A Private Equity Affair

Getting the most from venture capital

When Summit Partners of Boston approached Eric Fish about a possible investment, the 42-year-old founder of San Francisco's GoldenGate Software took his time thinking it over. Fish had launched the $15 million, 100-employee company in his home in 1995 without venture capital or even a bank loan. GoldenGate, which backs up data and records business transactions for corporate clients, was cash flow-positive and debt-free. "I'd heard stories about venture capitalists taking control of a company. That was my biggest fear," Fish says.

So Fish called entrepreneurs who had worked with Summit. He wanted to know if the entrepreneurs had kept control of their companies and how Summit reacted during down quarters. Reassured that he wouldn't be muscled out, Fish agreed to a $23 million investment in May. Summit got a minority stake and two seats on the board.

The money gave Fish and his co- founders some welcome liquidity -- more than 80% of Fish's net worth was tied up in the company -- and will help GoldenGate develop its marketing and sales expertise. Fish also hopes partnering with an experienced investor will give GoldenGate more heft in pursuing strategic opportunities.

Private equity provides capital and access to a network that can transform a company into an industry player. But the price is high: a chunk of your business. Most investors want a voice in strategic planning, and the relationship between entrepreneurs and their co-owners can sour. Even the best partnerships won't last, as most investors generally cash out after five to seven years.

Which companies are eligible? Private-equity firms typically invest from $10 million to $50 million in companies with $5 million to $50 million in revenues. (Those seeking smaller amounts usually do better with a loan.) They typically target companies that have solid track records and strong prospects for continued growth.

It's a good time to be looking for private equity. After a slump, investments are picking up. Some $4.6 billion was invested in later-stage deals in 2003, a 9% increase over 2002. Some analysts say $56 billion in investment capital solicited during the late '90s, but conserved since 2000, is poised to fall into entrepreneurs' laps. While other experts say much of that was returned to investors or eaten up by management fees and follow-on financing, there are other encouraging signs. "Banks are more willing to loan money, and companies are doing better," says J. Fentress Seagroves Jr., a principal in PricewaterhouseCoopers' transaction services group. "That gives everybody lots of options."


R. Matthew Neff's Indianapolis company has already benefited from its investor's network. Senex Financial, the 65-employee company Neff founded in 1998, buys health-care companies' accounts receivable. But growth has been slow. Neff thought his $8 million company could soar -- if only he had the cash to pay off debt and expand his sales and marketing. Neff asked an investment bank to drum up interest in Senex.

In May, SKM Growth Investors, a Dallas private-equity fund, made a $7.5 million investment. SKMGI bought a minority ownership and took three seats on Senex' board. Neff and his co-CEO, Kyle E. Lanham, retained control of the company. The capital retired several million dollars of startup debt and will also help boost Senex' sales efforts.

The deal also had a bonus: SKMGI's contacts are Neff's for the asking. "They are good at introducing us to people who didn't use to return my calls," Neff says. SKMGI has referred him to a commercial banker who has offered the company a line of credit and an investment banker who represents a hospital chain Neff hopes to make a customer.

Not all partnerships run so smoothly. Problems are most likely when entrepreneurs rush into deals, says Peter Z. Hermann, a general partner at Boston-based Heritage Partners. "You suddenly have a partner who's smart enough to ask, 'Why are we selling to this customer and not making a profit?' or 'Why is your son the CFO?"' Hermann says. Some entrepreneurs also wrongly assume their investors will be passive because they have only a minority stake.

Which means you need to do your due diligence. Don't ink a deal at the first sign of interest. Evaluate more than one investment group before signing, and interview other entrepreneurs with whom the company has worked. And remember that everything is negotiable. "Often the terms referred to as 'standard and customary' are anything but," says Denver attorney Robert W. Walter, author of Financing Your Small Business. Watch out for boilerplate term sheets that are short on specifics, and make sure you understand the details of legal fees, compensation, and employment agreements. Failing to negotiate a cap on investors' legal fees could leave you with a huge bill. And beware of investors who want to take a large percentage of your company -- say, 40% or 50% -- immediately, and annual ratchet clauses that let investors take more if the company misses benchmarks.

Private equity isn't for the faint of heart. But then again, entrepreneurs aren't known for being timid.

By Karen E. Klein

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