How a start-up positioned itself to appeal to investors and landed $2 million in venture capital.
From day one, Tom Weldon worked to position his competitive but risky start-up to appeal to investors. So far, so good
While many entrepreneurs believe that a well-planned strategy, talented management, or an exquisite product will ensure their company's success, Tom Weldon is not among them. To him, the drive for capital must be the primal urge that informs and energizes a young company. "Money is the lifeblood of any company," says Weldon. "Whatever you do early on in the life of your company should be oriented toward raising money for product development."
Weldon is the president and principal founder of Novoste Corp., a start-up about to enter the hotly competitive -- and now highly uncertain -- medical-devices industry with products focused in the specialties of electrophysiology and interventional cardiology. To the unschooled eye, Novoste seems indistinguishable from your garden-variety technology start-up. The company has leased space in a nondescript suburban industrial park outside Atlanta, and at this point it has few bodies, much energy, and many ideas still waiting to come together in the form of salable products and real revenues.
But what has broken Novoste somewhat out of the pack is that last October the company landed $2 million in venture capital from a top-drawer venture firm, the Hillman Co., based in Pittsburgh. (See "The Silent Partner," page 4.) While the signing of that deal gave Novoste legitimacy and life, it also signaled an end point of sorts to the company's quest for capital, which had begun in earnest 16 months earlier.
In retrospect Novoste's search can be seen as a 15-point plan applicable to service-company start-ups as well as to manufacturers, to those seeking money from venture capitalists, private investors, or even traditional lenders. While every start-up's financing is different, the steps leading up to the Hillman-Novoste deal -- and the reasoning behind each step -- can inform any aspiring and capital-hungry entrepreneur. What follows, then, is Weldon's plan, step-by-step:
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1. Determine whether equity or debt will be the funding source.
Although many entrepreneurs fund their companies with their own or the bank's money, for Weldon equity funding was really the only way to go. "It would not be possible to fund our company with debt. We have no products and no cash flow right now," he says. If a company is eventually successful, equity is a very expensive way to raise capital, since stock sold for $1 could someday be worth $10 or $20. On the other hand, notes Weldon, "that premium is the compensation we pay to the investors for the risks they take."
Weldon concluded that if he structured his company carefully and executed his business plan, equity in Novoste could be good hard currency. That view differs from that of many entrepreneurs who want to hold major equity stakes in their companies, fearing dilution or lack of control. Weldon, by contrast, has paid most of his advisers and contractors in stock. He has granted liberal stock options to his employees -- and pays them modest salaries -- thus aligning the interests of employees and investors in the search to build value for the long haul, and to slow the cash "burn." "This is a team approach," he says, "and if the company is successful, there's no need to be greedy. We'll all get rich."
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2. Develop a business strategy.
Weldon wanted to avoid the trap of applying the strategy he had executed -- successfully -- at another medical-device company he had founded, grown, and eventually sold in order to start Novoste. Often entrepreneurs who have had one success in their industry don't take the time to understand the new and different market conditions that may face a new start-up -- and the risks a lender or an investor might perceive.
Weldon knew he had to reduce the perception of "environmental" risk in the eyes of potential investors. In recent years the regulatory climate at the Food and Drug Administration has changed, and the agency has been devoting more resources to enforcement and, consequently, fewer to product approval. As a result, devices that once took months to get to market are now taking years.
Weldon believed that a lot of start-up health-care companies were underestimating the impact of that change. Though start-ups in every industry make overoptimistic projections about when they'll get to market, the FDA factor amplifies the potential for delay -- and investor disappointment -- in the health-care industry. Moreover, many health-care start-ups were basing their fortunes on breakthrough devices, which take longer to get approved than simpler, more derivative devices do.
Weldon thus pursued a two-pronged strategy. Novoste would develop both derivative and innovative products. The derivative products would gain approval and get to market faster, thus creating a revenue stream. The innovative products' passage through the FDA would be slow, but when they finally came to market, they would produce higher sales and margins. The strategy ran counter to that of many health-care start-ups that focused solely on breakthrough products in order to get into secure and profitable niches in a competitive market. But Weldon wanted to send a clear signal to investors: he had thought through the environmental risks associated with health-care reform and changes at the FDA; he had positioned his company to withstand those risks; and he was prepared to generate sales and profit in the near term, thereby assuring would-be investors that profitability was a key goal at Novoste.
