For emerging companies, landing a capital investment can feel like a Catch-22.
Serious investors want to see examples of previous funding before they feel comfortable handing over their own money. That forces entrepreneurs to ask the question: How do I develop a history without securing investors?
That’s a reality of doing business regardless of when times are good or when the economy is backpedaling, as is the case now.
It is no secret that traditional lenders have tightened their standards, but some venture capitalists, private-equity firms and startup financiers have become more conservative, too, about where and to whom they float their funds.
Still, investors have money to invest. A Dow Jones Private Equity Analyst report released Monday showed that U.S. private-equity firms raised $58.5 billion in 81 different investment funds in the first quarter of 2008, up from $44.3 billion in 68 funds in the year-ago quarter.
“If you’re looking for money, it’s a never-ending process for any kind of venture,” said Thomas Duening, director of entrepreneurial programs at Arizona State University’s Ira A. Fulton School of Engineering.
Duening is in charge of the school’s Arizona Technology Investor Forum, a group started in 2006 that invests in companies spun off from the university.
He and other investment experts agree that lobbying for financing can be tiresome, but growing businesses can take steps to bolster their appeal to potential investors.
The first step is determining where to seek funding.
Investors are divided into three categories: family and friends, “angels” and venture capitalists. In most cases, the financial source will depend on the company’s stage: Whether it’s just starting out or is established and looking to grow.
Each source will have different expectations, and entrepreneurs need to anticipate and prepare for those expectations when pitching to each group.
The three F’s
Entrepreneurs starting out don’t need to look far when beginning an investment search.
“Raising money of the equity variety usually begins at home with ‘FFFs’: friends, family and fools,” Duening said.
“They’re the ones who would possibly invest . . . in a very early-stage venture. That’s because they know you, they believe in you, and they’ve heard your vision.”
That’s the path MSDx LLC is taking to fund its development of the first diagnostic blood test for multiple sclerosis.
The Tucson-based firm, housed at the University of Arizona’s Science and Technology Park, got its start in 2006. To date, the startup has supported itself on $250,000, some of which came from the management team’s personal network, President Marie Wesselhoft said.
The amount is small, but it has allowed the company’s team to forge ahead in developing its technology and buy time until it has a proven sales record to show future investors that the company has potential.
Relying on personal investments and donations from family and friends also has allowed MSDx to put off an important decision that more advanced firms have to face when accepting venture capital: How much ownership to give investors.
“We don’t want to give away more of our company than we need to,” Wesselhoft said.
Pitching to family and friends doesn’t necessarily mean an entrepreneur can sidestep preparing the information that more advanced investors seek, including a solid business plan, sales projections and competition analyses.
In that sense, a personal network can allow the business owner to hone pitching skills to interest for future investors.
“Angel” investors are the next audience to whom entrepreneurs usually try to pitch.
These investors tend to be more fickle than family and friends but not as aggressive as venture capitalists when it comes to taking equity in a company.
Angel investors often are organized in networks that look for promising new businesses in different sectors. Most of the businesses they fund are early-stage, and their investments typically are far less than those made by traditional venture capitalists.
One local example is the Arizona Angels Investor Network.
The network of business executives, technology experts and retirees selects companies to make presentations to the group every month. The companies that show the most promise often receive funding down the road.
“What we are interested in are companies that have the potential for fast growth,” said Dee Harris, chairwoman of Arizona Angels and senior managing director of Scottsdale-based investment banking firm Alare Capital Partners LLC.
Harris said Arizona Angels is interested in information technology, medical devices, renewable energy and related firms.
In 2007, the group’s members invested about $1.6 million in six companies, with individual investments ranging from $250,000 to $500,000, according to Harris.
Like all investors, Harris said, angels want to know about the company’s management team, competition and revenue projections.
Most angel investors seek companies that demonstrate a potential to grow, but they don’t expect their investments to produce returns as quickly as venture capitalists do.
The state has made efforts to spur more investments with its Angel Investment Tax Credit. The program, which started in 2006, aims to encourage people to invest in technology and life-science companies.
Under the program, investors can receive an income-tax credit from Arizona worth 35 percent of their investment in a rural or bioscience company and 30 percent of their investment in any other qualified business.
A business must be certified through the Arizona Department of Commerce to qualify as an investment prospect.
As of March, 58 companies qualify under the program, which is funded through June 30, 2011. Of the certified companies, 23 received investments worth a total of $6.8 million, according to David Drennon, department spokesman.
The next stage of financing companies seek is venture capital. Such investors look to infuse larger amounts of money into firms for larger equity stakes.
To be attractive to a venture-capital firm, a company needs to have a proven management team in place and often a sales track record to show the ability to be profitable down the road.
One of the biggest mistakes a company can make when going after funding is pitching to an investment group that focuses on sectors unrelated to what the company does, said Terree Wasley, who runs ASU’s Technopolis, a program that provides mentoring for emerging technology companies.
Investment firms typically specialize in specific areas. Experts urge entrepreneurs to learn about past companies in which venture capitalists have invested to get a sense about whether they’re a good match.
Early-stage firms can fail at landing money by providing wrong information to potential investors.
“They want to talk too much about the technology and not enough . . . about how it makes money,” Wasley said.
It’s important for an entrepreneur to be able to describe what the company does in a way that’s easy for outsiders to grasp. An investor, in addition to that, wants to have a clear idea of the impact an investment will have on the bottom line.
Entrepreneur Neeley Neal is hoping her company will land a venture-capital investment after presenting at the Invest Southwest Capital Conference in December.
The annual conference drew about 100 investors who listened to 10-minute presentations from startup companies that were selected by a committee.
Neal’s company, Sideline Star LLC, an online social network geared toward those in the cheerleading industry, was one of 14 firms that presented at the conference in Scottsdale.
“I think there is sort of this hurdle,” Neal said. “You have to either bootstrap and show some success on a shoestring budget or . . . find the larger firms that are willing to invest $1 (million) to $2 million.”
Entrepreneurs such as Neal not only must show investors how their companies can make money, they must know, too, what they own before pitching a venture-capital firm, said Jennifer Lefere, an associate with Rogers & Hool LLP, a Phoenix law firm that specializes in business and financing transactions.
“One of the issues I see are companies that haven’t properly taken ownership of all of their assets,” she said. “I see this more in the tech area . . . where they don’t own what they think they own.”
Assets can include patents, trademarks, copyrights and other intellectual property that may be attractive to a prospective investor.
“If you have no (intellectual property), then you aren’t looking at what’s around you because every business has IP,” Lefere said.
At the end of the day, the financing game is all about preparation.
“I always tell entrepreneurs, ‘Look, you have to have your pitch in your pocket because you never know when you’re going to run into someone who might be interested in your product,’” said Duening, the Arizona Technology Investor Forum’s director. “The crisper you can tell people this is how you can make money, the more exciting it is for investors.”
More on this topic
The following organizations either provide funding or can help point you in the right direction.
• Desert Angels
Description: A Tucson-based network of angel investors that invests in promising startup companies.
Web site: edesertangels.safeserver.com
• Arizona Angels Investor Network
Description: A Valley-based network of angel investors that invests in startup firms.
Web site: arizonaangels.com
• Solstice Capital
Description: Venture-capital firm based in Tucson that focuses on alternative energy, education and environment-related ventures.
Web site: solcap.com
• Hercules Finance LLC
Description: A Scottsdale-based financing firm that specializes in software, biotech, information technology and real estate.
Web site: herculesfinance.com