From Seeking Start-Up Funds to Fielding Offers
Cliff Young faced two big obstacles in financing his Marina del Rey high-tech start-up--and if you know how the capital markets work in California, you already know what they were.
The obstacles: It was a high-tech start-up, and it was in Southern California.
High-tech start-ups in Northern California gain backing from venture capitalists nearly every day, it seems, while businesses of all stripes, high- and low-tech alike, go begging in Southern California.
Indeed, when a Southland high-tech start-up does get venture capital backing, the temptation is to say of the event what the great English lexicographer Samuel Johnson said about a dog that could stand on its hind legs: The wonder, Johnson said, was not that the dog did it well but that he did it at all.
Young’s experience, however, is not unique; indeed, the lesson to be drawn from it is that if you have a good idea for a solid business and you work hard to make it attractive to investors, you can get all the backing you need, even if you have to import your capital from Silicon Valley.
Young founded his company, InternetConnect, an Internet service provider for businesses, in 1996 with about $50,000 in seed capital from his own pocket. In the early going the company used standard modem technology, but when high-speed digital subscriber line technology became widely available, InternetConnect saw opportunity and jumped on it.
DSL technology operates over existing telephone lines at speeds many times faster than modems. It gives you a dedicated connection to the Internet, allowing businesses to connect themselves continuously with vendors and customers.
Young saw an opportunity to offer DSL technology to businesses nationwide, and he needed capital to seize it. He wrote an offering memorandum, identified dozens of potential investors and set about wooing them. It took him a year to raise $500,000 from about two dozen investors, most of it debt convertible to stock.
In plain English, it took a long time to raise not very much money.
“It was very difficult, initially,” Young said. “I came to this business from real estate development, and I never had trouble getting investors for my real estate projects. I thought it would be easy raising money from the same people for an Internet business too, but I had to earn their respect all over again.”
Young completed that first round of financing in April 1998. Three months later he launched a second effort, and this time things went more smoothly: He raised $1 million from more than three dozen backers, including many of the original investors, in eight months.
At that point he sensed that the hard work was over; indeed, he felt it only a matter of time before venture capitalists came looking for him, not the other way around.
They did. Last April, the Silicon Valley venture capital firms Spectrum Equity Investors and Crosspoint Venture Partners approached Young, and by July he had another $20 million in hand--enough to launch a drive to expand InternetConnect nationwide.
What made the difference? Young raised enough money in his first two rounds of financing to get InternetConnect off the ground and then ran the company with an eye to making it an attractive bet for venture capitalists.
In particular, Young grew revenue very rapidly. When he launched his first round of financing, InternetConnect’s “run rate” was $250,000, and when he launched the second round it was $750,000. (To calculate a company’s run rate you take revenue for the most recent quarter and multiply by four--in essence predicting revenue over the next year. Investors track changes in run rates over time as a measure of growth.) Young expects revenue to hit $5.2 million this year.
The company now operates in a dozen cities, including Los Angeles, San Diego, San Francisco, Seattle, Chicago, Washington, New York and Boston. It employs 90 people in its Marina del Rey headquarters and Young expects to add another 60 by the end of the year.
What all this adds up to is simple: Young did whatever it took to make his first two rounds of capital-raising successful, and thereafter he worried less about financing than he did about building a company that investors would understand--namely one with a good stake in a big market, and with an attractive revenue stream to boot.
“Many people approach financing with the question: What do I have to do to get outside capital? What they really need to do is to focus on building a company so that venture capital will come looking for it,” Young said.
“Venture capitalists are smart people, and they’re out there looking for opportunities. For a high-tech company, the key is to focus on being the best at what you do-- because investors seek out the best.”
That means building a track record to give investors comfort that you can realize your vision, Young said.
“It takes a lot of hard work, and you’ve got to be patient,” he said. “There are no shortcuts, and until you get some investors on board and start showing results, it isn’t easy. But then you get to the point where you really are showing results and you attract the money you need.”
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Juan Hovey can be reached at (805) 492-7909 or at jhovey@gte.net.
