The Private-Capital Survival Guide

Such win-win outcomes have lured both institutions and individuals into the private-capital market, making for a high degree of liquidity. According to the University of New Hampshire's Sohl, angel investors and other informal investing groups poured an additional $30 billion into growing businesses in 2001 and at least that much again in 2002. Only about 5% of that money is start-up funding, Sohl says, with the rest going to meet the capital needs of going concerns.

Larger, more formal investing partnerships, which invest in later-stage enterprises, also have money to put to work. Thomson Financial Venture Economics reports that private-equity investors put a total of $13 billion into later-stage deals in 2001, up from $4 billion in 1997, the last year before the outbreak of Internet madness, when private investment surged, touching $16 billion in 1999 and $26 billion in 2000. (Generally speaking, later-stage financing flows to established companies with revenue of $10 million or more that are well managed, consistently profitable, and generate positive cash flow.) So great was the flood of money into new-venture financing during the gold-rush years that much of it is still waiting to be invested, says Thomas S. Shattan, whose Shattan Group, based in New York City, matches entrepreneurs with financiers. "Pension funds and other organizations," he says, "have given so much to private-equity funds over the years to invest in companies that much of it is still there." That's one reason more growing enterprises than ever have been able to arrange financing. Venture Economics reports that 1,172 companies received an average of $11.4 million in later-stage private-equity funding in 2001. In 1997, by comparison, 849 companies received an average of $4.7 million.

Angel investors, private-equity partnerships, and venture-capital firms may have a lot of cash available, but they are in no hurry to part with it. Investors in growing enterprises have repented of their boom-era zeal and incautiousness, and are now subjecting every deal to microscopic scrutiny. "In 1998 and '99," says Joseph Beninati, chairman and CEO of Greenwich Technology Partners, an information-technology consultancy, "institutions were throwing silly sums of money at new ventures. Today, $2 billion funds spend six months agonizing over $5 million investments." Even if an entrepreneur manages to locate investors willing to commit their funds, those investors may not be as knowledgeable, well connected, and energetic as Stack and SRC. "The smart money is not always as smart as you think it is," says a jaded veteran of three start-ups.

Even taking into account those qualifications, cautions, and caveats, however, private capital represents a vital resource for growing companies. It's not the first big financial step in the entrepreneurial life cycle. That first step, seed capital, comes from friends, family, savings, and credit cards and finances the earliest stages of an enterprise -- the development of a prototype, say, or the rental of a storefront and equipment, or simply a market-and-feasibility study to determine whether further investment is worthwhile. Angel investors -- individuals with money to spare and a taste for action -- are the next link in the chain, when a business needs $250,000 to $750,000 in start-up capital. It's in the third stage of growth, when a business's capital needs are greater than most individuals can or will bear alone, that venture-capital firms and private-equity partnerships usually come on the scene. (They don't come on the scene fast enough to suit everyone. For more on one attempt to close the "structural capital gap," see "Closing the Capital Gap" below.) Private-equity partnerships, which often include both institutions and wealthy individuals, are formed to invest in growing enterprises for a fixed period of time. These partnerships often invest alongside venture capital. But private equity tends to be more patient than venture capital, investing in five- to seven-year blocks, compared with the three- to five-year life span of most venture-capital partnerships.

In practice, there is considerable overlap and interplay among angel investors, private equity, and venture capital; the boundaries between angel investors and venture-capital investors are particularly fluid, having mainly to do with their degree of organization and the size of their investments. For the purposes of this article, the term "private capital" will be used broadly to refer to individuals and institutions that operate outside established securities exchanges to provide equity capital to small and midsize businesses in their early stages of growth. For most of these businesses, the key to tapping this capital is in understanding who these financiers are, what drives them, how to find them, and, most important, how growing enterprises can win their backing.

Career Capital: Private Money's Turbocharger

Some entrepreneurs appear destined to succeed. Smooth, polished, fluent in the language of commerce and prepared for every contingency, they seem to take all the uncertainty out of launching a business. Rick Inatome inspired no such confidence at the outset of his career. When he set out to open a computer store in his native Detroit, "nobody was more unskilled or less credible than I was," he admits. "I had no idea about business." What he had, though, was a passion for his idea and enough nerve, or maybe naiveté, to ask Joseph Hudson Jr., scion of the retailing dynasty and then head of Dayton-Hudson Corp., to join the board of his fledgling company. To Inatome's amazement, Hudson said yes. Hudson signed on for the same $500 meeting fee that Inatome paid his other board members, and he coached Inatome through the hazards of setting up an operating budget and hiring a chief financial officer. Hudson's investment in Inatome's enterprise consisted of time, energy, and decades of retailing experience -- passion, in short -- rather than money, for which Inatome, in any case, had other sources. "It put the whole relationship on a more altruistic footing," says Inatome. Today, Inatome's store has grown into Inacomp, a leading computer-services and -support specialist. Much credit, says Inatome, goes to Hudson, who helped develop Inacomp's first strategic plan. "When you're an entrepreneur in start-up mode," says Inatome, "all your decisions are tactical: How do I make that sale? How do I pay that bill? You need someone who can look down the road a ways and help you steer." Early on, Hudson saw how Inacomp could differentiate itself by not just selling computers and other IT gear but also by helping clients decide what to buy and how to use it.

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