A Tale of Venture Capital Wanted

by H Lee Rust

Not long ago I had a visit from my friend Al B. Rich. I had seen Al a year ago just after he completed the concept design for an Internet B2B portal for buyers of eye glass hinges and screws. I had explained then that the Internet bubble had already burst costing most investors I know a good portion of their funds. Now Al was back to relate his experiences in The Money Search.

His first stop had been the bookstore which cheerfully supplied 16 volumes on how to write a business plan, attract venture capital, and live a life of idle wealth. I glanced out the window and noticed that Al had traded his Porsche Boxster for a ‘97 GEO with a little rust under the door. As we talked, I turned to the marketing section of his two hundred page “Private Placement Offering Memorandum and Disclaimer”, the disclaimers added at great expense by his lawyer. As usual, “Marketing” started with the astounding statistic that there are 250 million people in the U.S. Once this population had been distilled down to the eye glass wearers, companies that supply them, and the 10% market share Al’s B2B exchange would attract, his projected third year sales were a conservative $78.6 million with a 16% after tax margin. I could easily see how everyone was going to get rich; instead I think most of them got Rich.

He had sent the Plan to 36 venture capital firms and 12 SBIC’s listed in the free state development office directory of money sources. That was the only item Al got for free. Nine of the VC’s responded that they were putting his Plan in their files pending further market developments. Four SBIC’s passed it on to people they knew in the industry for evaluation. Fifty follow-up calls later, Al found that these experts passed the Plan on to more specialized experts until they found one who knew enough to kill the idea.

But one venture capitalist wanted to talk. Never mind that he was not on the list or that his address was the South Bronx, Al gladly spent $1,789 for a first class (he might sit next to an investor) ticket to New York. Maybe he should have wondered when the meeting was at O’Mally’s Italian Diner and Al picked up the check, but this guy controlled millions. Most of the conversation, however, concerned the New Yorker’s search for distressed Florida hotels that could be bought for no money down with 100% financing. Al couldn’t help him, and he couldn’t help Al.

However, it wasn’t a wasted trip; Al stopped in to see Monnie Dodge, an old friend who had done tax shelters in the ‘80’s. Dodge still couldn’t believe the game was over. He could package Al’s deal as an intellectual property partnership. Al would still own 100% of his company and just pay royalties to the partners. Converting the Business Plan into the Partnership Offering only cost $5,000 up front to Dodge plus twenty grand to the lawyers and a minor $7,500 for new financial projections. Oh, Al also remembered the $5,634 tax opinion and the $678 for FedEx delivery, the only mailing service those lawyers knew existed. If Dodge didn’t know the tax shelter partnership game was over, he found out on Al’s deal. He joined his brother-in-law’s Roto-Rooter franchise.

A friend of Al’s knew a guy in Miami who controlled South American money. Forget that Gonzales Sneed had blond hair and an office in a three floor walk-up, the deal sounded enticing. His client would lend Al $50 million; Al would deposit $43 million in a Cayman Island bank and pay for the balance at 4-3/4% over prime, repayable in six months with roll-over privileges and convertibility if his company succeed. That exercise only cost Al $5,000 to Sneed, a bargain when you compare it to the partnership deal.

There was, however, a new venture incubation center opening right near Al’s home office. Everything a budding company could need was provided including a state development officer for consultant. For only $4,000 a month Al got an office, copy machine, secretarial service, phone, and free coffee between ten and two. He virtually lived there before he discovered that the new venture incubation center had everything except a source of development capital, the one item a new venture needs before all others.

The development officer did, however, introduce Al to four venture capital clubs and got his Plan accepted for a high-tech enterprise forum where capitalists and entrepreneurs meet to exchange money for stock. Al made presentations to the clubs in front of accountants, deal packagers, other hopefuls, and office supply salesmen but no investors. The only difference at the enterprise forum was it took four days instead of four hours, and Al didn’t win the beauty contest.

At this point, he was getting desperate so he finally visited the High-Tech Pawnbroker and Financing Authority in Coral Gables. “Welcome”, said the man behind the counter, “so you want to start a high-tech company; I’ve got the money, but it ain’t cheap.”

“Right,” responded Al, “for just a million I’ll give you 10% and a seat on the board.”

“Just a minute, I’m the guy with the money; I’ll set the terms. I’ll give you $50,000 now for 40% and two board seats. If it works and I approve your business plan, you get another $100,000; I get another 30%, two more seats, and meanwhile I drive your Porsche. That’s a generous deal.”

“But that’s not enough,” said Al quietly. “How about my house; it’s gotta be worth $250,000.”

The man, who happened to be a real estate broker on the side, was quick to answer, “Hundred grand, my best offer, and how about your watch. I pay top dollar for Rolexes.”

Is there a better way? I tried to tell Al about market research and management teams, structuring the financing for the target investor, and using an expert’s knowledge of the capital markets. “But wait,” said Al, “I’ve scrapped the Internet portal idea and developed a new video game that plays automatically everytime your cell phone rings…”

 

H. Lee Rust has been a corporate finance consultant for the past 27 years helping small companies accelerate their growth with acquisitions and mergers and developing strategic plans to target and control that growth. He is the author of Let’s Buy a Company – How to Accelerate Growth Through Acquisition. Mr. Rust directs his entire corporate finance practice to those small companies who aren’t usually of interest to large investment banks, but uses big bank acquisition techniques tailored to his client base and their individual situations. He lives with his wife in Apopka, an Orlando, Florida suburb.

 

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