Working the private equity circuit.

Are you a prime candidate for venture capital or other private investment backing? Here's how to get in the game.

Buyout specialist John Douglas has seen the best and the worst of private equity funding. "The first deal that I tried to put together was an acquisition of a television station in Austin, Texas," recalls the 59-year-old entrepreneur, who's based in San Francisco. "I needed $1.6 million to complete the deal so I lined up four sources of capital, with a $400,000 commitment from each one. At the last minute one of my backers got greedy, tried to squeeze me out and the whole deal fell through."

Fast forward a few years to another opportunity to secure financial backing in the TV arena in California. "I had learned not to raise `just enough' capital," says Douglas. "This time around I worked with several top firms, including Syncom and Opportunity Capital Partners, that specialize in helping minority entrepreneurs. I lined up enough capital to give myself a cushion, no one got greedy -- and the deal went through."

Douglas, who buys and sells companies for a living, wasn't out of the woods, though. "Not long after the acquisition, two critical pieces of equipment failed. Not only were they expensive -- $100,000 altogether -- but there was only one supplier and a long waiting list," he says. "We turned to Opportunity Capital Partners, which not only came through with the money but had a connection with the supplier. In fact, this company was one of Opportunity Capital's investors. We were bumped up to the head of the line, got the equipment in time and were able to keep broadcasting. That's when it paid off to have the right partner."

This may seem surreal to many entrepreneurs and business owners. A wealthy friend comes along at a crucial moment and intervenes in high places on your behalf. Fortunately, private equity funding is real, not make-believe. "In fact, this is an excellent time for lining up private equity capital because there's a great deal of money available for qualified entrepreneurs," says Lewis E. Byrd, general partner at Opportunity Capital Partners in Fremont, California, a family of three venture capital funds with $35 million in assets that provides debt- and equity-oriented financing to minority-owned businesses.

If you think there has to be a catch, you're right. Since business backers are selective, only the chosen few will receive private equity capital. And funded recipients must negotiate carefully to ensure a fair deal.

To win the private equity game, you first need to know the rules. begin with some definitions. The term "private" suggests that investments are made in companies that aren't traded publicly. "Equity" indicates that backers want part ownership in exchange for their investment, but that's not always the case. Sometimes private equity providers will be content with some form of debt -- collecting interest plus a return of principal -- rather than owning stock in a company. "Every deal is different," says Laurence C. Morse, partner at Fairview Capital Partners in Farmington, Connecticut, "so the structure will vary according to the situation." Fairview provides investment and advisory services to pension funds and serves as investment manager of three funds totaling $300 million.

Although dissimilar, private equity transactions can be grouped into a few categories, according to Morse:

SEED. At this stage, the business may be no more than an idea. An entrepreneur may need start-up capital for a product or service that's being developed. You need a business plan to attract backers.

EARLY STAGE. This category usually includes companies that are in the marketplace, perhaps a few years old, but not yet profitable. Capital is needed yet banks aren't willing to make major commitments. If the early results are positive and are combined with the potential for exceptional future growth, private equity funding may be available.

Money directed to a company during the seed and early stages may be called "venture capital," which is considered a subset of private equity. However, the lines aren't hard and fast: some entrepreneurs use the term venture capital interchangeably with private equity. Don't get hung up on semantics; what counts is whether or not money is available.

EXPANSION. Companies seeking expansion financing may have been around for five or more years and achieved some measure of profitability. "Now they need a significant infusion of capital to move on to the next stage," says Morse. "There should be a reasonable strategy in place for making the most of expansion capital."

ACQUISITION. In these deals, an entrepreneur desires financial support to acquire another company where there's unrealized potential. Douglas' failed and successful attempts to acquire existing TV stations are examples.

"There's a continuum of risk here," says Morse. "An investor who participates in a seed company, for example, is taking much greater risks than an investor who helps a proven entrepreneur buy out an existing company. In return for taking greater risks, investors want the opportunity for greater rewards." In practice, that may mean offering better terms (giving up more of your company) to attract capital to start-ups and early-stage companies.

No matter what stage your venture is in, you should always keep in mind that the private equity investor intends to make a profit -- a large one, in fact. As a rule, private equity and venture capital funds attract money from corporations, institutions, large retirement plans and wealthy individuals. These investors are willing to put up risk capital because they expect a larger return than they could get with Treasury bonds or in the stock market.

"We want to see a realistic growth strategy," says Ed Williams, managing director of Black Enterprise/Greenwich Street Corporate Growth Partners in New York, a $75 million investment fund that focuses on expansion and acquisition financing opportunities. "We evaluate the management team to determine if they have the relevant experience and expertise to successfully execute their business plan. When you're seeking expansion financing, there should be strong financial statements to give investors a sense that this is a team that knows how to make a profit," he adds.

