Corrections or additions?
Capital Conference: Money for High-Tech
These articles by Peter J. Mladineo and Barbara Fox were published
in U.S. 1 Newspaper on February 11, 1998. All rights reserved.
The money is out there, and high tech firms are
scrabbling
to get it. But rapid changes are taking place in how these companies
get financed. Investors are setting records (they’re offering more
money) and so are companies (they’re growing and going public more
quickly).
New Jersey is right in the middle of this volatile market. In a survey
published by Business Facilities magazine, the state ranked fourth
in the nation in terms of high tech companies (6,881), and it paid
the second highest average high tech salary ($55,970). New Jersey
is also getting at least its share of venture capital money. For
instance,
Therics at Campus Drive received $4,752,000 last year for its 3-D
production process for medical products, and Sys-Tech Solutions on
Eastpark Boulevard had a $4,976,000 venture capital investment for
its packaging automation software.
So it’s not surprising that this year’s New Jersey Capital Conference
at the Princeton Marriott is attracting lots of interest. Sponsored
by the New Jersey Technology Council on College Road and set for
Thursday,
February 19, from 8:15 a.m. to 2 p.m., the conference has a capacity
of 300 people, and it may be oversubscribed by next week.
Mike Nelson, executive vice president of PNC Bank, explains
just why funding for high tech is such a hot topic. “Venture
capital
firms have set records, in the last three years, for funding high
tech companies,” says Nelson, who will give the luncheon speech
at the conference.
Returns have also been at record levels because companies are going
public in less time. Some make it from the start-up stage to the
initial
public offering in under four years, a rate that is phenomenally fast.
“With historically very high rates of return, money is chasing
after these deals,” says Nelson.
Just as the pool of capital has grown, so the number of these
companies
being financed is also growing at a rapid clip. “On the supply
side, for lots of categories of companies, going into business is
easy,” reminds Nelson. “You don’t have to buy a production
facility — you merely have to sell a piece of intellectual
property.”
The demand for capital is increasing, and the supply is growing. It’s
hot. “With things going on at once, you have an unprecedented
level of activity,” says Nelson. “I am seeing that all over
the region.”
Here’s the lineup for the New Jersey Capital Conference:
John Martinson of Edison Venture Fund gives the welcome and
keynote address at 8:15 a.m., followed by side-by-side workshops.
At 8:30 a.m.: “Private Equity Sources for Intermediate Stage
Companies,”
with Jim Gunton of Edison Venture Fund,
Dick Robbins f
Arthur Andersen, Gerard DiFiore
of Reed Smith Shaw McClay, and
Geoffrey Stengel of BT Alex Brown. Also at that time, “State
and Federal Backed Financing,” with Caren Franzini of the
New Jersey Economic Development Authority, Jay Brandinger of
the New Jersey Commission on Science & Technology, Jim Millar of
Early Stage Enterprises, and Don Christianson, of the Small
Business Administration.
“Growing Your Company through Mergers, Acquisitions, and
Recapitalizations”
at 9:30 a.m. features Tim Scott
of Price Waterhouse and James
Roberts of PNC Bank. “Debt Capital Sources & Solutions,”
also at 9:30, has Nat Prentice of BT/Alex Brown,
Dan
Conley
of Funds for Business + Leasing, Arthur Birenbaum of Jefferson
Bank, and June C. George of BT Alex Brown.
At 10:45 a.m.: “How to Finance Roll-Ups,” Brian Hughes
of Arthur Andersen and
Jim Hunter of Janney Montgomery Scott,
or “Joint Ventures/Strategic Partnering” with Bill Thomas
of Buchanan Ingersoll and Steve Socolof
of Lucent
Technologies.
David Sorin
of Buchanan Ingersoll and David Proctor of
Janney Montgomery Scott present the outlook for IPOs at 11:45 a.m.,
followed by lunch with Nelson as the featured speaker. Following the
lunch, at 2 p.m., CFOs and financial executives will have their own
roundtable on the IPO experience.
