business plan, meets its management, and then gives their recommendations to the Board. The Board reviews and evaluates the opportunity. "Our relationship with the board is very good, and although they are by no means a rubber stamp, they approve 9 of the 10 deals that we submit." A testament to the thoroughness and skill of Bob and his team.

Bob has over thirty years experience in the financial industry as a loan officer and president of both small and large commercial banks. He has been with the MTDC since 1978. The rest of the professional staff consists of six people with backgrounds in accounting business development, law, investment banking, and other corporate capital work. Their roles are opportunity assessment, corporate analysis and due diligence, and portfolio management.

The typical outlay by the MTDC to emerging companies is approximately $250,000 to $300,000 of an entire need of $1 million to $1.5 million. The balance is provided by partner firms such as banks or other VC firms. The firm tries to build six to eight deals a year. While this amount may appear small compared to the investments of other VC firms, it meets the needs of a growing number of companies that fall in the "capital gap." "Back when I started in 1978 a good size fund was $20 million. It is now anywhere from $200 million to $800 million. The problem with that is that the companies now that are seeking $1 million to $2 million will not get a hearing from these large funds because it is a decimal point to them. This is what is known as the capital gap and it has gotten more severe because of all the money going into these larger funds. Our job to is look at situations that may be overlooked by traditional VC firms because of their vision to only look at large opportunities where many millions of dollars are required by the venture." Another facet to the smaller start-up with these modest levels of financial needs is that this level of funding is also tell-tale of the maturity of the company and experience of the founders. "We nurture entrepreneurship where other firms will not invest in companies where the entrepreneur is a first time CEO. A lot of funds do not want to invest in a rookie unlike MTDC which is willing to invest in a Drew Bledsoe rather than a Troy Aikman."

III. Meeting the VC Firm - The Evaluation Begins

"One of the interesting things about being in the money business is that people will find you. The product I sell is not a difficult product to sell." With its sponsoring of business conferences and exhibiting at forums, the MTDC actively markets itself to the business community and to entrepreneurs. "Fortunately for us our restriction to only do business within Massachusetts does not hinder us because Massachusetts is such a strong breeding ground for entrepreneurs. It's also good in that we don't spend a lot of time on airplanes." Whether a company has found the firm through a blind mailing, or by speaking to a staff member at a trade show, there are many ways to establish a relationship with the MTDC.

When Bob receives a business plan, first he reviews its potential. Bob places considerable value on the business plan. It is not the sole criterion for a proposal, but it reflects upon on the entrepreneur's credibility and diligence. "This is probably true for any VC firm, the business plan is a reflection of how committed somebody is to the idea. I could spend all day chatting with people about an idea. But it is a tool of self selection because if somebody doesn't want to sit down and put a business plan together, I don't want to talk with them. It is a reflection of the person's commitment to the project." There are different ways to create a business plan and many reference materials available on the subject (see the second issue of The EM , Arthur Andersen's "Summary of a Business Plan"). Whatever method a company uses, there are key features and information that should be communicated to the potential investor. "I have never seen a perfect business plan and I don't think one exists. I think the intent is to give some idea as to what the opportunity is. There is nothing wrong in using a business plan in using simple layman's language. When I evaluate a plan I considers the 'eyes glaze over factor' which is how long it takes for my eyes to glaze over when I am reading the business plan. If my eyes glaze after only two pages, that's bad."

What message should be conveyed in the business plan? Bob answers this question using a historical analogy, "In 1858 the statement was made that if you build a better mousetrap the world will beat a path to your door. What people don't realize is at that time mice were a huge problem in the world unlike today." In other words, marketplaces change, and you have to provide solutions for needs. "Unless you have a market for your product, it won't work. What I want to know is does the entrepreneur understand the marketplace they are in?" Generally he really doesn't want to know how a product works. He wants to know what problem does it solve. "If you're not solving a problem you're not going to sell much. With technology companies there are feelings that if the consumer doesn't buy the product it's the customer's fault...wrong! There tends to be too much time spent on what the product does and how it does it than why it's important. I would say that many first time technology entrepreneurs make that mistake and give long doctoral dissertations as to the value of the technology...I couldn't care less. I want to know what problem does it solve."

IV. Further Evaluation - Who and What are we Dealing with?

If Bob feels a business plan has some merit, he will have an associate review it, and then the associate will meet with the entrepreneur. Information gathered from this meeting supplements the business plan, and it is analyzed at a staff meeting. The next step involves further meetings between the entrepreneur's management team and the MTDC's staff. "People are probably the number one item for me. You can have a great product, but if you have poor management you're not going to win. You can have a good product with excellent management and that is always the best of the two choices. If I go out and visit with a company and the CEO is talking for a while, I will ask someone else at the meeting a question. I don't really care about the answer, what I want to see is if that person answers the question or does the CEO jump in. If the CEO jumps in that tells me I don't have a team here, at best I have a benevolent dictatorship. I am much more interested in the intangibles."

Bob believes a common mistake made by entrepreneurs is their rigid approach to a face-to-face meeting. "This is particularly true of engineers. They want to run the meeting by a strict agenda and point by point." To test an entrepreneur's adaptability skills, Bob will let the person follow the agenda for the first couple of bullet points, then he will deliberately jump out of order. "This is what you're really looking for. There are a lot of people that are great practice players. What you want is someone you can give the ball to in the last 5 seconds of the game and they are not going to freeze. Whether or not they make the basket is irrelevant. What's important is do they have the confidence to make the shot?" The firm is entrusting a lot of money to this person, so they clearly want a sense of the person's makeup.

