More Strings Attached

Today, even veteran CEOs are having a tough time raising funds, and what money they do raise comes with a lot of strings attached.

Capital

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.

 1 | 2  NEXT