A venture capital primer.

I: venture capital funding

Venture capital (VC) is the best-known type of funding. It is a high-risk equity investment by experienced fund managers in companies with dramatic, short-term growth potential. Investments should yield earnings several times the size of the original equity investment over five to seven years. Venture capital firms will expect a minimum 20-percent return, usually in three to five years. Many will expect 40 to 50 percent. More patient investors--called mezzanine investors--will sometimes allow a longer lead time, make some money off interest on a loan and expect to have some warrants (equity shares) in the company. A few (but not most) Michigan VC firms finance as little as $50,000, but generally the smallest deal is in the $250,000 to $500,000 range. The average size of a "preferred" VC investment is about $2.5 million, although that can range up to $8 million to $20 million for several VCs. The venture fund intends to "exit" its investment and benefit from the substantially increased valuation of the investee through either an IPO of stock in the public markets or through sale, acquisition or merger of the investee.

II: BIDCOs

BIDCOs are privately owned, non-bank financial institutions that fill the moderate risk financing gap. BIDCOs provide financing between traditional bank lending and venture capital, although some do VC-type deals, depending on the specific BIDCO. They may do either debt or equity financing. Michigan BIDCOs have in excess of $65 million under management. BIDCOs in Michigan indicate that the amount they finance ranges from $50,000 to $1.5 million. The "average" size of their preferred deal is about $500,000, although some prefer larger deals and some lower.

III: Angel investors 

"Angel" capital is a loosely defined term generally referring to individual investors of high net worth who provide "first-round" financing for riskier investments. Often these "angels" are successful business people or professionals themselves and are interested in putting their expertise and capital into other entrepreneurial ventures. Sometimes angels act on their own but often they are organized in various venture forums that facilitate initial contacts between entrepreneurs and investors. These networks or forums do not become involved in completing or structuring transactions. After introducing entrepreneurs and potential investors, they leave all further interactions to the parties involved.

For more information, visit these Websites:

* Michigan Angel Capital Electronic Network, ACE-Net--www.sbam.org/org/who/acenet.htm. The Entrepreneurial Development Center is Michigan's node into ACE-Net, a nationwide Internet-based, password-controlled, electronic service linking "accredited" angel and institutional investors to "qualified" entrepreneurs.

* Michigan Angel Investor Network (MAIN)--www.sbam.org/who/main.htm.

IV: Small Business Investment Companies

SBICs are groups of investors that form an entity, under U.S. Small Business Administration licensing, for the purposes of investing in small companies. Most SBICs are looking for businesses that are in hot growth areas and will turn a profit for investors within three to five years.

V: Venture forums

Michigan venture forums vary in orientation, approach and composition. For more information, visit these Websites:

* New Enterprise Forum, Ann Arbor--nef.bizserve.com.

* Southeastern Michigan Venture Group (SEMVG)--www.semvg.com.

* Venture Center of Mid-Michigan--www.bus.msu.edu/venture/

* The Growth Capital Symposium--www.umich.edu/~ospef/gcs.html.

VI: Small business R&D programs

Several highly competitive federal programs provide funding for research and development of new technologies to meet the R&D needs and goals of federal agencies. These programs have been used successfully by a number of Michigan entrepreneurial firms as a source of difficult-to-obtain pre-seed/venture capital for proof-of-concept and applied research. The Michigan Economic Development Corp. contracts the Entrepreneurial Development Center to work with small Michigan firms on a number of programs. For more information, visit www.sbam.org/who/sbir2.htm.

VII: Expert advice

From Michael Staebler, an attorney with the Detroit office of Pepper Hamilton LLP, which specializes in setting up and licensing Small Business Investment Companies.

"First, you need to go through a path of self assessment as to what your business objectives are. Do you want to make a lot of money in three to five years, or is it a business that you want to operate for a long period of time? One of the things you need to do early on is start going to conferences, making friends, meeting with investment bankers. Set up relationships with people who have been through the process, find mentors and start learning what their business really is and how they can make it a commercial success."

From Harold Lacy, author of "Raising Venture Capital Made E-Z."

"The most important thing is doing the business plan. I would recommend using some sort of business plan software. The people who are loaning the money, the people who are investing in businesses, make their decisions based on a written presentation. So the business plan is critical. Then, I would circulate the business plan to some people who can give you some constructive feedback. Not necessarily friends, but someone in business such as an accountant or financial consultant--someone who can give you some feedback on what needs to be added or what needs to be taken out before you take it to the next level.

Next, you need to distribute the business plan to contacts that know you. Don't make the mistake of just circulating it to people with money. You need to focus in on people who know you and can attest to your character. Think of them as a bridge because those people are then going to be contacting their friends and contacts who you would never otherwise know."

Treasure trove 

The Michigan Economic Development Corp.'s Website has a wealth of information for starting a business in Michigan, including a sample business plan, a business start-up check and other resources. Go to medc.Michigan.org and click on "Services."

A taxing situation

Got a tax-related question? The Internal Revenue Service's new Taxpayer Education and Communication (TEC) unit might have the answer.

TEC deals with the small business community and covers such topics as the small business tax workshop program, employment tax workshops, specialized business workshops, speaking engagements and the practitioner income tax institutes.

Venture tips

1. Always have a solid business plan, and have it reviewed by business professionals, or your idea and all of the sweat equity you have invested will not matter.

2. Never approach a venture capitalist, bank or other source of capital without a recommendation, or "warm introduction."

3. Never assume your idea is unique.

4. Do not present bankers with gifts during the first year you are doing business with them.

5. Use the indirect approach when talking to potential investors. Direct appeals for money are usually regarded as a turn-off.

The 5 Cs of credit

When processing funding requests, loan officers consider the "Five Cs of Credit" in evaluating applications:

1. Character--The willingness, not just the ability, of the applicant to repay the loan.

2. Cash flow--The actual movement of cash as well as profits and projections.

3. Capacity--The ability to succeed in the industry and to financially "weather the storm."

4. Condition--The economic and regulatory factors that can enhance or interfere with success.

5. Collateral--The value and marketability of the company's assets including cash, accounts receivable, inventory, equipment and other income sources/valuables, especially in a liquidation scenario.

Financial/accounting Websites

IRS forms and publications www.irs.gov/forms_pubs/index.html

U.S. Tax Code online www.fourmilab.eh/ustax.html

State of Michigan tax forms www.treas.state.mi.us/formspub/frmindex.htm

Federal Reserve rates www.ny.frb.org/pihome/statistics/dlyrates

Financial Accounting Standards Board accounting.rutgers.edu/raw/fasb

Rutgers University raw. Rutgers.edu (click on "Accounting Resources)

American Institute of Certified Public Accountaints home page www.aicpa.org/index.htm

AICPA links page www.aicpa.org/yellow/index.htm

Michigan Association of Certified Public Accountants www.michcpa.org

SEC filings of public companies www.sec.gov/edgar.shtml

U.S. Commerce Departments Bureau of Economic Analysis www.bea.doe.gov

White House Economic Statistics Briefing Room www.whitehouse.gov/fsbr/esbr.html

Uniform Commercial Code www.law.cornell.edu/uniform/ucc.html

Uniform Business and Financial Laws Locatorwww.law.cornell.edu/uniform/vol7.html

For more information, call the TEC speaker hotline at [phone] or visit the IRS small business Website at www.irs.gov/smallbiz.

Miles S. Wright, the Michigan TEC unit territory manager, has a staff of eight specialists with extensive tax background.