Bob also wants to know the entrepreneur's level of salesmanship. Entrepreneurs have to constantly sell themselves, whether it is to VC firms or consumers; therefore, Bob carefully looks for this ability. Other criteria includes a company's gross margins and its location. "We also consider how much we are needed in the deal and how much of a percent our funding represents in an entire round of funding." If the MTDC is the primary funding source, they have more involvement in the venture.

The MTDC tries to avoid involvement with service companies. They look for companies that develop or manufacture products. As the product company grows, it will expand its facility, thus creating jobs. When a service company grows, they expand by location and this may be out of state. "I also have a personal bias for investing in a product company. A successful product company will continue to grow in sales and as that happens its cash needs will also rise. Thus at some later point the only way the company is going to get the money it needs to grow is by selling out to another company or by going p ublic which is a liquidity event that will give payback to the investors. A growing service company will not have the same cash needs. The need for a service company to go public or be acquired is not there. As an investor my experience shows that you will not get that same type of return."

When it comes to investing in the marketplace, the MTDC 's preferences lie off the beaten path. "We do not wish to be part of a herd. The Internet is an example of an industry where there is a herd. When something goes from a cottage industry to a mature industry in 14 years such as PC software, there have been winners and losers. I think the time frame is going to shrink for the Internet. We don't want to get involved in such a large realm of opportunity where it's like people throwing spaghetti against a wall to see what sticks. It's not a good way to grow a business. We tend to look more for niche situations where there is a real opportunity where other people aren't. We tend to try and avoid the crowd." They also feel they can afford to be more patient with a venture. "We are more sympathetic to a deal that will be more a single or a double than a home run. VC firms that have five deals to choose from will pick their number one and number two. We go for numbers three, four and five. I have yet to see someone with the wisdom of Solomon to know which ones will be the top two."

Because of the level of scrutiny that goes into the evaluation, and the variable nature of entrepreneurial companies, the time to complete an evaluation is never a constant. "The process can take anywhere from three months to one year. Often times we have an opportunity that needs further evaluation and maturity before it can be considered. The main thing is considering the people, the opportunity, and the resources they will need. There are a lot of intangibles in this business. You also have to have a sense of humor! If you're too stiff you're not going to make it in this game, and it is a game."

V. Post-Evaluation Involvement and Return on Investment

After the company receives its funding from the MTDC, a new relationship begins between the organizations. The MTDC provides managerial advice and assistance to the entrepreneur; the reason why its staff has diverse business experience. But, the MTDC is careful to remain at arms-length from the venture's operations. "There is a tendency in this business that people like to wear battle ribbons to present what boards they are on." Bob feels there is potential for trouble, if there are too many VC people on the company's board. "This is a big ego business and if there is room for only one VC person on the board, how is that person chosen?" He says the board should be balanced with people who have good business, marketing, and technical skills. "We retain observation rights to go to board meetings which we can participate in. We prefer to not go on boards but will if requested or needed to. My experience shows that you make more money on the deals you spend less time on."

And just what is the VC firm's expected rate of return? "Our cumulative rate of return since we started is about 17% a year." According to Bob, the standard rate of return in the VC business is 40% or five times the investment in five years. "In the early 80's VC partnerships earned good returns, then a lot of money started coming in and the returns in the late 80's and early 90's went down. There was too much money chasing too few deals." Bob felt there was a time in the mid-80's that a person could sit at a word processor, write a business plan, drop it in the mail, and a check would come back. Those type of deals are bound to fail. "Because of this environment we do not have a target return rate, so 20% a year would make us thrilled."

As in life, and in business, some outcomes cannot be anticipated, "We have never made a bad investment. They have gone bad, but when we got in it appeared good to us. You have to have the competence and maturity to realize that not everything is going to work out. An effective practice that I always adhere to in my work is what I call the "doctrine of no surprises" which means that if there is a problem, put it out on the table. Don't sweep it under the rug because the rug is only going to get bigger."

VI. The State of Emerging Business - You are not Alone

As explained above, the funding process can take anywhere from three to twelve months. It is naive to think your business plan will receive the immediate attention of a VC firm. "We receive 300 business plans a year. From that 300 I take a serious look at 150. The ones we don't look at are either out of state, want too much money, or are simply not relevant to our interests. We then take a more serious look at 40, then a very serious look at 10, and go forward with six to eight." An entrepreneur can take some basic actions to facilitate the process. "This is probably true of any VC firm that you could contact them to get their investment interests, goals and requirements to ensure your plan is going to a place that is appropriate. It's worth the call to get this information and facilitate an introduction. An introduction is not a prerequisite but it won't hurt you."

Emerging business is a steadily growing world phenomenon thanks to corporate downsizing and to increasing technological resources available to aspiring entrepreneurs. This phenomenon is keeping the VC community very busy in its search for viable entrepreneurial companies. "I think the environment continues to be strong. We continue to see opportunities. Downsizing is creating opportunities because growing companies are accessing talent that they could not access before. Companies are also nimbler now because of the corporate revolution as well." The current economic environment appears to be conducive to a start-up company seeking funding to grow a fledgling operation. Regardless of the funding source, an entrepreneur must understand that, "If you have something that is going to solve a problem, and you can define what the problem is, what your solution is, and what you need to get from here to there, that's all you really need."- ###


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