Joseph Bartlett, a partner at the New York City law firm Morrison & Foerster L.L.P., had seen it with his own eyes. Last November, a small company, which was a client of his, was in the middle of raising its Series C round of financing from its two strategic partners. Valued at $150 million by the investors, the company was looking to acquire another firm out of bankruptcy and needed the funds to complete the deal.
Then the telecom industry imploded. One strategic investor, who was deep into the telecom industry, got skittish and pulled out of the deal, which prompted the other to follow suit, leaving the company to go “hat in hand” to the venture capital community. The venture capitalists valued the business at a significant reduction of less than $25 million and extended the financing for that amount. “The company took it, but that round of financing diluted and squeezed out the existing shareholders — including the founder — and left them with essentially nothing.”
Though the small business was able to finance the acquisition, it was left in dire straits, mostly due to less than ideal practices by venture capitalists. In periods of depressed stock valuation and sluggish economic times, unscrupulous VCs — often referred to as vulture capitalists — often take advantage of entrepreneurs. While venture capital funds invested $107.7 billion in 2000, by the next year, VCs had only invested some $41.3 billion, according to the National Venture Capital Association in Arlington, Virginia.
However, by allocating more time and effort to the process, selecting the most compatible partners, and not allowing themselves to be taken in by vulture capitalists who ask for too much in exchange for too little, entrepreneurs can get their share of the pie. Here are five strategies to use to get there:
- Be Willing to Put in the Time: Three years ago, it took small businesses a month or two to find and close a venture capital deal, whereas today it’s not uncommon to take six or eight months to do the same, according to Jim Brown, 35, president and CEO of Burlington, Massachusetts-based software development firm InvisibleHand Networks Inc. His 4-year-old, 40-employee firm, which expects $500,000 in sales for this year, recently closed on its $12 million Series A round of venture capital ($5 million in May 2000 and $7 million in December 2001) from Polaris Venture Partners in Waltham, Massachusetts. The company is now about three months into its hunt for a Series B round. “A few years ago, a company with our level of customer interest would have taken a month or two to raise funds from beginning to end,” Brown recalls. “It’s been about three months now, and we’re hoping to get a deal done within the next month or so.”
- Watch for Red Flags: Pamela S. Robertson, a partner with Boston-based law firm Edwards & Angell L.L.P., warns business owners to look out for investors who are unwilling to negotiate terms, or those who display a “take-it-or-leave-it” attitude. Also watch for investors who
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