Are You Safe Or Sexy?

Corralling Capital

 

Butch Cassidy, the 19th century American philosopher and bank robber once wrote, "I got vision and the rest of the world's got bifocals."

Many entrepreneurs feel like Mr. Cassidy--they don't understand why financiers don't get as jazzed about their companies as they do.

There are a couple of reasons for this. First, a vast majority of ideas aren't worth funding--period. Second, and more important, most financiers balk at writing checks to companies that don't fit their specific investing criteria.

These criteria are best defined by two metrics: stage and potential. Understanding where you fit on those axes will determine how you should go about raising capital.

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"Stage" simply refers to how developed a company is. Early-stage outfits, for example, are not nearly as developed as companies that have been around a while. In general, the stages include:

--Pre-sales. This is the period before the product or service is developed. Financing is all but impossible to get from independent parties.

--Seed. The product is ready, but there is no business plan. Investors can get customer feedback. Trade press may stir up some interest.

--Start-up. You've drawn up a business plan and have selected a management team. Eager investors (including those who don't really understand your technology or competitive advantage) may find your venture attractive.

--Emerging. The venture has revenues, losses and negative cash flow. Investors can analyze why customers are buying in order to estimate the company's potential. The length of this phase can be crucial: If your business can show positive cash flow quickly, you may have more financing options, such as raising debt; if you are likely to have negative cash flow for a long time due to the high growth rate, lenders will shy away.

--Growing. Marked by increasing revenues and profits and persistent negative cash flow due to high growth rates. You may need external equity financing to sustain high growth.

--Mature. The company is pulling in sales, posting profits and kicking off enough positive cash flow to pay dividends.

"Potential" refers to growth. A neighborhood coin-operated laundry may reap respectable profits but never serve more than a few thousand customers, while a small software company with no profits today may have millions of potential customers in a few years. (More on "potential" in future columns.)

In the eyes of the investment community, early-stage companies with lots of potential are "sexy ." (Think Google (nasdaq: GOOG - news - people ), Amazon.com (nasdaq: AMZN - news - people ) or Yahoo! (nasdaq: YHOO - news - people ) before they hit it big). Mature companies with healthy cash flow, strong balance sheets and limited growth opportunities are "safe" (retail stories, utilities and the like). The question, then: Are you a safe bet or a sexy one?

If you have sex appeal, talk to the venture capitalists. Steady performer with modest growth prospects? Banks and other lenders are a logical choice. If you think you're both safe and sexy, saddle up to an investment banker. (Some bankers also like sexy without safety if, as in the mortgage market, they can slice the securities into tranches and sell them to unsuspecting pension fund managers.)

Let's not kid ourselves: Very few ventures are both safe and sexy. If investors are piling in because they think they can't loose, simply look up, say thank you, find an investment banker, go public and sell your shares at the highest price you can get. Then hire a good public relations company to tell the world what a humble genius you are.

What if your small business is neither safe nor sexy? Start ringing family, friends, Uncle Sam and "development financiers"--governments and government-funded nonprofits that finance businesses that boost local economies. Oh yeah, and pray.