Capital Challenge: The Modern-Day Prospector in Virginia
By: Dr. David E. Martin February, 1999

The speed of technology progress is determined by innovation and execution. In Virginia and across the globe entrepreneurs are confronted by increasingly complex capital prospecting challenges. Companies must consider three issues – management for vitality, opportunity definition, and capital planning.

Vitality management is a critical element in the successful company’s quest for investor attraction. In the midst of the desire for capitalization, there is a need to allocate ample time to conduct the business of the company. A great paradox for the growing company is that the business credibility sought by investors requires resources, both human and capital, which cannot be accessed without investment. Management must remain vigilant to timelines and deliverables, irrespective of capital, to demonstrate that an opportunity can be defined. Telling a credible story to convey an investment opportunity, while defining reasonable present VALUE and future VALUATION, is essential for a successful financing quest. As “deals” become increasingly complex in the intricacies of technology, markets, or exits, the financial picture must be plausible and conservative. Nathan Levin of PriceWaterhouseCoopers, LLP offered a new paradigm approach to valuation of technology businesses, a ‘Real options” valuation. This approach estimates progressive value of technology milestones and intellectual property. It serves as a conceptual overlay to clarify the traditional Discounted Cash Flow (DCF) valuation. Reliance on classical valuation models with appropriate “modernization” is prudent in most cases.

In 1995, 67 percent of all businesses had annual revenue under $1,000,000. Failure rates within the first five years among emerging small businesses exceed 70 percent. The lack of access to funding for initial capitalization, follow-on growth and business expansion play a major role in driving up this failure rate. A business failure limits economic growth, and means that valuable technologies and services may never reach the market. Drugs to treat diseases, technologies to move greater amounts of data utilizing less bandwidth and new Internet solutions can be paralyzed due to the inability to develop the business at the right time. Conventional financing involves raising funds through various sources, including friends and family, angel investors, venture capital and other equity investors. Other traditional sources of investment funding are becoming increasingly unavailable to the “small” capitalization business. Businesses, which once contemplated access to mezzanine financing closely followed by Initial Public Offering (IPO), have fallen victim to the consolidation of large investment institutions. These institutions have increased the minimum size of the offerings in which they will participate, therefore reducing the total number of IPOs.

Faced with the potential loss of control through dilution of ownership, as well as the economic reality that growth requires capital, many owners of emerging companies see debt financing as an attractive option. However, as an emerging company, accessing debt capital from conventional banks has several intrinsic problems, including:

• Lack of negotiable collateral
• Limited business performance
• Non-traditional products and markets
• Novel operational models – too unconventional. Traditionally, banks have viewed the “emerging company” market, especially the high technology arena, as very risky and have avoided signif

Increasingly, small businesses are turning to nontraditional sources of funding. Growing numbers of start ups are engaging in strategic alliances and licensing agreement with large established organizations to build momentum in order to attract investor’s interest. Venture Groups, Private Investor Networks and the Virginia’s Center for Innovative Technology offer excellent intrastate networking and collaborative opportunities – relationships that can add sizzle to a funding pitch.

Today’s entrepreneurs and fledging companies are presented with myriad options in their battles for funding. Selecting the right weapon, or combination thereof, has a critical bearing in deciding which live or die.