Capital Markets

Yes, Venture Capital is Available

How to raise capital in this post dot-bomb era.
Ed ZwirnFebruary 9, 2001

Is venture capital funding back?

Well, sort of. The new year has seen the return of various capital funding mechanisms, including corporate bonds and equity issuance, both of which have rebounded from the almost non-existent level seen in the fourth quarter of 2000.

New businesses are actually finding it possible to raise money, even the nouveau pariah, the dot-com sector.

But insiders and outsiders agree that it is doubtful we will see a return to the pace seen during 1999 and the early part of 2000.

And those firms successful in raising bucks find themselves having to pass through hoops that were unnecessary just a short while ago.

Some of these hoops, such as tighter business plans and more defined (and shorter) “paths to profitability,” have obvious rationales known to most financial professionals. But many stratagems require firms to insert special provisions into the structure of the deals, provisions intended to reassure investors but be kept secret all the same.

One Dot-Com’s ‘Sweeteners’

Take, for example, the structural features employed by one recently incorporated dot-com in its quest for “seed money.”

The firm, which refused to be identified, structured its “series A” round as a preferred-stock offering.

First of all, as a standard sweetener the investments of the “angels” participating in this round were declared to be more senior than the money put in by the founders, giving them a prior claim on assets in the event of liquidation.

Also, the angels got an “anti-dilution” provision guaranteeing their preferred shares–which are convertible into common stock–protection against the dilutionary effect of the firm’s employee stock option plan.

With the firm setting aside up to 15 percent of its common stock for use under its stock option incentive plan, angel investors were guaranteed that their common stock holdings would be bumped up in direct proportion as employees received shares.

“We do this by adjusting the conversion rate up to a total of 15 percent [as the employee option participation grows],” explains the firm’s CFO.

The investors were also promised “tag-along rights,” which enable them to sell shares if they choose each time “the founders find some sort of liquidity out and decide to sell more than 20 percent [of the stock],” he adds.

Lower Risk/Lower Return

Sean Schickedanz, who as managing partner of San Francisco-based Sunflower Capital has been an active angel investor in Internet firms for several years, says that a new VC “wrinkle” making the rounds, albeit one which “we’ve never done and never will do,” uses “double- participating preferreds.”

This scheme, arising out of today’s tough investment environment, “narrows the window of risk and return,” according to Schickedanz.

How does this work? “Before the conversion into equity, [the preferred stock holders] are allowed to take out twice the money they normally would.” At the same time, they are subject to an upside “cap,” he said.

On the other hand, Schickedanz, whose firm recently led InterKeel, a Palo Alto, Calif. web services infrastructure provider, in a $2.45 million Series A round, voices skepticism that there is much new in the way of structure that could make a difference in terms of luring money.

“The bottom line is that investing is still a matter of picking the right companies,” he says. “These provisions are only in there in case of failure anyway.”

The Fundamental Things Apply As Time Goes By

And other experts tend to agree that the attraction of VC funding is more a matter of fundamentals than gimmicks, especially given the current state of the market.

“The market now is pretty much like it used to be prior to the huge upsurge in the early part of last year,” says Stephen Berman, president of Synergy Capital, a firm providing investment banking services to small and middle-market companies. “Venture firms are moving more slowly, more particularly.”

“Many of them are raising the bar,” he acknowledged. “Companies need to draw up very cogent and comprehensive and clear business plans that can convince venture capitalists that [they] can reach profitability in a couple of years without having to spend tens of millions of dollars in marketing and other costs.”

Spencer Weisbroth, director of venture operations at Starter Fluid, a San Francisco-based firm which participated in the InterKeel funding along with Sunflower Capital, also argues that there is nothing that new under the VC sun.

“Provisions and agreements are detail issues,” he says, arguing that the structure of most deals boils down to one basic formula: “We give the money and they give us stock.”

But here the thing is not to overdo it. “We don’t want to take so much of a stake in the company where it would depress the chances [for others to join] the next round of funding.”

Keep It Simple Stupid

Richard Driscoll, chief executive officer and president of, a startup based in New Providence, N.J., says his firm has had success so far in raising more than $800,000 in its “seed” offering of convertible preferred stock because it has a simple, “easy to articulate” business plan.

His offering, while it incorporates many of the kinds of investor lures and safeguards described above, has gotten as far as it has only because it features a “very solid business idea, a boring, no flash, definable revenue stream [based on] subscriptions and licensing fees,” he says.

“People no longer want to see that you’re going to raise $5 million and buy a Super Bowl ad,” he quips.