Capital ideas: Injecting funds into a business takes caution, diligence

For entrepreneurs seeking to start or expand a business, raising capital involves entering a strange new world of terms and trepidation.

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No, an “angel” isn’t just a haloed, winged harp player or a Los Angeles-based baseball player, and “VC” doesn’t just stand for videocassette or Viet Cong. Learning about such funding sources as angel investors and venture capital can make the difference between the success and failure of a startup, expansion or innovation.

“There is disproportionate access to capital,” said Ari Newman, a partner in Boulder-based Techstars, a global early-stage investor and accelerator. “There’s lots of angel capital to get ideas off the ground, but less sources for the later stage. The bar continues to go up.”

Getting started may be the biggest obstacle to clear.

“When somebody comes to me and wants to be an entrepreneur, the first thing I try to do is talk them out of it,” said DuWayne Peterson, vice president of Fort Collins-based Colorado Angel Investors. “It’s a tough grind, and funding is part of it.

“I ask them what is the purpose. Is it just ‘I hate my boss’? I ask them, ‘Are you married? If you are, that might not last long, because running a business is a 24/7 thing. Things always go wrong,” Peterson said.

“Every startup I’ve invested in is a soap opera. You’ve got to have a strong stomach for some of the things that go on. Most of the reasons companies fail are related to people — people who have no concept of how to go out and sell, how to hire people.

“If you can pull it off, though, it’s the greatest thing you can do in your life,” he said. “Once they pass my trying-to-discourage-them test, we go to the next step.”

The priority then, he said, is to determine whether the entrepreneur really needs to raise capital “or can they bootstrap for awhile?” — through their own money, credit cards, help from friends or family members, or online crowdfunding on sites such as Kickstarter or Indiegogo “to sell your product, not for equity.”

Crowdfunding “works for certain products but not for everything,” Newman said. “You collect the money, and then you’ve got a bunch of people waiting for money.”

Peterson warned that if a business seeks investors too early, “they’re giving away too big a percentage in their company.”

One option is grants, such as those from the Small Business Innovation Research program, designed by the U.S. Small Business Administration to help small businesses conduct research and development, or those from the state Office of Economic Development and International Trade.

“Once you get your act together, explore SBIR funding and any grants you can get,” Peterson said. “That’s not equity. It’s not giving away any part of your business.

“The only trouble with grants is that they’re often restricted to certain kinds of things you can use your money for. They don’t allow you to spend your money on commercialization, only on building and testing the product. But there are a lot of grants just for commercialization,” he said. “You don’t have to pay it back. It’s not a loan. It’s a grant.”

But eventually the time will come for capital.

“A ‘funding round’ is a financing event for a company where you are selling equity or borrowing in the form of a debt instrument, capital that lets you operate the business for a period of time. All of the money is coming into the company at once,” Newman said. “Some will raise money from friends and family and then spend it; that’s not a funding round. A real funding round should be enough to let a company hit a set of milestones.”

“Once you’ve exhausted your friends and family they’re not going to talk to you anymore,” Peterson said. “Now, you have to go into that big, bad world of people that don’t know you. How do you know which ones you should talk to? Networking! Ventures clubs, incubators. angels groups.”

Angel investors could be an acquaintance, your banker or attorney, like-minded people in your industry or anyone who looks for opportunities to invest in return for equity ownership. They’ll offer guidance on running a business in hopes of getting that return.

“Angels never take more than 50 percent, ever,” Peterson said. “We want these companies to grow and stay around here.”

Peterson traced the angel-investor movement to the founding of “A Band of Angels” in San Francisco in 1994 during the dot-com boom. He launched the Pasadena Angels in 2000, then founded Colorado Angel Investors, part of the Rockies Venture Club, in 2010.

“Angels tend to be the seed round — trying to grow this thing out of the ground, see how much is needed to create more and more value,” he said — “and then the money gets to the point where the venture capitalists come in.”

A report issued in February by CityLab ranked Boulder fifth in the nation for per-capita attraction of venture capital. Venture capitalists can provide funds to companies that can prove they have a solid track record and a good chance for a return on the capitalist’s investment.

“At that point, your company is raising money at higher and higher value, and you’re not giving away as much of your company in higher and higher funding rounds.”

Venture capitalist David Gold, managing director of Access Venture Partners, noted that “VC generally is only a fit for a very small portion of businesses. VC funds companies looking to be game changing and disruptive, in a market that will be very big.”

Newman noted that angels almost always invest out of their own bank accounts, whereas venture capitalists primarily invest “other people’s money.” And Peterson noted a funding gap between angels and VC.

“Angels get tired of putting money in two, three, four times,” he said, “and sometimes it takes two or three times to raise $2 million or $3 million. Venture capitalists don’t want to waste money on companies that small. They’re looking or $5 (million), $10 (million) or $20 million. They want big returns. It almost takes as much work to work with a company that wants to raise $3 million as $30 million.

“When your company gets acquired or goes public, that’s when we get our money back.”

Going public — with an initial public offering of shares of stock on the Nasdaq or New York stock exchanges — is a much bigger step.

“There’s no hard and fast rule for size of a company to do an IPO,” Gold said. “In general, it has to be pretty large. The penny-stock days have mostly passed. You’ve got to be a pretty darned sizable company to think about an IPO.”

The primary benefit of such equity capital is that the company isn’t required to repay shareholders’ investment. The disadvantage is loss of total control, because each shareholder owns part of the company.

The Regulation D program, created under the Securities Act of 1933, lets companies raise capital without having to register the securities and provides information to investors.When businesses offer equity or securities to raise capital, they must file a notice on Form D with the federal Securities and Exchange Commission within 15 days after the first sale. These “Reg D” filings notify federal and state authorities of the amount and nature of the offering. Even if a company sells securities in a way that’s not subject to specific disclosure requirements, all such sales are subject to the antifraud provisions of the securities laws and false or misleading statements are illegal.

Reg D filings are common for companies seeking to raise money but not ready for or interested in an IPO, and providing an alternative to venture capital.

Whether it’s angel, venture capital, crowdfunding, a public offering or a private offering, such as a Reg D filing, raising funds will consume a lot of an entrepreneur’s time.

“Fundraising is time-consuming and painful,” Newman said. “If you’re the founder of a startup, you have to acknowledge that raising money is something you do every day, as part of your job. Communicate with your investors, keeping them updated, so when you’re ready for more capital you’re not starting from scratch. It’s ongoing relationship management.

“Otherwise, you’re like the grandkid who wants the check from the grandparents on his birthday but never spends any time with them.”

Dallas Heltzell can be reached at 303-868-6631 or dheltzell@bizwestmedia.com. Follow him on Twitter at @DallasHeltzell.