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Consider Thorny Issues Before Seeking Capital

After two years of a funding drought, could this finally be the time for entrepreneurs to raise capital to build or expand their start-up companies?

From The Wall Street Journal Online
By JEFF BAILEY
Staff Reporter of The Wall Street Journal.

Encouraging signs are all around. Higher technology stock prices. A boomlet of filings for initial public stock offerings. And a vast reservoir of funds held by venture capital and private equity firms.

But some entrepreneurs who secured big venture-capital commitments during the past boom suggest you think twice before selling a major stake in your business to outsiders.

They aren’t swearing off outside funding altogether — almost every growth company requires a capital infusion at some point — but they’re trying to be smarter about when to accept funds and under what terms.

Joan Lyman, as chief executive officer at SecureWorks Inc., in Atlanta, helped raise about $30 million in venture funding to launch the Internet security concern. But the investment cost her control of the company she co-founded, and by 2001, she says, investors persuaded her to step aside as CEO, a decision she now regrets.

Building a new technology company, nmotion LLC, Ms. Lyman, 40 years old, is using $500,000 of her own money. "It’s mine," she says. "I’m not raising money." She wants to have customers and revenue and enough of a track record before looking for expansion capital, Ms. Lyman says, so that the amount of financing she seeks won’t put control in the hands of others.

Lauren Flanagan, 49, raised about $25 million to launch WebWare Corp., a software concern in Sausalito, Calif. Before the big cash infusion, WebWare had been frugal, weighting its compensation toward options to conserve cash, persuading customers to partially pay in advance.

"It was a better way of operating," Ms. Flanagan says. "When you raise capital, there is an expectation of rapid growth. You bulk up. You move from a lean machine to an excess-capacity machine. That’s a tough way to be when hard times hit."

When sales fell, Ms. Flanagan, the CEO, had disagreements with investors on the board, and the board replaced her a year ago. "It was a very acrimonious parting," she says. "It became intolerable from both sides of the fence."

Winston J. Churchill, managing general partner at SCP Private Equity Partners, Wayne, Pa., a big WebWare investor, says of Ms. Flanagan and the market crash that hurt WebWare: "She was a terrific partner. We all got run over by the same truck." (WebWare was acquired by Insci Corp. this month.)

Now, Ms. Flanagan is advising other entrepreneurs on raising money and setting strategy. She recommends: If you’re going to take venture-capital money, go with investors who themselves have run companies; diversify your funding to avoid "one big gorilla" on the board; and even if you’re staying on as CEO, if you’re selling a controlling stake, you should try to structure the transaction so that you personally receive a sizable sum because your negotiating power won’t ever be as strong again.

One of Ms. Flanagan’s clients is Laurie Brown, founder, CEO and majority owner of Restore Products Co., Minneapolis, which makes household-cleaning products to appeal to those with environmental concerns. Consumers can bring back their containers and refill them, a reuse feature that cuts costs and trash.

Ms. Brown, 49, has her products in six Twin Cities retailers, just recently turned a profit, and is ready now to expand. Rather than sell stock, however, she took out a $500,000 one-year loan, secured by all the assets of the company, to fund the initial growth.

And Ms. Brown says she is negotiating to raise $3 million by selling preferred stock to a group that includes wealthy individuals and perhaps larger companies that could help her business grow, including a consumer-products concern, an equipment supplier and a manufacturer of cleaning supplies. She’s aiming, however, to retain her majority stake even after the preferred-stock sale.

Ultimately, Ms. Brown, a big thinker, says she wants to see her products "in every grocery store in the U.S., Europe and Asia. To do that" will require huge amounts of capital, she realizes, and that means "I’m going to lose control."

But not any sooner than she has to; the more established the company is when she sells stock, the less of it she’ll likely have to sell. Ms. Brown also has another job-security strategy: "My picture is on the bottle."

The dream of many entrepreneurs, of course, is to be like Anna Bean, 55, who founded MSI Solutions Inc., a Marietta, Ga., software company, nurtured it for nearly a decade without ever taking outside capital, and then sold it in 1999 for stock then valued at more than $50 million.

Getting there took discipline. She paid workers monthly to conserve cash, offered discounts to customers who paid within 15 days, stretched out payments to vendors and frequently had to restrain her urge to grow faster.

http://www.startupjournal.com/columnists/enterprise/20031002-bailey.html

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