Danger Zone

Red flags

For entrepreneurs seeking expansion capital, danger lurks at every turn. With any viable method of acquiring additional funds comes a warning, a caution, a potential scam. Because small business is on the rise nationwide, more would-be plunderers are picking inexperienced business owners as possible targets.

Securities enforcement officials across the country report a variety of tricks, from dishonest brokers taking a wide array of unreturnable upfront fees to market manipulators who merge a relatively small but expanding firm with a dormant "shell" company. With the Internet taking on increased importance, the possibility for electronic chicanery is on the rise as well.

What makes matters worse in some cases is that most of the losses could have been avoided with a little common sense and greater attention to sound business practices. Risk-taking comes naturally to many entrepreneurs, some of whom readily fall victim to a combination of their own greed and foolishness. Getting money isn't easy, but in the quest for expansion capital, overeager entrepreneurs often miss some obvious, telltale warning signs. In the process, they can lose their companies, most of their money or both.

"As a result of our activities with capital-raising individuals, we have an iron-clad rule in the company that we simply don't pay upfront fees," says Joseph Meshi, a principal with Genovation Inc., an electronics product development company in Irvine, California. "Hundreds of people come here [offering to raise money for us]. As soon as we say 'No. Go ahead and perform, and we'll really fatten your wallet in the tail end,' they disappear, in which case we know [they were unscrupulous]." Other small-business owners report a similar plague of dubious brokers descending upon them. Placing an ad in a newspaper seeking capital can be tantamount to putting out honey for a swarm of flies.

Perhaps that's because small businesses represent a sector of the nation's economy that is doing so well. The number of new small businesses opening in the United States has increased steadily since 1991, according to the U.S. Small Business Administration (SBA). That number reached approximately 810,000 in 1995. Corporate downsizing, the declining price of office technology, and a new emphasis by banks on lending to small businesses are all contributing factors to the phenomenon, says Bruce D. Phillips, a director of economic research for the SBA.

Those particularly at risk in expansion debacles are businesses trying to raise between $500,000 and $5 million, says Neal Sullivan, executive director of the North American Securities Administrators Association (NASAA). "You have a lot of people out there holding themselves out as either matching services or other services entrepreneurs need to get desperately needed capital," Sullivan says. "Through 'angels' and family connections, [entrepreneurs] can usually raise a [limited amount]. Above $5 million, they're usually sophisticated enough to get public capital through more ready means. But between half a million and $5 million, that's where the real problem seems to be taking place. It's an area of the market completely off the [radar] screen for the SEC. It's too small."

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This article was originally published in the August 1996 print edition of Entrepreneur with the headline: Danger Zone.

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