Southland Businesses Must Be Poised to Catch Financing Wave
The event was yet another forum on financing where, after the buffet dinner and formal presentations, small-company owners tried to snag a moment with venture capitalists, angels and traditional funders.
“I didn’t even know what this event was all about,” confessed one entrepreneur at the Westlake Village event. “But I sent in my business plan anyway. . . . I didn’t get picked” to present the plan.
No surprise, according to venture capitalists and small-business advocates. Entrepreneurs who dream of venture capital often don’t do the work to get it. Failing to do research and to plan or structure their businesses to make them attractive to venture capitalists, they end up among the 95.5% of companies that seek but don’t get venture capital in Southern California.
“There’s a tremendous amount of naivete out there,” said Rohit Shukla, executive director of the Los Angeles Regional Technology Alliance. “We’ve seen it over and over again. Entrepreneurs do not do research because they think it hinders them and puts a brake on vision.”
But the real vision is in doing the prep work, particularly now. Southern California could be on the verge of a venture capital boom. Venture money increased 92% last year to $1.2 billion in the Southland, venture capital firms are continuing to open branch offices here and angel organizations in Orange County and Beverly Hills are gaining momentum.
Meanwhile, the number of venture forums and training sessions keeps increasing. PricewaterhouseCoopers will hold a session, called Venture In, April 29 in Santa Barbara, and the Small Business Administration plans a June 2 event in Los Angeles.
Driving this activity is increasing disenchantment with Northern California. Venture capitalists complain that Silicon Valley companies are overvalued, which means investors get less company for their dollars. Northern California real estate is at a premium, making it tough for start-ups to get reasonably priced office and manufacturing space and driving up costs. Finally, the very business smarts that venture capitalists say they admire in Northern California firms mean company officers there cut harder deals.
That’s why venture capitalists increasingly are looking southward. Sprawling Southern California, with start-ups in myriad industries and with business owners who are VC neophytes eager to cut deals, represents an untapped opportunity for venture capital.
But before small-business owners go running off to photocopy their business plans like the luckless entrepreneur in Westlake Village, they’d best bone up on venture-capital basics:
* Not every profitable business idea is venture-capital material. Size matters to venture capitalists, who typically expect a 33% to 45% rate of return on a large investment.
Many venture capitalists won’t even look at any deals unless they yield at least $50 million within three to five years, said Allen H. Clason, an equity financial coach with Quest Financial Services in Pasadena. Entrepreneurs too often ask for a mere $250,000 to $1 million or ask for venture capital when what they really should seek is a bank loan.
* Too often entrepreneurs boast that they’re the only ones in the market with their unique product or service. But their lack of research fails to uncover that someone else bailed out on the same product after an unsuccessful try or fails to take into account alternatives to their product that have already claimed the market.
“In my 20 years [in venture capital], I can’t think of more than a couple of situations where there’s been no competition,” said Massoud Entekhabi, a partner in PricewaterhouseCooper’s global technology group. “If somebody tells me the market is $2 billion and growing to $5 billion and they’ve got no competition, they’ve already lost my attention. It’s completely unrealistic.”
* Many entrepreneurs who devise a winning product or service think they also have the skills to develop, manufacture, market and distribute their idea on a global scale. Completely wrongheaded, say venture capitalists, who will often provide the necessary outside help to make an idea succeed.
Business owners need to be honest enough to know their own strengths and weaknesses and get others on board to fill in the gaps. At minimum, a business owner needs an accountant, attorney, experienced management team and advisors, Clason said.
* Venture capitalists want to know their money will be used to create the new product or service and not simply to cover existing salaries and operations. They also need to know that entrepreneurs believe enough in the idea to risk their own money.
They want so see something “in addition to sweat equity,” said Jerry Knotts, California Manufacturing Technology Center’s financial services program manager in Thousand Oaks. “If it’s good enough for you to hock your house, then it’s good enough for them.”
Three years of past financial records with income statements, balance sheets and cash flow charts by months or quarters are important, Knotts said.
* It’s not enough for entrepreneurs to envision what they will do with the money, they also need to figure out how and when investors will get their money back.
“There must be a very clearly articulated exit, and it must be clearly seen,” Shukla said. “IPO, merger and acquisition are perfectly reasonable.”
That means, ultimately, that the originator and founder of the business will relinquish control or step aside completely to see it grow, an idea that few small-business owners understand or accept. In the end, if venture capitalists decide to invest, they end up with a piece of the company. That’s in addition to fees for any consultants who helped broker the deal. Those fees can range from 7% to 18% of the money to be invested, either up front or on contingency.
The search for equity capital can take two to three years, even for those with all the pieces in place. With the coming swell of venture capital in Southern California, entrepreneurs here would do well to wash the stars out of their eyes and buckle down like their Northern California brethren.
“A great percentage of the people who seek support for their business growth do not realize the extent of the effort needed to get equity capital,” Knotts said. “Smoke and whistles don’t count.”
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Times staff writer Vicki Torres can be reached at (213) 237-6553 or at vicki.torres@latimes.com.
