A handful of sucessful entreprenuers become venture capitalists, helping small companies with money and advice.
Where America's new businesses really get their money
We often about hear the role that venture capitalists play in fueling start-ups. But we all know they place their bets on just a handful of companies. So where do all those other entrepreneurs turn for capital? Savings, friends, and relatives, sure. But from all reports, it seems the deepest pockets belong to other entrepreneurs -- the adventur e capitalists. Let's find out how they go about doing deals.
-- E.C.
Tom Sears couldn't believe he'd stayed up most of the night for this. Rejected by bankers, venture capitalists, and even friends, here he stood red-eyed and rumpled in front of his last hope: five guys who looked more interested in their next tee-time than shelling out $300,000 to help his company.
When Sears proudly passed out his business plan for an educational software company, no one even flipped to the first page. While one potential investor sculpted his scrambled eggs, another scratched notes on the back of his green paper place mat. At the far end of the table, still another discussed the pros and cons of caffeinated coffee with the waitress.
Standing next to the wall of golf trophies at this country club in the New Hampshire hills, Sears yearned for the trappings of high finance: the gleaming skyscrapers, the oak-paneled boardrooms, the high-gloss presentations. Still, he pressed on, pointing to his 10-year reputation in the industry, his exclusive contracts, the relative vacuum in the market niche he had identified. But he thought he had lost them. No one seemed to be listening.
Sears slumped back in his chair and waited. He had barely lifted his cup of coffee when the questions came rapid-fire -- questions that were precise, penetrating, and to the point. Why would students switch to this product? How much of the design is proprietary? How will quality control be assured? How complex is the programming? Sears was stunned. Their informality belied the intelligence of these investors, and he quickly began to think maybe he was in the right place after all.
Such is the impression left on most newcomers to "the breakfast club," the Hollywood-inspired moniker for this group of middle-aged entrepreneurs who meet for breakfast about seven times a year to hear presentations, hash over business plans, and decide which start-ups to back with their time, energy, and capital.
Individually, these investors don't merit a blip on any chart of total investment capital in this country. Collectively, however, in cities and towns across the country, hundreds of thousands of similar investors -- successful entrepreneurs who are willing to invest in other entrepreneurs -- have quietly become the nation's major source of start-up capital, far outpacing the venture capitalists who grab the headlines.
Professional venture capitalists are expected to invest only about $1 billion this year in seed financing. Because start-up investments from the likes of the breakfast club are informal, scattered, and rarely talked about openly, solid numbers are hard to come by. One person who tried was Robert Gaston, commissioned to do a study by the Small Business Administration. The study (later published by John Wiley as Finding Private Venture Capital for Your Firm) put the total at $27 billion a year. While people may quibble about the exact figure, there is no question that the entrepreneur-turned-investor has become an extraordinary economic force.
These individual investors -- nicknamed "business angels," an apt description given their inclination to invest where others fear to tread -- typically provide their personal capital to the high-risk, early-stage deal and help the entrepreneur get started. While the power of angel capital grabs the spotlight when business icons like H. Ross Perot, the billionaire Texas industrialist, invests $20 million in the latest venture of Steven P. Jobs, most business angels operate far from the spotlight and lack even the informal structure of the breakfast club. Preferring instead to work alone, they find investments through friends, casual conversations, and referrals.
It's not a new phenomenon, of course. Henry Ford's auto empire was launched thanks to five angels who plunked down about $40,000 in 1903. What's changed is the power of this capital both in terms of numbers and the need it answers. In the past 20 years new incorporations skyrocketed almost 200%, and in step with this burst of new companies is the growth in the number of entrepreneurs who are angel candidates. In particular, start-ups from the high-tech boom of the 1970s have come of age, unleashing the wealth of founders who are eager to invest in the next generation. At the same time, start-ups gobble more dollars than ever before, making it less likely that founders can make do with back-pocket savings. Not only are there multiple markets to consider, but inflation and the rise in the value of the dollar both add to today's start-up costs.
Yet as much as venture capitalists agree that start-ups are costing more, they shy away from these riskier, untried waters. It's not because the venture money isn't there, however. In the last 10 years the venture pool multiplied 10 times, with about $32 billion invested by the end of 1988. Of the $3 billion invested in 1988 alone, nearly 50% went to later-stage deals and 19% to leveraged buyouts and acquisitions. Only 32%, or about $1 billion, went to early-stage deals. By venture capital definitions, these seed investments average about $800,000 to $1 million, much more than many start-ups need or want.
For angels, this spells opportunity. Record numbers of them stand ready to embrace would-be company founders, relishing the aura of uncertainty they themselves remember from the early days of their own ventures. The notion is a romantic one: entrepreneur begetting entrepreneur, one generation fueling the next. Sounds wonderful. And often it is. But an angel deal supposes that two strong egos -- the kind it takes to build a company and disprove all the naysayers -- can work side by side, sharing ideas and compromising when necessary. It's inevitable that on occasion, egos clash, angel takes on entrepreneur, and a bitter fight over the company ensues.
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The New Hampshire breakfast club first began meeting three years ago, but their friendships and business deals extend back as long as 25 years. Members include Douglas Drane, a founder of Atex, the $60-million publishing computer-systems company acquired by Eastman Kodak Co. in 1988; George Schwenk, a founder of the INC. 500 company Termiflex, a manufacturer of hand-held computer terminals, and an investor in three other INC. 500 companies; Mort Goulder, a founder of Sanders Associates, now a $1-billion division of Lockheed that builds advanced electronic systems; and Dick Morley, founder of Modicon, a $250-million company that builds programmable controllers. All have since moved on to other ventures.