For registration information ($150 at the door) call the New Jersey
Technology Council at 609-452-1010. Interviews with Jim Gunton, Gerard
DiFiore, Brian Hughes, David Sorin, and Mike Nelson follow.
Top Of PageStart with a Bank Loan?
Almost everyone at this conference will be talking about
fancy alternatives to a bank loan, alternatives that have been devised
because banks are supposed to be fiscally conservative when it comes
to high tech financing. Will a banker float a loan to a risky start-up
when the only collateral is a great idea? Until now, not likely.
High tech firms are almost never profitable when they are young,
admits
Mike Nelson of PNC Bank, “and they have an extraordinary
growth rate ahead of them. That will place unusual demands on them
for capital, and they won’t be able to fund themselves through cash
flows.”
That’s why only a handful of banks nationwide — Silicon Valley
Bank and Imperial Bank on the west coast and Fleet Bank in the
northeast
— boast a lending group specifically organized to lend to high
technology and emerging growth companies. PNC has joined this limited
supply.
Nelson gives the luncheon speech at the New Jersey Capital Conference
on Thursday, February 19, at the Marriott, and he will tell how and
why the market has changed.
“Our unit was formed at the demand of our chairman to address
the needs of high technology and emerging growth companies,” says
Nelson. The son of an chemist who worked for NASA, he majored in
psychology
and economics at the University of Pittsburgh, Class of 1979, and
stayed for his finance MBA.
Based in Pittsburgh, Nelson is now executive vice president and has
seven people on the staff of his unit. “The bank has made a
substantial
commitment to this business,” says Nelson. “Most of the
individuals
on my staff have technical backgrounds.” In less than a year the
unit has made “relationships” or loans to two dozen firms.
“We need to assess the future success of the company rather than
what it has done in the past,” says Nelson. “We spend a lot
of time determining what is unique about the company, what might
create
some value in the future, on the appropriateness of the management
team and whether it can execute. We spend time on understanding the
other parties supporting the company; we view professional venture
capital firms as being very helpful. Having the right accounting firm
and legal counsel and board of directors at an early stage can be
very helpful in executing a strategy.”
Nelson’s PNC lenders assess risk very much the same way that venture
capitalists do. But when venture capitalists invest they get equity,
in contrast to a bank making a loan. The bank expects to be paid back
in cash. If the investment is successful the venture capital firm
is going to make a considerably higher profit than the bank, but the
bank has taken fewer risks.
How does Nelson try to risk-proof his loans? “We tend to structure
our transactions so we are the only senior lender,” says Nelson.
In other words, PNC Bank would always be in line to get its money
first. Also, the total amount of PNC’s loan should be smaller than
the total of everyone else’s investments or loans. “That is a
little safer from our point of view,” says Nelson.
Also — unlike the venture capitalist — the bank does not
retain
hands-on supervision of the young firm. “We stay involved with
our clients. We consider the active involvement of a venture
capitalist
to be our surrogate. We have several close relationships with venture
capitalists in the region and nationally.”
PNC has a new kind of start up loan available to companies on the
heels of their first major venture capital financing. “It is a
very simple, very flexible loan, directly from the bank, not
associated
with SBA,” says Nelson. A typical first round of venture capital
financing would be in the $1 to $2.5 million range, and PNC might
add about $1/2 million on top of that. This loan could be used for
general working capital and would be secured by whatever assets the
company has.
More traditional loans for later stage companies would be for working
capital (against receivables), for equipment (against the equipment
value), and for real estate. “If there is something we are seeing
the most of these days it is Internet based companies,” says
Nelson.
“Electronic commerce is a specific part of the market we
understand
well. We’ve also done companies in semiconductors and medical
devices.”
Prospective borrowers can contact Virginia Alling, or a new
PNC hire Greg Cote, or a biomedical specialist James
Roberts.
