From the March 1999 issue of Entrepreneur

Andrew Klein made waves in 1995 when he raised $1.6 million for his New York City microbrewery by offering stock to potential investors over the Internet. Magazines and newspapers nationwide trumpeted the first Internet-based initial public offering (IPO), grabbing enough attention for Klein to pull in 3,500 individual investors for Spring Street Brewing Co., which specializes in Belgian-style wheat beer.

While online brokers had been selling stock over the Internet for some time, Klein, 38, bypassed traditional investment banks to appeal directly to qualified investors. And with thousands of entrepreneurs asking him how to raise capital the same way for their own companies, he launched Wit Capital (wit is the Flemish word for wheat), an online investment bank and brokerage firm that grooms companies for IPOs to the firm's member investors.

Most of those who followed Klein's lead were not nearly as successful. "We raised capital because we were first and got lots of media attention," Klein says. "Since then, most companies that have gone online and tried what we did have failed."

And in cyberspace, with the inherent potential for fraud, even modest bids for capital, such as private placement opportunities, have no guarantee of success. "There are real risks in investing online without an investment bank," Klein says. "If there's no intermediary, you're taking the company's word for [its success]."

Online Obstacles

Consider the experience of Debra Cox, 42, who three years ago launched BR Logos & More, a retail store in St. Augustine, Florida, which manufactures embroidery, heat transfer and graphic art products. She's looking for $275,000 to purchase additional machinery and place her products with mass marketers. "I've been to every bank in St. John's County, plus the SBA," Cox says. "If you don't own real estate, they don't want to talk to you."

Last June, Cox posted a description of her business and financing needs on http://www.financehub.com , one of more than a dozen Web sites designed to connect entrepreneurs to venture capital. She's also been researching venture capital firms online and sending e-mail memos to those that look promising. So far, her only response has been a request for more information from a West Coast firm that arranges financing. "I'm not very optimistic, but I'm going to keep trying," she says. "I'll probably have a better chance going this way than through any local bank."

Can you find venture capital online? "Absolutely not," says Sidney Williams Jr., principal partner with Axia Partners LLC, a venture capital firm in New York City. "What you can do is open a dialogue." Williams advocates using the Internet for thorough research so you can make informed contacts with promising firms and begin building relationships. Then, when you do send a business plan or prospectus, you're not a stranger.

Terry Bibbens, the former owner (now retired) of a computer simulation company who now serves as entrepreneur in residence at the SBA's Office of Advocacy in Washington, DC, agrees. "Entrepreneurs should be thinking of the Internet not as a way to have a check show up magically at your door from someone you don't know," he says, "but as a way of getting information about your company in front of people in a position to help."

That's what worked for an online shopping and information center about the independent film industry called Independentfilms.com Inc. Launched last June, the company is growing rapidly because it owns several valuable domain names that allow it to dominate Internet traffic regarding independent films.

Co-founder Tom DeLuca, 31, needed $500,000 to launch a product division that would sell films online. He posted information about the company on a venture capital Web site, but his most valuable contact came from a film producer who had visited the company's site.

After the producer expressed interest, DeLuca perused the producer's Web site, then set up a meeting. They are now close to closing a deal that will provide the needed funding. "You never know who's going to visit your site," DeLuca says.

This story illustrates the general principle that the businesses most likely to succeed in raising money online are those appealing to a built-in market. An Internet business, for example, can offer its own customers a chance to invest in the company, just as Ben & Jerry's Homemade Inc. once raised money by inviting inquiries on its ice cream cartons. Likewise, potential investors who surf the Web are more likely interested in a software, Internet or other high-tech company than any other type of business.

The Capital Game

Traditional investment banks usually aren't interested in early-stage financing because of the risk of loss. Increasingly, venture capital firms are becoming just as difficult to tap. According to the SBA, venture capital firms invest approximately $10 billion annually, but they fund fewer than 2,000 ventures per year-each needing $5 million or more. "If you're a really small company looking to raise a million or two, you have just as much chance of winning the lottery as getting venture capital," Bibbens says.

A better hope would be hooking up with an angel investor, one of the more than 250,000 wealthy individuals who together invest between $20 billion and $30 billion each year in high-growth companies that each need between $250,000 and $5 million. The SBA reports that 30,000 such companies are funded each year by angels, who typically lend their business acumen along with their money to help ensure the venture's success. Rather than expecting to take the company public and then get out within a few years, angel investors expect to be involved for five to 10 years or longer.

But how can entrepreneurs get hooked up with that kind of investor? That's where the Internet comes in. The SBA's ACE-Net (Angel Capital Electronic Network) site, http://www.ace-net.org , attempts to match entrepreneurs with angel investors. Other Web sites also make the effort, allowing business owners to post descriptions of their businesses and search for potential investors. Unfortunately, the approach hasn't worked very well yet. "I've never met anyone who's succeeded in getting capital [through an angel network]," Klein says.

