A veteran fund-raiser finds it tough going as she seeks her fourth round of financing

Cherrill Farnsworth was relentless this past winter and spring as she pursued every source of investment capital she could think of for a fourth round of funding for her about-to-be-profitable company, HealthHelp. "I asked every venture-capital contact I had, 'Who's got the money right now? Who's just raised a round that they've got to get out the door?" she recalls.

As Farnsworth discovered, it's a difficult investment environment out there. After more than a year of economic volatility, exacerbated by a stock market that just won't lose its jitters, caution has become the name of the game. VCs now find themselves squeezed by the toughest fund-raising market they've faced for a while, mounting investment demands from troubled portfolio holdings, and far too many private and public investment prospects.

Many business owners think that the ups and downs of VCs and other private-equity investors don't matter to them, because their companies are unlikely candidates (either now or in the long run) for that type of capital. But when a major contraction occurs in any capital arena -- be it private equity, public equity, or banking -- it inevitably has a spillover effect in the other financing markets, damaging the money-raising prospects of almost everyone. Few entrepreneurial companies, or their customers or suppliers, are immune.

Just ask Farnsworth. She has successfully launched six start-ups since 1973, including HealthHelp, a seven-year-old Houston-based company that helps insurers, physicians, and patients manage the quality and cost of radiology services. She says today's venture-capital market is "unlike anything I've ever seen. I've got tremendous contacts in this community and a proven track record. And this is by far the most hostile financing market that I have ever encountered."

This past spring HealthHelp closed a $14-million round of VC financing. But, the CEO says, "it should have been a piece of cake to raise this money. We've already carried out three other financing rounds. We've met our forecasts. We've experienced significant growth -- we were at $27 million in sales in 2000 and are on target to meet our projections of $43 million for this current year -- and we were trying to raise this last round of financing at the point when we were just ready to flip to profitability. But instead it was enormously difficult. There were many firms that wouldn't even take a look at us."

Marc Sandroff, a managing director at Essex Woodlands Health Ventures, a Chicago-based venture firm that followed up its earlier investment in HealthHelp with more money, notes: "Good companies continue to be financed. But it's certainly true that the environment is proceeding more cautiously and that valuations have moderated."

ON COMPANY NUMBER SIX: "This is by far the most hostile financing market that I have ever encountered," says HealthHelp CEO Cherrill Farnsworth.

HealthHelp encountered more difficulty this time around in part because it faced tough competition from other kinds of businesses that were scrambling for financing. "There are a lot of companies that thought they were ready for an IPO and then got that door slammed in their faces," Farnsworth says. "They needed to go back for another round of venture-capital money to keep them going until they could carry out their offerings." What she heard from VCs: "We're working 7 a.m. till 11 p.m. just trying to keep our portfolio companies going that are on life support. That's where our money and our attention have to be right now."

Making matters worse, there were a growing number of public companies that found themselves unable to carry out additional stock offerings because either their financial conditions or their industries seemed too shaky. So they went after private-equity capital, including venture capital, through deals known as "PIPEs," which is short for private investment in public equities. (See "PIPE Dreams," below.)

All that is not to say that venture capital is impossible to raise these days. But one must-have for any company pursuing venture deals is strong management. Sandroff is quick to note that the biggest deciding factor in his firm's backing of HealthHelp was Farnsworth herself, because she's an "experienced, well-track-recorded entrepreneur." Her team is a strong number two: "Very experienced as well, and thoughtfully put together."

In the wake of the dot-com investment debacle, VCs' due diligence has become extremely thorough. Before lobbying for her latest round of funding, Farnsworth believed that she had taken all the necessary precautions by relying on a Big Five firm to audit HealthHelp since its start-up phase. But she was wrong. "Astonishing as it may be," she confides, "new investors in this round insisted upon hiring a different Big Five firm to audit our auditor's reports. I've never seen precautions like this. The time it took. The number of meetings. The intensity of those meetings and the kinds of questions that we debated." Farnsworth typically advises other entrepreneurs that it will take them at least six months to raise a round of VC funding; this last go-around, it took her nine months.

Don't expect the due-diligence requirements -- and other related control factors -- to end when you manage to persuade a VC to sign on the dotted line. "Milestones are an increasingly big part of the landscape in ways that we haven't seen for a long time," emphasizes Stephan Haimo, a partner in the New York City office of law firm Gibson, Dunn & Crutcher LLP. "It's no longer unusual to see deals that spell out controls and targets on a three-month, six-month, and nine-month time frame. Owners that aren't willing to go along with these restrictions are going to find themselves unable to raise money, at least for now." Expect to see a similar tightening in controls in any capital deal your company manages to close within the current environment, including bank loans and angel investments.

But Farnsworth, for one, is scarcely complaining. "It's true that our valuation ended up being about half of what we wanted -- or would have gotten if we had been ready to go after this round a little earlier than we did," she says. "But the good news is, we got the deal done."

Jill Andresky Fraser is Inc's finance editor.

Related links on
" How to Get Funded Now: Two VCs Weigh In"
" Quiz: Are You Ready to Get Funded?"

Pipe Dreams

Wondering where venture capitalists and other private-equity investors have been spending their money these days? One interesting source of statistics is a new Web site,, that tracks all kinds of deals in the capital marketplace, including the PIPEs (private investments in public equities) that attract funds that otherwise might have gone to private companies like HealthHelp.

During the first five months of 2001, $43 billion worth of PIPE deals were closed, signed, or announced, adding up to 618 transactions. And those numbers should keep rising, according to James F. O'Brien Jr., a managing member of Promethean Asset Management LLC, a New York City-based investment-management firm that frequently invests in such deals. "In troubled times like these, public companies turn to the private-equity markets because they don't have the same financing opportunities that they might otherwise possess, either by selling more stock in the secondary markets or by borrowing whatever money they need from banks," he says.

Why are these deals so successfully drawing funds from VCs and other private-equity investors? "It's the fact that PIPE issuers have already carried out their IPOs that makes them so appealing to private-equity investors," says O'Brien. "They know they'll have a greater chance of liquidity."

Hands On

Christopher Franceschelli worked for large publishing houses for 18 years before launching his own company, Handprint Books, in Brooklyn, N.Y. Getting his tomes distributed in bookstores wouldn't be easy or inexpensive, so Franceschelli decided to join hands with two other children's-book publishers. Together the three companies negotiated a better distribution deal than they could have gotten alone. Under the terms of their recent contract with Chronicle Books, Franceschelli and his partners expect to save 10% to 15% in distribution fees. Two of the companies are also sharing the cost of producing a joint catalog. What's more, Franceschelli is creating an organization to help publishers negotiate group advertising rates and joint exhibitions at trade shows. "It's really about collective marketing," he says. "No matter what you're negotiating, it's a model you can use."

--Susan Greco and Thea Singer

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