They’ll all be there on the 19th. A representative from Friedman
Billings
& Ramsey, PNC’s IPO equity underwriter, will also attend.
The bank loans that Nelson discusses are for companies with a first
round of venture capital funds and that are moving quickly to an IPO.
Nelson has an optimistic view of the IPO market: “The very buoyant
IPO market has accepted companies at earlier stages in their
development
than before at very high values. Companies are going from startup
to IPO in just under four years. With historically very high rates
of return, money is chasing after these deals.”
— Barbara Fox
Top Of PageIPOs: Bust or Boom?
From one angle, the initial public offerings market
is turning into a high stakes whirlwind of technology firms, quick
millionaires, and inflated stock prices. But from another point of
view, it’s not quite what it was just last year. In the opening month
of 1998, reports David Sorin, the managing partner of the
Princeton
office of Buchanan Ingersoll, he has seen only a fraction of the deals
done at this time last year. Sorin is less sanguine than Nelson about
the IPO picture.
“The first five weeks of 1998 have been relatively slow when it
comes to IPOs,” he says. In all of January only 15 deals
“priced,”
amounting to a total of about $750 million. “In comparison to
recent history, that is low but when you look at it over a longer
term, raising $750 or $800 million a month in the IPO market is hardly
something to sneeze at.”
He and David Proctor, an investment banker with Janney
Montgomery
Scott, give an “Outlook on IPOs” at the Capital Conference
on Thursday, February 19, beginning at 11:45 a.m.
“We’re going to do things a little differently than in the last
couple of years, when most of the talk was about profit,” Sorin
predicts. “We’re going to talk about the current state of the
IPO marketplace, about some of the benefits and advantages of going
public, and about some of the burdens and challenges of being a
publicly
held company and some of the processes.”
Some skeptics have gone on record preaching doom about technology
firms after watching the air explode out of Netscape’s stock last
year. But Sorin challenges them. “I’m not sure that the Netscape
experience is all that relevant,” he says. “I think the lesson
is that high tech companies in general are in markets that involve
great volatility and intense competition. The people who play in the
technology arena understand that.”
For investors in technology, Sorin has this advice: “Look for
uniqueness in the technology that the company produces and whether
or not that technology’s been adequately protected. You need to look
at the size of the market that the company’s playing in. It’s really
important to look at the management team that’s been developed. The
R&D effort and time to market — those are all real serious issues.
And of course, the competitive landscape.”
One contributing factor to the uncertainty is that after the record
IPO years of 1996 and 1997 there could be an unconscious feeling that
the other shoe could drop on the market at any time. Couple that with
recent world crises (in Asia, Iraq, and the White House, to name a
few) and there’s plenty of reasons to believe that the IPO market
— and any financial market — might be in for a harder time
this year than last.
There has also been a rise in the numbers of mergers and acquisitions
as well as other alternative strategies to growing a company. One
example: Last week’s purchase of Princeton Softech by Computer
Horizons
of Mountain Lakes. “Increasingly, companies are doing strategic
partnering arrangements and sale of the company as an alternative
to going public,” says Sorin. “I believe that if you actually
looked at relative valuations you would find that going public results
in a higher public valuation. But there are some companies that don’t
open the kimono in the way that you have to in order to go
public.”
Sorin refers to the disclosure required by the Securities and Exchange
Commission, which can dissuade many companies from going public. To
Sorin, this kind of reluctance is tantamount to paranoia. “I think
most people tend to overstate the anti-competitive nature of making
the disclosure,” he says. Prospectuses, moreover, “make very
interesting reading but also involve not only the good things about
a company but all of its wars.”
— Peter J. Mladineo
Top Of PageFinancingExpansions
B>Gerard DiFiore sounds a bit like Forrest
Gump
when asked about structuring financing deals for expansion stage
companies.
