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How a company raises expansion capital can have profoundly different effects on its owner. Robert Robison, an independent consultant in Sanibel, florida, who works with entrepreneurs getting financing, says, "Most entrepreneurs would choose debt [equity] if they could get it, because they believe they wouldn't have to give up any control. But it's not always a choice. Few new companies have assets to collateralize-like land, equipment or a patent. Entrepreneurs who do often end up leveraging their most valuable asset, and there goes the business if they don't satisfy the debt."
Of course, there's the psychology of ownership. Certain entrepreneurs just don't want to give up anything. According to Robison, "In [my] 15 years at PricewaterhouseCoopers, my biggest task in advising entrepreneurs was getting their mind around sharing control."
A look behind the scenes at two entrepreneurs who made it through the financing process highlights the profound differences between debt and equity financing. Entrepreneur Jane Witheridge reveals what happened when she borrowed money to purchase and expand her small business. Farhad Mohit, on the other hand, opted instead to sell ownership of his BizRate.com to venture capital investors-and has a different story to tell.
Cynthia Harrington, a freelance writer in Austin, Texas, writes about business for a variety of publications, including Bloomberg Wealth Manager and Senior magazines.
An Entrepreneur's Uphill Climb
Road To Garden-ville
Witheridge is what you might call a reluctant entrepreneur. At 41, she was an upper-level executive at Waste Management Inc., a garbage collector in Oakbrook, Illinois. Her perks included limos to the airport and first-class accommodations. Five years later, she's sitting in an unadorned two-person office at the end of a San Antonio, Texas, dirt road. A wood sign bears her company's name: Garden-ville.
Garden-ville sells mulches, composts and fertilizers to landscapers, distributors and individual gardeners. Witheridge's enthusiasm shows when she describes ingredients in her company's compost: "We take animal bedding from race tracks and the zoo: the heavier and wetter the better. Paunch, that's the undigested contents from cows' stomachs, comes from the packing plants. We get guano from the largest bat cave in the world, just down the road. All this organic matter mixed with dirt makes the best compost in the world."
Her trip from Fortune 500 executive to Garden-ville started with the realization that there was money in garbage. As vice president of strategic operations at WMX Technologies, which owns Waste Management Inc., she analyzed numbers and predicted the future. But her advice that sales could be made from garbage fell on deaf ears, so she opted to capitalize on the idea herself.
She quit her executive job to purchase companies occupying unique niches in serving landscapers. "We needed $3 million to $8 million to buy the companies and install the efficiencies," Witheridge says. "Over a hundred capital providers turned me down." But she regrouped. "I looked at the four companies we had letters of intent with and chose the one with the best brand name."
|They've been with you through thick and thin-the "Friends & Family" section will tell you how you can turn to loved ones for financing.|
That company was Garden-ville. In late 1998, she renegotiated the deal to buy it. For $500,000 upfront, the seller would hold the note for the remainder of the equity. "Where was I going to get the cash?" she remembers. "I was able to pull in a favor from a friend, who got me a second mortgage on my house for the upfront payment."
After closing the deal, she still faced the balloon on the company debt. "I needed a bank," Witheridge recalls. "A local bank saw the asset base of land and buildings. They took a risk, taking out the balloon and extending us a line of credit. That was a very happy day."
Challenges Of Borrowing Money
After failing to raise equity for one business plan, after moving her family from Chicago to San Antonio, after putting her house up to secure a loan, Witheridge was an entrepreneur. "There's no gentle way to get into the water," she says. "You've just got to get in, but it's cold."
The water metaphor took on a whole new meaning when Witheridge took over Garden-ville-just before a major flood. Everything washed out-roads, phone lines, electricity. "We had to start over with everything," she says.
With an eye on making payments to the seller and the bank, Witheridge and her team feverishly went to work. Garden-ville had over $3 million in sales but had been generating losses and needed to pay debts. They streamlined product lines, ended unprofitable contracts, and trained sales people to focus on products that added to the bottom line. Says Witheridge, "I thought I'd have the time to do all this once the capital was there. But we had to hit the ground running. We had no margin for error."
Three years later, Witheridge is philosophical about financing. "I may own equity, but I'm still paying off the previous owner. Even now, we are capitally constrained. But I have the confidence now we can make it on our own. It could be a 'grass is greener' situation, but I often wonder what we could have done if we'd raised equity financing. I'm sure we wouldn't have found our way to the efficiencies as quickly."
Pros And Cons
Each method of raising capital comes with its own joys and sorrows. Here are just a few:
- Investors share your viewpoint because they take the risk with you. They get their reward when you do when stock price increases.
- If additional equity is needed to grow, early investors usually have extensive contacts and can help raise the needed capital.
- Investor cash can help attract top-notch management teams.
- Founders give up a percentage of their companies' ownership.
- Owners lose some operational control of their companies, and the outsiders even have a say over the founders' salary.
- Companies can get into the "more where that came from" syndrome, always looking for investors but never making a profit.
