Mark's weekly blogging

I have no idea who wrote this originally but I thought it was brilliant and I am thankful for my dear friend sending it to me.  You see if you are anything like me, you get caught up in the things that need to get done.  These things are always for the benefit of our families or some greater good.  (At least that is what I tell my self)  See what you think! 

            The Mayonnaise Jar and 2 CUPS OF COFFEE

When things in your life seem almost too much to handle, When 24 Hours in  a day is not enough,  Remember the mayonnaise jar and 2 cups of coffee.

A professor stood before his philosophy class and had some items in Front of him.  When the class began, wordlessly, He picked up a very large and  empty mayonnaise jar And proceeded to fill it with golf balls.

This week I would like to explain the purpose of me explaining the terms and definitions that I am posting.  Many of the deals that we are receiving are startup ventures where they are buying real estate as well.  This is absolutely fine except for the fact that many of these deals want to borrow enough money to fund startup costs and buy the collateral.  I am hoping by giving this information we will prevent a lot of people from wasting time on deals that simply do not make sense from an investment perspective.

How much money is available for investment in venture capital situations?

During the past decade, the venture capital industry has witnessed an unprecedented expansion of resources and activity with nearly $300 billion raised and invested over the last five years alone.

Total Annual U.S.Venture Fund Investments

According to The National Venture Capital Association and Venture Economics, venture fund investments in emerging enterprizes reached a record $103 billion in 2000, an increase of 73.5 percent over 1999's total of $59.4 billion. Year 2000 also saw the number of companies who benefited from venture capital financing hit a record of 5,380, a 36 percent increase over the 3,967 companies funded in 1999.

Despite of all the difficulties associated with an economy in recession, a stock market in decline, continued fallout from the dot com fiasco and the attacks on the World Trade Center, U.S. based venture fund investments exceed $36.5 billion during 2001 - ranking the year the third largest in history in terms of total dollars invested.

And now, after declining for five successive quarters, venture investment rose in the fourth quarter of 2001 to $7.1 billion, the first quarterly increase since such investments peaked in the second quarter of 2000 - the height of the Internet boom.

"If you have really done your homework, this could be a great time to be an entrepreneur seeking venture capital,"

says James McNiel, a principal in Pequot Ventures.

Moreover, a  Price Waterhouse Coopers study concluded that venture capital funds now supply over 90 percent of all dollars invested in startup companies.

Our conclusions:

1. Availability of capital is not the problem. The challenge lies in developing a credible and attractive offering and then selling the deal.

2. If you are seeking to launch a startup venture and you are not preparing to solicit capital from VCs, you are ignoring at least 90 percent of the venture capital market.

What type of return do venture investors require?

Venture investing is a high-risk, high-return proposition.

"Venture capitalists want to hit home runs with their investments",

says David J. Blumberg, managing director of Blumberg Capital.

Entrepreneurs always seem to underestimate the high level of risk associated with even the most promising and well planned endeavor. Frequently, investors find themselves in an adversarial position with management, even when the venture succeeds, because the entrepreneurs forget the risks taken, focus only on the current results and begrudge the investors (and investment bankers) their just profits.

Entrepreneurs also forget that not all of a venture investor's projects are going to be successful; therefore, the successful enterprize must not only provide a sufficient return to warrant the risk of that investment, it must also provide a return sufficient to cover the investor's inevitable losses in other deals.

For most startup situations, investors are going to want at least a six-to-one return in three years or approximately 90 percent compounded annually. This can rarely be achieved based on cash flow alone, especially assuming the investor has taken a minority equity position.

However, if management has a well-thought-out business plan including a strategy to take the company public, it's possible to project, and deliver, such a return based on the liquidity premium obtained from the establishment of a viable public market for the company's stock.

What types of returns are possible?

Kleiner Perkins Caufield & Byers, a San Francisco venture fund which backed Genentech in 1976, got an 800-to-one return on its money when the company went public in 1981.

Janet Axelrod was a secretary employed by a tiny computer software company. Offered stock in the company, she invested $4,000 because some other employees were doing so. The name of the firm? Lotus Development Corporation. The eventual value of her shares? $9 Million.

One reason why startup ventures have become a sort of new American dream is that capital appreciation deals give management and investors, alike, the opportunity to amass multimillion dollar fortunes without paying enormous income taxes. Since you only pay tax on your stock when you convert it to cash (by selling it), the majority of your increase in net worth comes tax free.

Even when you sell your stock, your income from such sale (capital gains) is generally taxed at a much lower rate than other so-called ordinary income. The tax laws are somewhat volatile in this area - so you never know for sure what the tax rate is going to be three to five years out - but the current federal rate for assets held over 18 months is only 20 percent.

Thus, at the top of the Forbes 400 you'll find mostly entrepreneurs and astute investors who have accumulated their fortunes through the capital appreciation of equity assets. Relational Investors' Ralph Whitworth sums up the potential for outstanding returns in venture capital with the following comment,

"It only takes one."

