The Private-Capital Survival Guide

Indeed, experienced entrepreneurs and financiers say that the time to start thinking about later-stage financing is during a business's earliest stages. Most small businesses, says Stack, go through "three or four circles of hell" as they grow. As a business moves from one circle to the next, its financing needs increase by several orders of magnitude. Those needs are met only by diluting the equity held by current investors. Satisfying a business's financing requirements while placating investors dismayed at the shrinking of their ownership stake is "a brutal, energy-sapping business," says Stack. He advises working backward from the moment in the future that a business goes public or places a large block of private equity with institutional holders. "You've got to be realistic in your business plan," he advises, "and prepare your early-stage investors for the prospect of dilution." Freedom Medical's Gwynn suggests one way to frame the issue for those early investors: "Would you rather have 100% of $20 million or 50% of $500 million?"

That's a question many entrepreneurs would love to have to ask. Reaching that stage, says financing expert Tatum, "takes a series of small miracles." One of those miracles, surely, is finding a source of capital that can bring more than money to the table. And though this guide may be helpful, we can't guarantee that everyone who reads it will find the financier or venture of his or her dreams. But if we can make those small miracles a little more a matter of planning, and a little less a matter of dumb luck, well, it's a start.

Harris Collingwood is a business writer based in Cambridge, Mass. This is his first article for Inc. Additional reporting by Thea Singer

Cashed Out, But Still the Boss

In 1995, William Green was the chairman and CEO of $48 million Wilmar Industries Inc., a wholesale supplier of repair and maintenance products to apartment-building owners. Then 37, he was the sole owner of the business, having bought out his father and cofounder in 1990, and was supporting his wife and three young children on a salary of about $130,000 a year. Wilmar, based in Moorestown, N.J., was consistently profitable, boasting gross margins of around 40%, but nearly all the profits were plowed back into the business. "All my net worth was in the company," Green says.

It was time to take some chips off the table. After briefly considering taking Wilmar public, Green turned to the private-capital market instead. He entertained pitches from half-a-dozen private-equity firms, ultimately opting to cut a deal with Boston-based Summit Partners, which paid him $22 million for 55% of the company. Summit's winning edge: Its principals assured Green that they wanted him to continue to run the company. "Quite frankly," Green says, "they wouldn't know the difference between a light bulb and a toilet seat. They wanted a company that had growth opportunity and great management. Why fool with the chef when the restaurant customer is real happy?"

Private capital is becoming an increasingly popular route for those entrepreneurs who want to harvest some of the equity they have built up in their business without giving up operating control -- and without taking on the reporting, regulatory, and administrative burdens that accompany public ownership. A big pile of cash, though awfully nice, is not the only benefit of the transaction, entrepreneurs say. Green credits private capital with making him a better, more decisive manager. "When you're alone," he says, "at least if you're a conservative businessperson like me, you don't want to make mistakes. But the minute that you have some real smart people who do this for a living buy in, you pull the trigger faster."

While the private-capital market has long been the market of choice for entrepreneurs who are looking to play out their exit strategies, it can come on the scene well before the last act, enabling business owners to realize liquidity without relinquishing control of their enterprises. For many entrepreneurs, raising private capital is as close as they'll ever get to having their cake and eating it too.

Thea Singer

Closing the Capital Gap

Think of it as a Bermuda Triangle for growing companies. The good ship Enterprise is sailing smoothly along, volume is expanding, the business is ready to step up to the next level, and...the tiny ship sails into a fog bank, never to be seen or heard from again.

What is this strange zone that growing companies seem almost compelled to enter, but from which so few emerge? Call it the capital gap, an in-between place occupied by companies that are, in the words of small-business financing expert Douglass M. Tatum, "too big to be small and too small to be big." Jeffrey E. Sohl, director of the Center for Venture Research at the University of New Hampshire in Durham, has found that companies typically enter that zone somewhere between $100,000 and $2 million in revenue. When they require additional capital to expand, add employees, or take on more inventory, business owners suddenly find their needs too great for angel investors to afford, yet too small to attract the notice of banks, venture capitalists, or private-equity partnerships.