“Think of it like Baskin Robbins — there are different
flavors,”
he says. “You can have a redeemable preferred, or a convertible
preferred that’s not redeemable. With either of those you can have
detached warrants, or no warrants. Those are like sprinkles.”
Sweets aside, an expansion stage company is often synonymous with
an intermediate stage company. This is the subject of a panel at the
New Jersey Capital Conference with DiFiore, an attorney with Reed
Smith Shaw & McClay, Jim Gunton of Edison Venture Fund,
Richard
Robbins of Arthur Andersen and Geoffrey Stengel, of BT Alex
Brown. The fun starts at 8:30 a.m. Call 609-452-1010 to see if there’s
a seat left.
DiFiore, whose career has included four years with the federal
Securities
and Exchange Commission, describes the intermediate stage company
as a firm “with stable revenues, with a product that’s been
accepted
in the marketplace,” and that is approaching profitability or
already profitable.
As far as raising cash goes, intermediate stage deals are often
precursors
to initial public offerings. “For a company that’s likely to do
a significant IPO, they can’t get to that point without something
like this in between,” says DiFiore. “They need more equity.
There could be companies that go public at this stage but it would
be poorly planned because they give up too much of their equity.”
Like the IPO, the intermediate stage deal is mega-complicated, and
DiFiore urges management to stick close to legal and financial
advisers.
“There could be unfortunate surprises for the company that’s not
paying attention,” he says. “Surprise is good for no one.”
Contracts often contain many different tethers between management
and investors and, if not understood, they may give management the
impression that they are being squelched, or as DiFiore coins it,
“put into the box.”
“Basically management gets put into the box so there’s a
guaranteed
line of communication between management and the investor,” he
explains. “It’s to keep the investor involved in the affairs of
the company. Frankly, in the worst case, if the company wanted to
do something that was stupid it would prevent the company from doing
it. Maybe investors have built the company on sweat equity but
investors
have put hard money into that.”
DiFiore isn’t suggesting that once a company accepts intermediate
stage financing it is abdicating the helm. On the contrary, a good
investor will want to keep the same management in place and has most
likely based all or at least part of the decision to finance a company
on the strength of its management.
Gunton classifies intermediate stage companies as between $1 and $15
million in revenues, with a product or service that’s already been
accepted on the market. They also have customers “that have tried
and validated the product” and have “multiple distribution
channels, either indirect or direct.”
“The third characteristic would be a track record of growth,
typically
more on the revenue side,” says Gunton. Earnings may still be
negative.
Gunton, 32, has a degree from Stanford University (Class of 1988)
and worked at Oracle and as a consultant for Big Six accounting firms
before becoming a principal at Edison.
As a financier, Edison Venture Fund usually comes in at earlier stages
than senior investment firms like BT Alex Brown, but, says Gunton,
there is a world of difference between his deals and what would be
considered early stage investments. “Early stage companies are
the ones that get the most attention, because they’re the ones that
have an attractive concept,” he says, “whereas the expansion
stage companies are the ones that have gone to the next step.”
Companies of the midway also have a much easier time getting other
types of financing, Gunton reports. When a company has $1 million
in revenues, it is often too small to qualify for things like bank
financing, but when it approaches the $15 million mark it starts to
qualify for things like debt financing, he explains.
Expansions can also be accomplished without financial help.
“There’s
always the alternative of not raising capital,” says Gunton.
“You
can just grow at a slower rate. You become somebody that could be
acquired by somebody else.”
Other alternatives include venture capital or acquiring corporate
partners without losing control of the company. “IBM might provide
some amount of capital for a small amount of equity,” he says.
“It might fund a project that is strategic to them.”
Like a growing segment of sources from all over the financial world,
Edison Venture Fund has a penchant for the technology sector. “The
overall theme is applying technology to automate old ways of
business,”
says Gunton. What criteria does he look for? “The opportunity
for rapid growth, for market leadership, for defensible proprietary
technology, then for experience in terms of the management —
ideally
success in their area.”
