Questions the Entrepreneur Can Ask

The investor presentation phase of the venture-capital-seeking process is demanding and pressing, which is appropriate for this high-stakes game. Venture capitalists have an enormous legal and fiduciary respon­sibility to their limited partners, not to mention their powerful self-interest. Therefore, they are thorough in their due diligence and questioning to assess the intelligence, integrity, nimbleness, and cre­ativity of the entrepreneurial mind in action.

Once the presentation and question-and-answer session is complete, the management team can learn a great deal about the investors, and enhance their own credibility, by asking a few simple questions:

Do you believe in our plan to bring scale to our business?

Tell us what you think of our strategy, how we size up competition, and game plan. What have we missed? Whom have we missed?

Are there competitors we have overlooked? How are we vulnerable, and how do we compete? What is the likely response of the major competitors?

How would you change the way we are thinking about scaling the business and planning to seize the bigger opportunity?

Is our team as strong as you would like? How would you improve this and when?

Give us a sense of what you feel would be a fair range of value for our company if you invested x amount of dollars?

Their answers will reveal how much homework they have done and how knowledgeable they are about your industry, technology, competttors, and the like. This will provide robust insight as to whether and how they can truly add value to the venture. At the same time, you will get a better sense of their forthrightness and integrity: are they direct, straightforward, but not oblivious to the impact of their answers? Finally, these questions can send a very favorable message to investors: this management team is intelligent, open-minded, receptive, and self-confident enough to solicit our feedback and opinions, even though we may have opposing views.

Due Diligence: A Two-Way Street

It can take several weeks or even months to complete the due diligence on a company, although it can go much more quickly if the investors know you. The verification of facts, backgrounds, and reputations of key people, customer satisfaction and market estimates, technical capa­bilities of the product, proprietary rights, and so on, is a painstaking investigation for investors. They will want to talk with your directors, advisors, management team, key customers, and major suppliers. Make it as easy as possible for them by having very detailed resumes, lists of ten to twenty references (with phone numbers and addresses), includ­ing former customers, bankers, and vendors, who can attest to your accomplishments. Prepare extra copies of such material as published articles, reports, studies, market research, contracts, purchase orders, and technical specifications to support your claims.

One recent research project examined how eighty-six venture capi­tal firms nationwide conducted their intensive due diligence. In order to evaluate the opportunity, management, risks, and competition, and to weigh the upside against the downside, firms spent from 40 to 400 hours, with the typical firm spending 120 hours. That is nearly three weeks of full-time effort. At the extreme, some firms engaged in twice as much due diligence.15 Central to this investigation were careful checks of the management's references and verification of track record and capabilities.

While all this is going on, do your own due diligence on the venture fund. Ask for the names and phone numbers of some of their success­ful deals, some that did not work out, and the names of any presidents they ended up replacing. Who are their legal and accounting advisors? What footprints have they left in the sand, vis-a-vis their quality, reputation, and record in truly adding value to the companies in which they invest? Finally, the chemistry between the management team and the general partner that will have responsibility for the investment and, in all likelihood, aboard seat is crucial. If you do not have a financial part­ner you respect and can work closely with, then you are likely to regret ever having accepted the money.

Other Equity Sources

Small Business Administration's 7(a) Guaranteed Business Loan Program16

Promoting small businesses by guaranteeing long-term loans, the Small Business Administration's 7(a) Guaranteed Business Loan Program has been supporting start-up and high-potential ventures since 1953. The 7(a) loan program provides 40,000 loans annually and is extensively a guarantee program. But under this program the Small Business Admin­istration also makes direct loans to women, veterans of the armed forces, and minorities, as well as other small businesses. The program entails banks and certain nonbank lenders making loans that are then guaran­teed by the SBA for 50-90 percent of each loan, with a maximum of $ 1 million. Eligible activities under 7(a) include acquisition of borrower-occupied real estate, fixed assets such as machinery and equipment, and working capital for items such as inventory or to meet cash-flow needs.17 SBA programs have a noteworthy effect on the economy and entre-preneurship. The $ 1 million guarantees, the largest of all the SBA pro­grams, have helped many entrepreneurs start, stay in, expand, or purchase a business. According to the SBA, over 541,000 jobs were cre­ated by SBA borrowers in the year 2000, and the SBAhelped create 2.3 million jobs - about 15 percent of all jobs created by small businesses between 1993 and 1998.

Small Business Investment Companies*

SBICs (small business investment companies) are licensed by the SBA and can obtain from it four dollars in debt-capital loans for each dollar of private equity. The impact of SBICs is evidenced by the many major U.S. companies that received early financing from SBICs, including Intel, Apple Computer, Staples, Federal Express, Sun Microsystems, Sybase, Inc., Callaway Golf, and Outback Steakhouse.18 The SBIC pro­gram was established in 1958 to address the need for venture capital by small emerging enterprises and to improve opportunities for growth.19 One or more commercial banks, wealthy individuals, and the investing public generally supply an SBICs equity capital. The benefit of the SBIC program is twofold: (1) small businesses that qualify for assistance from the SBIC program may receive equity capital, long-term loans, and expert management assistance; and (2) venture capitalists partici­pating in the SBIC program can supplement their own private invest­ment capital with funds borrowed at favorable rates through the federal government. According to the National Association of Small Business Investment Companies, as of December 2000 there were 404 operat­ing SBICs with over $16 billion under management. Since 1958, the SBIC program has provided approximately $27 billion of long-term debt and equity capital to nearly 90,000 small U.S. companies.

SBICs are limited by law to taking minority shareholder positions and can invest no more than 2 0 percent of their equity capital in any one situation. Because SBICs borrow much of their capital from the SBA and must service this debt, they prefer to make some form of interest-bearing investment. Four common forms of financing are long-term loans with options to buy stock, convertible debentures, straight loans, and, in some cases, preferred stock. In the year 2 002, the average financ­ing by bank SBICs was $4 million. The median for all SBICs was $2 50,000.20 Due to their SBA debt, SBICs tend not to finance start-ups and early-stage companies but to make investments in more mature companies. According to the SBA, major changes have been made in the SBIC program over the last few years, including the Small Business Pro­gram Improvement Act of 1996, which states in its declaration of policy:

Research and development are major factors in the growth and progress of industry and the national economy. The expense of carrying on research and development programs is beyond the means of many small-business concerns, and such concerns are handicapped in obtain­ing the benefits of research and development programs conducted at Government expense. These small-business concerns are thereby placed at a competitive disadvantage. This weakens the competitive free enter­prise system and prevents the orderly development of the national econ­omy. It is the policy of the Congress that assistance be given to small-business concerns to enable them to undertake and to obtain the benefits of research and development in order to maintain and strengthen the competitive free enterprise system and the national economy.21

More thematic eBooks are located at : capital structure