Early-stage funding

Identifying sources of funding when lending from banks and credit unions falls short

Editor’s note: The insight that follows is part of the New North Entrepreneurial Development Series panel overviews that B2B shares with readers in the edition following each panel discussion.
The following responses come from a couple of the three panelists who spoke about early-stage financing during the New North Small Business & Entrepreneurial Council meeting in March. For more information on the New North Professional Development Series, go online to www.thenewnorth.com.
Responses are also available online at our Web site, www.newnorthb2b.com.

Dan Thome
Principal at Edgemoor, LLC
of Appleton
danthome@edgemoorllc.com
Edgemoor LLC has offices in Appleton and Milwaukee and
helps clients to build their business wealth.

David Cook
Partner at Hamilton North
& Co. in Green Bay
www.hamilton-north.com
Hamilton North & Co. helps facilitate middle-market mergers and
acquisitions and is a  private investment banking and real estate firm.
Its emphasis is primarily in the manufacturing, distribution and service sectors.

What is a typical situation where someone would call Edgemoor looking for help?
Thome: Generally, owners and/or key executives of companies come to us when they are looking at strategic options regarding their capitalization. They could be considering any of the following:

• Considering an exit via a sale of some or all of the company;
• Considering an acquisition of a business or a product line;
• Adding to capital base via an injection of equity and/or
    debt;
• Changing the capital structure, via a recapitalization, some-
    times using new equity or debt;
• Or changing sources, e.g. change in shareholders and/or in
    lending institutions due to changes in needs or expectations.

What can a typical inventor or entrepreneur expect when they first meet with you to discuss investing in their company?
Cook: When a potential client comes to Hamilton North & Co. for the first time, we are looking for a few key pieces of information.

First, we need to understand what it is they are trying to get funded, which may be a new product, business acquisition or an entirely new business idea. Once we get a basic understanding of what they are trying to accomplish, we ask a lot of questions about where they are in the process. That is, have they already engaged a patent or business attorney, is the required corporate documentation in place, do they have an established banking relationship, or have they previously raised funds from any other sources?

While having this part of the discussion, we listen closely to understand the potential client’s background and expectations. On average, our projects last from six to 12 months, so we have to feel comfortable the potential client has the passion and ability to stay with the project to the end. If not, we would rather not take on the project.

Another point of discussion with the potential client is the dreaded budget. The business of raising capital is time consuming, requires hard work, and costs money. There are no short cuts. Depending upon the complexity of the deal, the process may require the effort of several professionals. The entrepreneur needs to make sure they have enough “dry powder” before beginning the process.

What are the types of advisory services your company offers to people looking to either sell their company and/or get funding for an idea they have?
Thome: Our first goal is to make sure they have a good understanding of the environment for such a financing or sale, and that the transaction they are considering actually meets their personal and financial goals. It may be appropriate for them to proceed, or to take a pause and reconsider their expectations or change their timing. So the early phases of the advisory relationship are very education oriented.

In order to determine if their goals and the potential transaction appear to be aligned, we then perform an objective, rigorous review of both quantitative and qualitative aspects of the company. We feel it is imperative the client knows what they have to offer and why capital sources or buyers should be interested in financing or purchasing their business. Again, knowing the client understands the transaction before it begins is critical.

From there, if appropriate, we assist them in executing the transaction, with cooperation from their legal counsel and other key advisors, as appropriate. Approaches vary based on client expectations.

What are some of the mistakes small business owners make when considering a venture capital investment?
Cook: The biggest mistake we see entrepreneurs make with regard to raising capital is not engaging the appropriate professionals up front to help them through the process. The process can be very intimidating and if they have never been through the process before, it may discourage them to the point of abandoning the project.

When Hamilton North & Co. gets involved at the outset, we help guide the client through the process of finding the right attorney, banker, accountant or other service provider they may need.

Furthermore, before the entrepreneur is ready to get out and present their opportunity to investors, they need to have the proper documentation in place. There are five main documents that investors will want to see, and if you don’t have them at the ready, not only will you annoy the investor, but you probably won’t get funded. Again, it goes back to having the help up front to ensure that all the pieces are in place before going to market.

Another big mistake has to do with capital structure. When entrepreneurs accumulate their first round of financing, it often comes from a home equity line, friends and family. There is nothing wrong with this in principal, after all Warren Buffet made it work.

However, it is important to make sure you give everyone the same deal. Selling 10 percent of your new business to Aunt Sally for $20,000 and then six months later selling 20 percent to your brother-in-law for $10,000 may sound good at the time. However, it could be a real problem later when you go out to raise much larger amounts of money.

Early stage investors and private equity groups like clean balance sheets and complicated capital structures may make them uncomfortable.