On the Horizon
Last year was a good one for companies seeking expansion capital. Of the record $29.4 billion in VC funding handed out last year, 31 percent represented later-stage deals--up from 28 percent in 2006--according to the "MoneyTree Report" by PricewaterhouseCoopers and the National Venture Capital Association; venture capitalists inked more than 1,100 later-stage deals, worth over $12 billion.
But can the good times last through turbulent 2008? Not if you're counting on banks to finance your growth, says Jeffrey Sohl, director of the Center for Venture Research at the University of New Hampshire. Even the outlook on venture capital is mixed, according to the April report: VC investing dipped slightly in the first quarter of this year to $7.1 billion--down 5 percent compared with the first quarter of 2007. Still, the quarter was the fifth largest for VC investments since 2001. Sohl maintains that this year's outlook is positive for business owners seeking growth financing, particularly from angel investors, venture capitalists and private equity firms. And entrepreneurs we spoke with confirmed that there's plenty of money still flowing to fund proven companies.
At Fountain Hills, Arizona-based business consulting company Profit Dynamics Inc., president Brian Hill sees more money floating around this year as some wealthy investors, disenchanted with low interest rates, sinking real estate values and a volatile stock market, are becoming more interested in venture investing as a path to high returns. Deal valuations remained strong through the first quarter of 2008, says Hill. "I'd describe the market for fundraising as strong, sustainable and rational." Here's a sector-by-sector look at growth capital for 2008:
Bank Loans and Vendor Credit
Many banks are still reeling from last fall's collapse of the subprime mortgage market. But Corey Pierce, CEO of small-business loan portal Businessfinance.com, says loans are still being made--mostly to businesses with good credit.
"Most business owners ignore their credit score until they need it," says Pierce. He advises doing everything you can to improve your business's credit score before applying for a loan. Use several business credit cards or small lines of credit so you have a track record of making payments on time.
If you've worked with a bank on another loan--and you are in good standing--go back to the lender to see if they'll finance your next growth round. You can also scout out banks with promotional business loan deals. Another option is to look for business loans based on your personal credit history.
Good credit can also help you negotiate better terms with vendors. Ask vendors if they'll let you pay in 60 or 90 days, instead of the usual 10 days, based on your payment history.
Best known as funders of M&A and company takeovers, private equity firms have shown a growing interest in providing businesses with expansion capital, says Jennifer Rossa, managing editor of Private Equity Analyst, a monthly newsletter from Dow Jones. "With what's going on in the credit markets, the big- and midmarket [private equity] buyout firms are more open to [funding] growth," Rossa says. "They can't always get the [bank] debt they need right now to do acquisitions."
The newsletter has chronicled a boom in new growth equity-focused private equity firms willing to invest in proven companies that need expansion capital in exchange for a minority stake. With banks pulling back on small-business lending this year, Rossa expects that growth-equity firms will see more opportunities for expansion funding deals.
Private equity firms can also be a source of debt financing, which is what David Bateman found for Property Solutions International, his West Provo, Utah-based property management software company. In April, co-founder, CEO and chair Bateman, 30, and co-founders Ben Zimmer, 31, and John Hanna, 29, closed on a $500,000 private debt agreement with InnoVentures Capital Partners, which specializes in debt funding.
InnoVentures participated in earlier small fundraising rounds for 5-year-old Property Solutions, but Bateman shopped the company's proposal around to other debt funders to verify that the loan terms were fair. He also lined up a commitment for another $500,000 in angel financing that the company could tap this summer if needed.
Bateman says there was quite a bit of interest from both private equity groups and venture capitalists in providing growth funding for his 55-employee company, which projects $4.5 million in revenue this year. Says Bateman, "[Everyone] we approached was interested in talking to us."
In the past, angel investors have focused on seed or startup funding, but that trend has changed recently, says Sohl. His study of the 2007 angel investor market showed that expansion-stage investing made up 21 percent of angel investments last year, compared with just 12 percent in 2006.
That's because in tough times, more established companies look like better bets to angels, explains Sohl. Another trend favoring expansion funding is the growing number of angel investor groups that function more like VC firms. To vary their investment portfolios, these angel groups are diversifying beyond just providing startup funds. Says Sohl, "The risk/return ratio is sweet on [expansion deals] because you have some data, not just proof of concept."
The story here is simple: VC firms raised a record $12 billion last year, and that money needs to be put to work, recession or not, says Mark Perutz, partner at VC firm DBL Investors. Most VC firms raise money from large institutional investors, such as retirement plans and college endowments, which, if anything, might be looking to put more money into venture capital, as real estate returns and interest rates remain low.
Also, venture capitalists tend to think four or five years down the road when they're hoping to cash out of an investment, so the current downturn isn't such a worry. This is all positive for more established entrepreneurs seeking growth capital, Perutz says, though the climate's a bit tougher for higher-risk startups. There's also more interest from venture capitalists in providing debt financing, an option that offers growing companies needed cash without forcing their owners to give a large ownership stake to the venture capitalist.
Corporate Venture Investments
This category might be the trickiest to predict, as each corporation's approach to and funding process for venture capital is different. Some companies might have funds put aside for venture investing, while others might scale back if their stock price has declined and they feel less flush. The "MoneyTree Report" showed that in the first quarter of 2008, corporate venture investing was down slightly but was on track to nearly equal last year's 800-plus deals, which were worth $2.5 billion.
Tracy T. Lefteroff, global managing partner of PricewaterhouseCoopers' VC practice, says he expects corporate venture capital to keep flowing this year, but with more focus on strategic investments--namely, funding for companies in the corporations' sectors that might make good future acquisitions. So expect large technology companies that do venture investing to stick to funding technology startups. "A lot of companies view these corporate investments as R&D funding," says Lefteroff. "They're going to continue to deploy their assets regardless of what's going on in the economy at this point."
Seattle writer Carol Tice reports on business, finance and social issues for Seattle Magazine, Washington CEO and other leading publications.
To see the top 100 VC firms, click here.