One reason is that people serious about investing venture capital don't tend to browse through Web site postings because they get an abundance of prospects contacting them directly. "We don't look at those postings because we don't think quality entrepreneurs would post their business plan on a Web site," says Ann Winblad, principle partner with Hummer Winblad Venture Partners in San Francisco. "The selection of an investment partner should be a careful process, not a 'come one, come all' offer."

Postings, however, do tend to garner responses from intermediary firms that can help you get your business plan in shape and provide access to possible investors-for a fee, of course. Axia Partners' Williams visits entrepreneur bulletin boards and chat rooms to invite people to look at his firm's Web site (http://www.axiapartners.com) and consider engaging the firm to locate angel investors. "You pay us to be your devil's advocate, to help you get your plan in shape and look at the competition," he says.

The Internet provides other tools to help entrepreneurs in their search for capital. Take basic research, for example. Numerous Web sites provide background articles that can help you get up to speed on the world of venture capital. One good site is http://www.capitalventure.com , which includes a glossary found under "Private Equity 10l." There's more information at http://www.vcapital.com and http://www.financehub.com These sites include links to specific venture capital firms for more focused research.

Venture capital firms' Web sites are also great sources of information that can help you pinpoint what the firms are looking for, so you don't waste your time and theirs barking up the wrong tree. "I'm amazed at how many entrepreneurs don't go to our Web site before contacting us," Winblad says. "They'll send a business plan for a hardware company. If they'd looked at the site, they'd know we only fund software and Internet ventures."

Once you've targeted the appropriate firms, don't start by mailing a business plan, Winblad advises. "The mailed-in proposal is dead on arrival," she says. "I won't lug them home to read them."

Instead, she advises entrepreneurs to send a brief e-mail in hopes of starting an electronic dialogue about the business. "I think entrepreneurs are always amazed that I answer my own e-mail," Winblad says. After initial messages, she might have them send a business plan electronically or suggest someone else who might be interested.

Selling Stock Online

So have any companies since Spring Street Brewing managed to sell their own stock online? Yes, but only because they were the right kind of high-growth companies with built-in markets.

Internet Ventures Inc. (http://www.ivn.net), founded in 1995, has raised $7 million in three separate stock offerings, all through the Internet. The company provides high-speed Internet services for small communities through a marriage of telephones and one-way cable. Founder and president Don Janke, 48, started with two $1 million rounds of private placement to sophisticated investors, then worked with Direct Stock Market in Santa Monica, California, to place a $5 million public offering. "We did a lot of public relations [regarding] the product and the company," he says. Word of mouth led to the location of 900 interested shareholders, who each made an average investment of $5,000.

None of this happened overnight, however. The first round of financing took six months, the second, four months, and the public offering, 10 months, with the final $1 million being sold through a regional broker, which took three months. "Triple the amount of time you think it'll take, and halve the amount of money," Janke advises. "It's a matter of you finding the investors and the investors finding you."

It's also a matter of keeping it legal. Entrepreneurs can get in serious trouble with the Securities and Exchange Commission (SEC) by selling unregistered securities, a federal crime subject to imprisonment. It's especially easy to do that over the Internet, where you can describe your investment opportunity and send it out to the general public without realizing you're committing a crime.

Offering securities across state lines requires applying to the SEC, which strictly regulates what disclosures you have to make and to whom you must make them, in the interest of protecting the public from fraud. Private stock may be offered to "accredited investors," a special category broadly defined as millionaires and large businesses. On ACE-Net, potential investors must certify their income before receiving a password that allows them to view the opportunities-each of which has been cleared by the SEC and all participating states.

"If you're doing a public offering on the Internet, you have to register in every state unless [you state in the offer], in bold letters, that the deal is only authorized in, say, Ohio and California," says the SBA's Bibbens. He warns that if you go on for venture capital or an IPO and it turns out your private placement securities weren't properly registered, that poisons the deal. "Either the venture capital firm or the investment bank will walk away," he says. "You have to go back to every investor and offer to rescind the deal."

Accordingly, if you're posting a prospectus on a venture capital Web site, ask about compliance with securities laws. ACE-Net has a no-action letter from the SEC stating that companies following the ACE-Net format are listed legally-and 30 states have agreed that a company listing on ACE-Net doesn't have to file further registration papers in that state. That makes a difference, Bibbens says, because it costs $5,000 to $10,000 per state to register.

In short: Don't try this alone. Work with a securities lawyer to make sure you navigate the regulations properly.

Whether you're looking for a loan, some venture capital or a public stock offering, the Internet is only one arrow in your financing quiver. You still have to get your business plan in shape, learn how to present your company's goals and dreams succinctly, and follow up personally on any contacts initiated in cyberspace.

Contact Sources

Axia Partners LLC,sw@axiapartners.com

BR Logos & More,brlogos@aug.com

Hummer Winblad Venture Partners,http://www.humwin.com

Independentfilms.com Inc., (310) 545-1793, http://www.independentfilms.com

Wit Capital,http://www.witcapital.com