When entrepreneurs dream, they dream of money. So do the venture capitalists who partner up and fund them. The money dreams of entrepreneurs tend to center on receiving a funding check. The best dollar-sign dream for a venture capitalist involves what the investors fondly term a “liquid event.” In these dreams, the plucky entrepreneurs in whose untried ideas they have invested sell the entire new company, selling off a production license, or, by taking the company public, bring in billions of dollars (think Google).
Yet only one in five firms survives its first three years, let alone becomes strong enough to make itself an attractive buy-out target. To help entrepreneurs and venture capitalists understand the joint effort needed to produce a gusher of a liquid event, the New Jersey Technology Council presents “Liquidity: Everyone’s Goal” on Wednesday, March 29, at 8:15 a.m. at the Garden State Exhibit Center in Somerset. Cost: $50. Call 856-787-9700 or visit www.njtc.org.
Susan Roos of Pricewaterhouse Coopers moderates. Panels include attorney Jeffery Nicholas of Fox Rothschild, based on Lenox Drive and in Bucks County; and Nick Baughan, managing member of Marks, Baughan & Co. in Conshohocken, Pennsylvania.
This event immediately precedes the New Jersey Technology Council’s Venture Conference, at which 50 early/mid-stage companies will make formal presentations. Visit www.njtc.org for registration.
Nicholas is heir apparent to the ultimate entrepreneurial path. His father was an attorney/businessman who was kept sane by the farmer’s daughter he met and married at Northwestern University.
“Dad was forever starting all sorts of crazy businesses,” says Nicholas. “He imported Irish wolfhounds from Ireland, and even began his own venture fund.” Not all of these efforts proved quite crazy. Like the time he bought several baby food formulas from Squibb, took out the salt and sugar, and renamed his new product Beechnut.
Nicholas attended Williams College, graduating with a B.A. in religion in l977. Then, following in the family footsteps, he came back to Chicago’s Northwestern University and took his law degree. For the last nine years, Nicholas has directed Fox Rothschild’s technology and venture finance group.
“Somewhere on a three, five, or seven-year schedule, new companies should plan for some sort of liquidity event,” says Nicholas. “Simply, an entrepreneur shouldn’t take capital if he doesn’t foresee liquidity.” Of course, the best way to make it a good event is to aim for it from the outset.
VC schemes. Venture capitalists are just investors playing for bigger stakes. As compared with the common stock shareholder, the VC is placing an all-or-nothing gamble — with cash he cannot pull out — in the face of those five-to-one survival odds. He naturally hopes for bigger rewards.
At that initial stage when venture capitalist and entrepreneur are circling around each other cautiously, the former hands the latter a spreadsheet. When the numbers are crunched, the venture capitalist hopes to find a high comfort zone: an early sales growth spurt of 25 percent, followed by sustained sales climbs thereafter. A picture of profit-taking potential going from X to 6X in a five year period makes the potential investor increasingly comfortable.
If both the entrepreneur and investor like what they see, then comes the inevitable question: What is the value of this company before I put my money in? Here comes the fun part. In determining this pre-money value figure, the venture capitalist is trying to determine just how much he will have to put in to get what percent of the company — and reap his expected return level. So obviously he tries to boost the power of his investment by keeping the pre-money value figure low.
Meanwhile, the entrepreneur shoots for a high estimate of his sweat equity, and the value of the firm as it already stands. His response is not only emotional, but fiscal. The higher he can raise the pre-money value, the less this investor’s percentage is worth, and the more likely he will be to pony up a larger sum. Sometimes attorneys help in this wrangling. Sometimes they don’t.
VC dreams. The sensible venture capitalist invests in a lot more than numbers and an enticing product line. The world’s best invention is not necessarily destined to be the world’s best selling one. “The venture capitalist is investing in management and people, as much as product,” says Nicholas. “Success depends on wisdom, contacts, and skills, and they all have to be there for an investor to come on board.”
Conversely, the entrepreneur often wants more than funds from an investor. He seeks a capitalist who can contribute contacts, synergy, and access to other funding markets. To satisfy both, the venture capitalist often takes a seat on the board or has an associate — or a hand-picked contact — take on a senior management post.
When such appointments occur, entrepreneurs often shiver, feeling they might be shut out in the cold from the very firm they launched. VCs on the other hand, know that their cash is stranded in this company until liquidity, and think that they should at least have a chance to guide it toward a good buy out. To some extent, contractual agreements can be drawn up to prevent anyone from giving away the store. Yet in the end it is a sense of trust that works best. If the venture capitalist can see the entrepreneur as a vital asset to the company and its future success, while the entrepreneur sees the VC as a seasoned businessman and the avenue to new capital markets, each will have the incentive to work well together.
Seductive targets. Not every firm that is bought out has a stellar track record with sales exploding off the charts. Of course having a company in a nice niche in an expanding growth market is certain to make a buyer’s heart beat faster. “Sometimes a firm can secure its position by buying up another small company,” says Nicholas. This not only expands its market share, but also shows potential investors that it is an aggressive firm on the move.
Additionally, the targeted firm must radiate a sense of smooth acquisition to the potential buyer. Remove all possible infringement issues and solve all human resource problems. Sometimes a pre-negotiated labor contract can be a selling point. While it is always a great fear among employees, most buyers do not want come in and face the hassle of mass firings, and then have to recruit and train replacements. If a buyer sees a solid group working of high-morale workers performing well under a unified management, he is likely to pay well for this whole, trouble-free package.
In business the old maxim of grow or die still holds true. If a firm succeeds, eventually it will expand beyond one ownership and one source of funding. Even if the liquidity is only selling pieces of your the company as pubic stock offerings, it will mean a substantial change, with a lot more horses pulling the wagon. The owner can gather all the new reins himself, or he can hand them over to someone else and go retire to a sprawling beach home in Aruba. Either way, working toward liquidity is a vital a part of today’s business planning, requiring as much attention as the current sales figures.