- There's no dilution of ownership; original owners keep it all.
- As long as the debt payments are made, the original owners give up no operational control.
- The company turns a profit sooner because owners must make cash to serve the debt and have access to additional credit.
- Not all companies have access to debt financing; lenders want collateral in land, equipment, or a patent.
- If the company doesn't make payments, it loses everything.
- Growth is limited to internally generated cash flow, or additional credit based on the company's profitability.
- Lenders want equity and convertible debt dilutes ownership.
An Entrepreneur's Road To Success
Don't Get E-Screwed
What's it like on the e-side of town? BizRate.com surveys e-shoppers and makes the data available to the marketplace. It also signs up vendors to sell on the site. Founder Farhad Mohit, 30, describes the company with evangelistic zeal: "We ensure democracy in e-commerce. Shoppers can access our information so they can make decisions on factors in addition to price."
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Mohit knew he had a big idea with BizRate.com and he'd been working on it for two years when he looked for financing. "The scary part in bringing in venture capitalists is that you've got people in your company you don't even know. And you don't own your company anymore. Your stock vests over time. If they fire you, they get your stock, too. At first I couldn't believe that was legal. But we were one month ahead of bankruptcy so we took the deal."
Mohit had been on track for a lifetime of academia. After five years at University of California, Los Angeles and a job at Andersen Consulting, he was off to get an MBA at University of Pennsylvania's Wharton School in Philadelphia. "I'd applied to law school, then I thought a Ph.D., and then teach," Mohit says. "Then the Web hit me. I type in a few keys, and all the knowledge of the world is available to me. This is really incredible."
After graduation in 1996, Mohit and two friends (Dave Schaller and Henri Asseily) spent the summer developing a business plan that had been a class project at Wharton. Setting up in Schaller's apartment, they designed infrastructure, signed up vendors and began collecting shopper data. As the summer drew to a close, decisions had to be made. Asseily's family was pressuring him to take his place in the family business, and Schaller indicated he wanted to return to his job at Boston Consulting Group. "If you've got other options, at some point it becomes irrational not to take them," Mohit says. "I hadn't interviewed anywhere, but if I had, perhaps I would have had an offer to manage a Caterpillar plant in the middle of Idaho, and I would have had to take it."
Struggles Of Selling Equity
No Other Options
Seeing his team disintegrating, Mohit took action. He persuaded David Reibstein, a Wharton professor, to get involved. "With Reibstein on our board, we had validity," Mohit says. "With his investment in the company, we were worth $1 million on paper."
Using the newfound credibility and company valuation, Mohit raised $220,000 in seed capital from friends and family that would last until March 1997. Only Asseily and Mohit stayed on, relocating the company to Mohit's parents' house in Los Angeles. Mohit describes the move: "Here I was, 27 years old, moving back into my parents' house, with $80,000 in school debts. I thought the world had come to an end."
By mid-1997, he had several VC firms vying for the opportunity to fund his company. He settled on two: Mission Ventures and Media Technology Ventures for a total of $4.5 million.
"Suddenly, it became serious," Mohit says. "I had real pressure, because with the money, I have to make something happen. Now I've got guys in suits asking for budgets for putting the capital to work."
When advising clients, Robison warns that one risk of selling equity is managing new relationships. "With selling equity comes requirements to report to someone else," he says. "The entrepreneur has to confer on things like his or her salary."
But Mohit saw the advantages of capital. They had six workers when they got financing and almost 100 just 18 months later. It also accelerated marketing. In 1996, Outpost.com signed up as BizRate.com's Charter Merchant. "We started this thing signing up one vendor at a time. It took us two years to sign up 1,500 vendors." That figure doubled in the last months of 1999, when 1,500 more retailers signed up.
Mohit seems to have dealt with his concern about bringing in investors, having given up his role as CEO to be Chief Technical Officer. "We're just finishing another capital raise of $22 million," Mohit says. "This was a walk in the park compared to the first one. But now we've got even more urgency to create revenues, to make it grow."
Getting It Done
The risk in borrowing money is the potential loss of assets used as collateral-and the end of the business. The reward is continued control. The risks of selling equity, on the other hand, are losing operational control and future dilution of ownership as capital is needed. But the reward is accelerated growth. So although entrepreneurs lose ownership, the value of the retained stock sometimes makes it worth it.
Financing methods differ but entrepreneurs are the same. "There's no real difference in the personalities of entrepreneurs who choose to borrow over those who sell a portion of their company," says Robison. "Both are characterized by a single-minded purpose."
Buddhists say there are many paths to the mountaintop. And as Robison puts it, "You get what you can get, and give up what you need to give up, to get the deal done. The best entrepreneurs mature into successful managers of enterprises they just happened to start."
- Garden-Ville Inc., 14080 Nacogdoches Rd., PMB #314, San Antonio, TX 78247, firstname.lastname@example.org
- Robert Robison, (941)472-7704