"There are time considerations, too," says Cleveland A. Christophe, managing partner at TSG Capital Group L.L.C. in Stamford, Connecticut, an $800 million fund that acquires and provides expansion capital to companies that focus on serving fast-growing, underserved ethnic markets. "No private equity investor wants to be your partner forever. Each investment group has a defined life -- we're willing to wait as long as four to seven years -- but there has to be an exit strategy that will provide investors with their return."

Although private equity investors are extremely profit-oriented, there are exceptions -- especially local groups that have alternative goals. "We have $63 million in our fund, which we invest primarily to create jobs and stimulate economic growth," says Kathryn Wylde, president and CEO of the New York City Investment Fund. "With our focus on New York, we believe a significant portion of our investments will go to minority entrepreneurs." The fund's backers, including some of the city's leading companies and institutions, expect a return of principal after 15 years, but not necessarily profits.

Even such civic-minded private equity investors insist on a clear exit strategy for the ventures they back. In general, there are several ways in which these investors can recover their money:

PUBLIC OFFERING. Some companies will grow to the point that shares can be sold to the public, often at a vast profit to investors. An IPO raises capital through federally registered and underwritten sales of the company's shares. Venture capitalists who were in the right place at the right time have been known to post 100:1 returns within three years. (That's certainly the exception and not the rule.) If your company goes public, you'll likely hold on to a significant block of shares, perhaps enough for effective control, but you'll be subject to numerous requirements for public disclosure of the company's operations.

BUYOUT. A buy-sell agreement stipulates that any owner of a partnership or corporation must sell back shares at a predetermined price upon separation. Your company may be acquired by another company, public or private. "That's what happened to my California TV operations," says Douglas. "My backers told me it would be like selling my first child -- and they were right."

REFINANCING. If your company grows impressively, your level of cash flow and profitability may support a large bank loan. You might use the proceeds from this loan to buy out your private equity investors. This may truly be the win-win outcome: investors get their money and you get to keep ownership of your company.

LIQUIDATION. In essence, you sell the assets of the business and everyone divides the cash, pro rata. "The first private equity venture that I was involved with wound up with a sale," says Ron Thompson, 49, now the chairman of Midwest Stamping & Manufacturing Co. in Bowling Green, Ohio. "The second time, though, it made more sense to just sell off the assets. The business had a great deal of retained earnings, which were distributed among all of the owners."

Naturally, you can't know when you launch a venture how it will end three, six or 12 years into the future. "Nevertheless," says Christophe, "possible exit strategies should be discussed right from the beginning so you have an idea of how things will wind up. There shouldn't be any major surprises down the road." Although there are exceptions, if you're hoping to build a business that will remain in your family for generations, you may not be an ideal candidate for private equity funding.

WHAT TURNS AN INVESTOR ON?

If you're willing to play by the rules, how can you attract private equity funding and cut the best deal? As might be expected, entrepreneurs and private equity pros have slightly different perspectives. Entrepreneurs see having the right personality (that is, fierce determination) and an intriguing concept as primary draws. Investment professionals stress willingness to do the research necessary to find a suitable venture capitalitalist, as well as the ability to present a sound business plan.

"You need to start out with the right concept," says Thompson, "then sell that concept to one or more private equity firms. Once you have your backers on board, you can go looking for the right acquisition."

That was the case with his present venture, Thompson says. He determined that there would be a consolidation among automotive suppliers, with the survivors rapidly increasing market share. "With private equity support, I put together a $90 million buyout in 1993. Since then, we've doubled our business."

Thompson was successful in his bid for acquisition funding because his growth strategy made sense to the right investors. "If you want to get private equity funding, you need to show that you can assemble a complete management team and operate the company successfully," he adds.

What about going in the other direction: finding a target company, negotiating a purchase price and then seeking the money from investors? "I wouldn't recommend that," says Thompson. "These [buy and sell] transactions tend to move quickly, so you don't want to delay the sale looking for capital. Sellers are more interested in getting the deal done than in negotiating a higher price that won't materialize."

Entrepreneur turned business owner Dumas M. Simeus of Simeus Foods International in Mansfield, Texas (No. 15 on BE INDUSTRIAl/SERVICE 100 LIST), says that private equity sources look for knowledge, experience and passion -- with the latter perhaps the most important. "Venture capitalists will back you only if they're convinced that running this business will dominate your life. They put extreme importance on your past experience in running a business and your ability to consistently deliver the bottom line. You have to convince them that you'll devote all your energy to making the company succeed." What's more, private equity investors generally demand that an entrepreneur make a substantial investment of personal wealth in the deal, enough so that he or she won't likely walk away.

