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Is your VC a vulture capitalist? Entrepreneurs should do their homework before signing with a financier. (Capital Matters).

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 appear jittery about the investment. "This type of young angel investor is likely to run during hard times when new to the market and may not have the stomach for the ups and downs of doing business," says Robertson, adding that investors typically suffer or prosper along with their portfolio companies. During a financial crisis, however, the investor may be concerned about limiting losses and may--through special rights negotiated before the investment is made--force a company to liquidate or sell its assets at a price for which only the investor receives any distribution.

* Seek Out a Compatible Partner: Like a marriage, compatibility is important when it comes to venture capital. Steve Dines, president and CEO at Sunnyvale, California-based semiconductor design and marketing firm Azanda Network Devices, says he interviewed 100 venture capital firms for his company's Series B round. From June 2001 to October 2001, he interviewed the various venture firms and has so far raised $33 million in venture funding. Dines was after investors with experience in the semiconductor industry--the kind who understood how his company worked and what its challenges were. To find them, Dines found a business broker (for some investments and used existing investors for others) who specialized in creating relationships between investors and companies. "When a storm comes, you need people on deck who know what they're doing," he says. The 50-employee company won't post revenues until mid-2003, and received a $10 million Series A round of financing in June 2000.

* Do the Due Diligence: Just as VCs review all of the information about a business, its founders, and management, Robertson advises entrepreneurs to do the same on their investors. "The VC industry is relatively small and a few phone calls can result in useful information," she says, noting that most funds have Websites, which list the company's portfolio of firms, investment strategy, and general partners.

* Know It's Not All Bad: Bartlett, co-author of Raising Capital for Dummies, (John Wiley & Sons Inc., $24.99), has seen a lot of venture capital lately that is heavily weighted against the founding entrepreneur. Valuations, which are the monetary values put on the business, are much lower than they were three years ago, he adds, making venture money "very expensive for the business owner." On a positive note, a good VC with a long track record can bring great advice, new customers, future funding rounds, and lucrative exit strategies to business owners who play their cards right. "If you choose the trophy investor names, they can also add enormous prestige," says Bartlett.

They'll continue to do so in the years to come, says Robertson, who even in this challenging capital environment has watched venture capitalists make first time and subsequent investments in small companies. What these investors are looking for, she says, are good management teams, a willingness to be versatile with business strategies, and for companies to stay lean, mean, and focused. Particularly attractive are entrepreneurs who have put their own money into the business and who can reduce unnecessary expenses without jeopardizing business development. "And because the average length of venture capital investment in a company is now three to seven years," says Robertson, "they're really looking for business owners who can go the distance."
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Author:McCrea, Bridget
Publication:Black Enterprise
Date:Nov 1, 2002
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