What else do investors expect?

Venture investors are likely to concentrate their attention on three areas:

1. The proposed product or service.

2. The potential market.

3. The management team.

While all three need to be satisfactory, you'll hear different investors say they emphasize one area or the other. Many are product or technology-oriented. Others are more fascinated by vast, emerging or protectable niche markets. Probably most would say that management is the most important factor.

[This is why most Commercial or Business Financing Deals even Rehab Loans require résumé`es.]

Stan Fung of Zero Stage Capital claims,

"Ninety-five percent of a company's success is determined by its team anyway, not a unique product idea."

Some even comment that what they really invest in is the entrepreneur - not the deal.

Our view is that all three aspects are vitally important and that emphasizing one over the other is a nonproductive exercise. However, we believe it's not unproductive to recognize that many investors are biased such that they may be more heavily influenced by one of these three elements. Discerning a particular investor's hot button may enable one to present the deal in a more persuasive manner.

I really hope this helps everyone to understand how to look at some of those deals that are WOW and you can not figure out why no one will fund them.

Have a Great Halloween and we will see you next week.

Mark 

What is "venture capital"?

Venture capital is capital invested or available for investment in the ownership element of a new enterprise.  While there may also exist a preferred return or debt component, the defining characteristic is that the capital investor retains some equity in the venture.

There are several types or stages of venture financing typically referred to as:

1. Seed

2. Start-Up

3. Second Stage

4. Third Stage

5. Mezzanine

6. Initial Public Offering (IPO)

What is "seed money"?

Seed money, seed capital or seed financing is venture capital used to finance the early development of a new product or service concept.  Generally, it is the most expensive in terms of equity concessions since there is no guarantee that the product or service under development will ever make it to the stage of a workable prototype much less a viable commercial enterprise.  While there are many firms that specialize in seed-stage financing, this is generally not the niche most attractive to Venture-Net.

What is "start-up capital"?

Start-up capital usually refers to venture funding sufficient to generate initial sales and profits.  Our view is that if an initial private placement, distributed on the basis of a viable three-to-five-year plan to reach fundamentals sufficient to undertake a successful public offering, is fully subscribed, there should be no need for second and third-stage equity offerings.  This is advantageous to both the founders, management team and first-stage investors in that neither suffer any subsequent dilution prior to the firm's initial public offering (IPO).

Why would these later stages be necessary?

In the event that the firm's initial private offering does not prove sufficient, the company may need to resort to additional debt or equity placements to raise more capital.  This may become necessary due to management's failure to properly utilize its initial financial resources or it may result from unforeseen changes in the company's operating environment or from many other factors.  If a follow-on-stage offering is used to fund an expansion that enables a company to later conduct a public offering, it is sometimes referred to as a mezzanine financing.  In all later-stage financings you can be sure of one thing, management's equity will almost certainly be reduced, drastically so in many cases.  We've seen common share "cram downs" as bad as 60-to-one.

This is the first part of a multi part series that will hopefully educate everyone as to what to ask for depending on the borrowers needs and positioning in the marketplace.

PS. We are into the Holiday season once again.  Please remember all of our troops and other men and woman that are overseas or on duty here in the US that are not able to be with their families this holiday season.  I do not believe that because we are Patriotic towards our country or our troops that it is a designation of support for our governments polices and procedures abroad.  I simply believe that we need to begin to show our support for mankind and humanity as whole. 

Thank You,

Mark

My son and I were unloading the truck after a trip back from Lowe's or Home depot when my 6 year old son was reading labels on what we bought, and he asked me this question:  Why does everything say made in China?

Wow!  I thought what a great question from a 6 year old and began to read everything he was reading.

Then I began to think...you see six year olds have a way of making you do that because they never stop with the questions. 

Here we sit today with almost 550,000 layoffs this year alone.  Everyone is happy though because the numbers are lower than last year in the same time frame (Go Figure). A Major International Bank announced almost a 3.2 Billion dollar loss due to the mortgage industry and therefore has to layoff a large part of its work force.  Bear Sterns has made a similar such announcement and several more Banks and Investment firms are expected to follow suit.  Now I understand that if you watch CNBC and listen to the experts they have all pretty much said that the Mortgage Industry has had little or no effect on the economy.  Excuse me for my ignorance.  (Check out my previous blogs if you got lost there).  The worst part is that the stock market keeps on going up!  The general public is buying all of this garbage even though you can look around and see all of the destruction. 

What happens when you push a car to the top of a cliff, it gets to the edge, and you let go?  The answer is obvious and so is the outcome. 

The bright spot is commercial money is beginning to flow again and good deals are being closed with proper documentation. 

Oh, by the way the whole made in China thing:  I explained to my son that as long as people are in denial about the state of economic preparedness and their own financial situations, manufacturing and distribution of most consumer products will be from foreign countries like China.  I also explained to him when that happens - the american worker will become extinct.  Craig then asked, "How will we afford to pay for stuff then daddy..."

Have a great week!

Mark