TIPS FROM THE TOP

What advice do private equity professionals have for entrepreneurs? "Chemistry is everything," says Herbert P. Wilkins Sr., managing general partner at Syncom, in Silver Spring, Maryland, which has three funds totaling $71 million and invests in telecommunications concerns. "Economics is not always the key to putting together a deal. A venture-capitalist backer will assign someone to keep track of you and your business for five or more years. That person is going to commit time, his or her most valuable asset, only if there's a strong likelihood of a good return. Matching entrepreneurs with venture capitalists is almost a mating process," he adds. "You should take the time to seek out venture capitalists with whom you can have solid personal relationships."

"We like to work with investors who share our perspective," says Christophe. "We don't want to run your company but we do expect to take an active role in providing advice and acting as a sounding board. If we're going to make this type of commitment, we expect our partners to do everything they can to make the business profitable. No matter what's in a document, at the end of the day it's trust between the parties that counts."

"Your business plan is the first introduction to a private equity company, so it should be a good one," says J. Peter Thompson, managing partner at Opportunity Capital Partners. "A well thought-out, well-prepared plan is a good indication that the person bringing us the plan is someone we can work with." (For more on writing a plan, see "Doing an Effective Business Plan," Enterprise, October 1997 through April 1998 issues.)

Thompson's partner Anita Stephens, principal at Opportunity Capital Partners, notes that most successful venture capital proposals come through intermediaries -- so it pays to network: "Ask an investment banker you respect for leads," she suggests.

"Expertise and experience are critical," says JoAnn H. Price, partner at Fairview Capital Partners. "Private equity companies want to see a history of success in your background. That makes it more likely you'll succeed in the future."

"Don't wait too long," says Divakar Kamath, managing director at Pacesetter Growth Fund in Dallas, a $46.5 million private equity partnership providing growth capital for minority-owned firms in manufacturing, telecommunications, food distribution and processors, broadcasting and electronics. "A lot of times, entrepreneurs look for funds when it's too late. Instead, you should do your homework and find out which venture capitalists specialize in your region or your industry. Get to know them so you're ready when an opportunity arises."

The key piece of advice that links it all together? A good deal of preparation can prevent you from taking a pounding when you go out in search of private equity. In other words, what you know can determine what you get. Happy hunting.

SEARCHING FOR PRIVATE EQUITY

Start by tapping your own network: ask for leads from the bankers, accountants and attorneys and so on with whom you've developed relationships. You can also contact the following firms, which are known for backing minority enterprises:

Black Enterprise/Greenwich Street Corporate Growth Partners 388 Greenwich St. New York, NY 10013 212-816-1308

Newly formed this year, this fund plans to provide expansion and acquisition financing to experienced entrepreneurs in diverse industries. (no start-ups). Generally, companies need $10-100 million in annual revenues.

New York City Investment Fund One Battery Park Plaza New York, NY 10004-1479 212-493-7548

Companies in New York City's five boroughs receive consideration. The fund's purpose is to create job and promote economic growth, particularly in disadvantaged neighborhoods. Provides acquisition, expansion and start-up financing; no minimum annual revenues required.

Opportunity Capital Partners 2201 Walnut Ave. Fremont, CA 94538 510-795-7000

Communications, healthcare and manufacturing industries are the primary areas of interest. OCP has backed three companies on the 1998 BE INDUSTRIAL/SERVICE 100 list. Invests in companies at any stage; no minimum annual revenues required.

Pacesetter Growth Fund 12655 North Central Expressway Dallas, TX 75243 972-991-1597

This fund looks for opportunities across a wide spectrum of industries. Recently, it helped to back Simeus Foods International. Provides acquisition, second-stage and leveraged buy-out funding; companies need $5-$10 million in annual revenues.

Syncom 8401 Colesville Rd., Suite 300 Silver Spring, MD 20910 301-608-3203

Recent deals range from Z-Spanish Radio Network to WorldSpace, a digital radio network put together by Ethiopian-born Noah Samara. This fund invests in companies at any stage, but emphasizes early-stage and start-ups. No minimum annual revenues required.

TSG Capital Group 177 Broad St. Stamford, CT 06901 203-406-1500

Specialty areas include media, communications, retailing, automotive and consumer products. Companies serving African American, Hispanic and Asian markets receive particular attention. This fund invests in buyouts (no start-ups); companies need $50-$200 million in annual revenues.

For information and advice on finding private equity capital, you may contact the following:

Fairview Capital Partners 190 Farmington Ave. Farmington, CT 06032 860-674-8066.

This company invests in other private equity and venture capital firms; it doesn't work directly with entrepreneurs. However, it is an excellent resource for advice.

The National Association of Investment Companies 1111 14th St. NW Washington, DC 20005 202-289-4336

The professionals at this association, made up of venture capital firms that back minority- and women-owned businesses, can steer you at several suitable private equity firms.