Note: This article is the first in a four-part series examining private-equity partnerships. In this series, a veteran private equity investor discusses the life cycle of equity partnerships from the first time the business owners needs growth capital to the demanding days long after the thrill of the IPO is over.

By the late 1990s, AlphaSmart had reached a crossroads.

Founded in Silicon Valley in 1992, the firm had self-funded its growth to profitability. Its success was driven by the acceptance of one product: a portable "computer companion" that improves basic student skills such as writing, keyboarding, and reading comprehension and makes grade school teaching more effective. But the founders -- two former Apple Computer engineers and a marketing executive from Eli Lilly -- saw potential to expand their business. "Naïve as we were, we started saying OK, it's time to go public," says CEO Ketan Kothari.

But Kothari and his co-founders soon discovered they needed more than just financial alternatives to going public. They were seeking growth capital, yes, but they also knew they had to round out their management team and broaden the offerings of their company. The ideal financial partner would challenge them to think through the company's strategic direction.

The three founders embarked on several rounds of conversation with different types of companies in the financial community. On one point they were crystal clear: it was about more than the money. The relationship had to be right.

It became clear that private equity investors could infuse the necessary capital. But the three founders also learned that not all private equity investors are the same. "Being in Silicon Valley, we heard horror stories of investors taking control of the company from founders. We had friends who'd gone through that," recalls president Manish Kothari. The right private equity firm would provide capital and contacts and strategic advice but leave the current management team firmly in charge of the company. The right financial partner would also convey credibility and strength to the financial market. In June 1999, AlphaSmart's founders selected Summit Partners to invest $20 million in the form of preferred stock and arranged a further $20 million in bank financing, which was used to rapidly expand their product line to ensure future growth.

AlphaSmart then tapped Summit's relationship network to hire a chief financial officer and a director of operations. And the equity firm's contacts helped AlphaSmart recruit a computer industry leader to its board. Subsequently, Summit advised the firm in its move from being a single-product hardware company to a broad-based education technology provider serving school districts across the United States and around the world.

Like AlphaSmart, a good number of young businesses reach profitability early and then see terrific opportunities to reach new levels through new product development, accelerated sales and marketing activity, geographic expansion, or strategic acquisitions. Capital from "friends and family" can't cover the bigger investments those businesses now need. It also doesn't bring the business and financial networks that a growing company needs to tap.

Credit-crunch headlines aside, growth financing is available for rapidly growing, profitable companies. According to Fleet Capital, more than $375 billion in institutional private equity is currently invested in the portfolios of middle-market companies, with $100 to $125 billion of dedicated capital in middle-market private equity funds that has yet to be deployed. But what isn't talked about is the need for more than just money.

There are many ways in which the right relationship with a strong equity partner can make a lasting difference to the vitality of a growing business. But what constitutes the right relationship? Entrepreneurs have to be selective. First, they must shortlist the investors that have proved they are interested in a company's prospects over the long term. Then they need to narrow the list to the equity partners with the strongest networks of contacts and the ability to help attract powerful board members. The next cut will screen the investors that can demonstrate knowledge of the entrepreneur's industry and offer strategic guidance customized to the company's challenges.

The final pick will acknowledge a characteristic that is hard to measure but easy to feel. It will come down to an investor that respects the accomplishments of the founding team. The fact is, great companies are built by great entrepreneurs, not by investors. The best financial partners understand that very well.

Here are 10 questions to ask before seriously considering an equity alliance:

  1. How do I know your business has staying power, and that your management team won't change soon?
  2. How do I continue to run my business if you take a stake in it?
  3. Have you invested in other emerging businesses in my sector?
  4. Can I have names and contact information at those businesses -- including the deals that didn't work out well?
  5. Tell me about your main investors.
  6. What happens if we don't meet our targets?
  7. How will you support me in both good times and bad?
  8. What industry introductions can you make for me?
  9. Who will I work with at your firm?
  10. How many seats will you take on my board?

Martin J. Mannion is a managing partner of Summit Partners, a global private equity and venture capital firm that invests in growing, profitable, privately held companies with proven business models, records of revenue and earnings growth, and the leadership capable of sustaining that growth. He can be contacted at: 617-824-1010, or mmannion@summitpartners.com.

For more on growth capital see:

The Private-Capital Survival Guide
Anatomy of a Financing
CEO's Regret #2: Not Seeking Financing Sooner
Summit Partner's AlphaSmart Case Study