Many entrepreneurs think investors make their decisions about funding new businesses based on the numbers. If the projections look good, the checks will start flying into your mailbox -- or so the theory goes. But Nigel Alexander and Steve Clarke, cofounders of SnowRunner USA, a Boulder, Colo., start-up distributing sporting equipment, recently learned one of the truths of entrepreneurial finance: people who know and like the product are often the best prospects.
Months of effort to stir up enthusiasm from professional financiers had yielded nothing, but the investor who plunked down the $1.5 million Alexander and Clarke were looking for last year had been impressed with their product the winter before.
Alexander, 31, and Clarke, 33, had spent about $200,000 of their own money during 1992 on test marketing their product -- Italian-made plastic boots designed for skating on snow. With growth in mind (they have sole North American distribution rights now, but they want to add products from other manufacturers), they began searching for money for marketing and new-product development. After flirting with the idea of a public offering, they decided to look for one investor for the entire sum. Helped by a Big Six accounting firm, they mailed about 50 business plans, marketing plans, and product-demonstration videos to prospects.
While SnowRunner's projections for 1994 showed revenues of $2.5 million and healthy gross profits, many would-be investors voiced concerns about whether the market would unfold as the founders envisioned, and if it did, how competition might squeeze margins. Others doubted it would be easy to cash out of an import business that had few assets. To help generate the contacts who could come up with the funds in time for the 1992-1993 selling season, the founders signed up a financial consultant. "We had lots of contact with people who said they were interested," recalls Alexander, an ex-banker. But five months later he and Clarke were still looking.
Their search ended with a wealthy investor who had seen the skating boot a few months earlier while on a winter vacation in Colorado -- and had liked it so much that he bought several pairs.
A deal was struck by the summer. As with many early-stage deals, most of the wrangling was over control. "Initially, the investor wanted 75% of the stock," Alexander notes. (For leverage, he says, it helped to have talks going with other parties.) The eventual deal gave the Washington, D.C., investor preferred stock (paying an annual interest rate of 5%), which can be converted into 51% of SnowRunner's equity in five years. Meanwhile, the investor has voting control, and he has agreed to provide guaranteed working-capital loans.
To offset the increased personal career risk caused by their loss of voting control, SnowRunner's two founders and their newly hired marketing chief asked for -- and got -- five-year management contracts. But the most important thing, says Alexander, is that the company now has enough capital to promote its products more aggressively. -- Bruce G. Posner