Edison usually invests $1 to $5 million to purchase a minority
ownership
position and joins the board as a partner. Edison also likes to
“refer
customers and new distributors and corporate partners and also help
with the financing side,” says Gunton.
In the past, EVF has helped to fund a few Princeton area companies,
including Princeton Financial Systems and Signius Corp. (formerly
ProCommunications), which recently moved from 345 Witherspoon Street
to 11,000 square feet in Somerset.
Good news for New Jersey companies is that Edison Venture Fund has
received state funding that will enable it to invest in more New
Jersey
companies. This, Gunton suggests, could easily translate into
additional
opportunities for the pharmaceutical and telecom sectors. “I think
that the geographical proximity to these customers helps give us a
leg up but it also spawns new companies that roll out of these
industries,”
he says. “The third point is you have talent coming out of these
industries that can join or strengthen these companies that are
already
here.”
— Peter J. Mladineo
You may be in an industry that is ripe for
consolidation,
says Brian Hughes. If your industry is fragmented, some big
firm can come along and consolidate the industry with a
“roll-up,”
the latest twist in entrepreneurial financing.
“Roll-ups are a way for entrepreneurs to create large companies
in obscure industries previously dominated by mom and pop
enterprises,”
says Hughes, a Wharton MBA who has worked at Arthur Andersen for 17
years and been a partner for five. He and Jim Hunter, of Janney
Montgomery Scott, will give a workshop on “How to Finance
Roll-Ups”
for the New Jersey Capital Conference on Thursday, February 19, at
10:45 a.m. The cost is $150; call the New Jersey Technology Council
at 609-452-1010 to preregister. A roll-up consolidates many small
firms into a new public entity, and it may occur with (or before)
an initial public offering. The concept is only three years old, but
one of the leading examples is in our own back yard —
Procommunications,
now known as Signius, the nation’s largest provider of inbound
telemessaging
services.
Founded by Barbara Robertshaw (a Brown alumnna and former investment
banker) and William Robertshaw (her father), it had an early
investment
from the Edison Venture Fund. In April, 1997, the firm bought out
its largest competitor and quadrupled its space with a move from
Witherspoon
Street to Somerset. It is well on its way to an IPO.
Hughes cites two different types of roll-ups. “One we call Poof!
Overnight you are created, and the companies come together as an
IPO.”
The second kind is more of a slow bake type. Someone buys companies,
integrates them, often with funding by venture capitalists, and then
goes public. Procommunications was of the second kind. Some of the
first roll-ups consolidated firms in the office products area:
Corporate
Express (in 1994) and U.S. Office Products. U.S. Physicians is an
aggregation of 37 physician practices to deal with third party payers
more effectively. It has filed SEC registration and hopes to be public
by March.
Another well-known roll-up was in the auto business, Republic
Industries,
for which Wayne Huizenga continues to buy dealerships. A Chicago
venture
capital firm, Golder Thoma, has financed more than 45 consolidations,
including a temporary staffing concern, funeral homes, pharmacies,
and security guard services. A Houston-based firm, Consolidated
Capital,
has created a blind pool of $600 million to finance roll-ups. Here’s
how to tell if you should start rolling up your industry:
Is it fragmented? Dominated by small players?Are there efficiencies to be gained if you consolidate,not only by increasing the revenues but decreasing costs.Arthur Andersen almost always has the buyer as a client.”Onlyonce have we been on the side of the company that got acquired,”says Hughes. But he takes a dim view of your being the top dog unlessyou are very smart and have very deep pockets. “We would probablytell people to go with Republic than fight Huizenga,” says Hughes.”Consolidations are very expensive. A lot of fees areincurred.”– Barbara FoxNext StoryCorrections or additions?This page is published by PrincetonInfo.com— the web site for U.S. 1 Newspaper in Princeton, New Jersey.
