Money – they say it makes the world go ‘round, and in business, it is a cornerstone for taking any operation to the next level. Sure, the real crux of any company is the ingenuity and expertise behind the concept but, without capital, that brilliant idea can only go so far. Even larger, firmly rooted companies will find there are times when a capital investment is needed in order to secure new technology, implement a new growth strategy or prepare for a sale by courting potential buyers. For companies desiring growth, access to capital means opportunity, potential and future success. For Greenville companies searching for the next step in advancing their vision, doing the legwork to find a compatible investment group could ultimately mean the difference between marked growth potential or being “closed for business.”
THE SPECTRUM OF AVAILABLE CAPITAL
A company’s lifecycle spans different stages, and their status determines what sources of financing are available from investors at each stage. The spectrum can be broken down into four main categories: seed, start-up, high growth and maturity investments. The risk/reward profile is dramatically different when comparing investments in early-stage start-ups as opposed to more mature businesses. Seed stage investments, firms typically funded by bootstrapping or friends and family, are the earliest business explorations that receive financing mainly from close personal sources. In this stage, early prototyping, web development and assessment of competitive landscape are the initial issues addressed. Once these start-up monies are exhausted, angel investors step in. Angel investors are typically high net worth individuals, oftentimes members of a formalized group, who back start-ups which have received validation in their business scope, are ready to enter the market and have little revenue for growth. Most angel groups operate under a network model, in which member investors are afforded the opportunity to pick and choose which deals to support.
Dan Adams, CEO at The Capital Corporation, says angel investors serve a vital role in the U.S. economy, bridging the gap for high-growth entrepreneurs looking to access capital. “Young entrepreneurs with nothing but an idea will receive a limited amount of start-up capital from their friends and family.
Venture capital and/or private equity funds won’t be comfortable investing their capital until they reach certain milestones. This is where angel investors step in and provide them with the financing needed after friends and family have maxed out their investment appetite but before venture capital or private equity funds are willing to get involved.” Venture capital groups, though supporting still-early stage investments, raise a committed fund typically from large institutional investors, where participating investors are legally obligated to provide financing when a capital call is issued. Private equity investments, or second stage investments, usually range in the millions of dollars and support mature businesses with substantially lower risk. According to Pat Duncan, Principal at Azalea Capital, LLC, such committed funds are comprised of general partners who control much of the decision-making and limited partners who provide the majority of the capital. The fund managers make the final decisions on which companies to support.
THE UPSTATE INVESTMENT LANDSCAPE
Our region is blessed with access to sources of both angel and equity investments. The Upstate Carolina Angel Network (UCAN), Azalea Capital, and The Capital Corporation are all working here in Greenville to provide entrepreneurs and established companies the resources needed to advance their business and grow profits.
UCAN, founded in 2008 by J.B. Holeman and Tim Reed, is a group of accredited investors focused on supporting start-up and early-stage high-growth businesses across the Southeast. Managing Director Matt Dunbar says, “UCAN members possess a wide range of business skill sets and expertise, which enables us to screen and evaluate a wide array of potential portfolio companies. After the investment is made, we can also provide advice and consultation.” ?To date, UCAN has invested in 17 companies (11 of which are in S.C.), totaling more than $4.7 million. Their average first round investment in a company is estimated at $225k, and they have made a second investment in six of their portfolio companies.
“We typically make preferred equity investments and buy ownership stake in the company. The total angel round typically represents a 20-40% equity stake. Since we are not debt holders, we don’t receive regular interest payments, instead seeking a return on the investment upon an exit when the company’s equity is purchased by a larger company,” says Dunbar. Angel investments range from $100,000-$1 million, and UCAN also partners with other high net worth individuals, angel groups and SC Launch on larger investments.
UCAN screens incoming investment applicants to ensure they fit nicely within the established parameters. “We look for early-stage ventures located within a four-hour drive of Greenville that address large or fast-growing markets and can scale with relative capital efficiency. UCAN anticipates annual revenues on investment ventures to grow to more than $20 million in a three to five-year span, with an expectation to create a liquidity event with a 50%+ rate of return. The group expects to see a clearly defined plan for investment dollars and a passionate management team with industry expertise.
Entrepreneurs applying for angel financing through UCAN submit an application through the group’s website. UCAN then gathers information to determine “fit”, selects three to four top contenders to put before a screening panel each month, and one or two companies are selected to pitch to the full memebership. If a “yes” vote is reached, the process continues with due diligence, after which a full report is delivered to all members, who then decide individually whether to invest.
While looking to raise capital to grow his business, NY Butcher Shoppe’s Jim Tindal learned of UCAN through some literature he read, as well as through some of his customers who were members in the group. “Not only did UCAN help raise the capital needed but also provided leadership to our board of directors and grounded advice from the membership’s industry talent,” says Tindal. “We opened additional stores, hired staff to support those locations and provided marketing support. It was the shot in the arm we needed.”
Private equity firm Azalea Capital is an investment firm headquartered in Greenville providing strategic equity capital to middle market firms in the Southeast. Founded in 1996, Azalea initial operations focused on merger and acquisitions advisory services until an opportunity arose to enter into private equity investments. After the firm’s first fund, Azalea focused solely on equity investments in 2003 and exited the m&a practice completely.
Azalea raised its first fund in 2000 and has sold all eight positions; the second fund, raised in 2005 have all but three sold; the third fund, raised in 2008, has four invested positions with one sold. “Azalea seeks to create significant wealth while minimizing the risks seen in other investments,” says Duncan. “In approximately 20 investments over the last eight years, we’ve only shown a loss on one occasion.”
Currently, Azalea writes equity checks up to $15 million. Azalea’s goal is to achieve an investment horizon of approximately five years. “We develop a strategic plan to double or even triple the initial investment,” says Duncan. “We intend to grow revenues of $25 million to the $75-$100 million range by assisting the management team with product development, marketing, acquisitions and more.” Azalea generates three main types of investments: management buyouts, recapitalizations and growth capital. In a management buyout, Azalea partners with a management team desiring to purchase a company from an owner who is exiting the business. If the management has expertise in the day-to-day operations but no capital with which to complete the sale, Azalea could invest in order to facilitate the transaction.
“In each investment, we provide strategic operating and financial guidance with consultation and review of performance. We allow the management team to run the business in an effort to grow and create long-term value in the company,” says Duncan. In a recapitalization, capital is injected into a company to execute on a new growth strategy for a still-involved owner needing financing assistance in order to expand. In growth capital deals, investors take an ownership portion in the company. Azalea invests in middle market operating companies with a proven track record of success in operations and product/service lines, generally within five main focus industries: manufacturing, value-added distribution, business services, consumer products and healthcare. Prospective clients have an asset base and cash flows to support the debt structure. Azalea expects minimum annual revenue of $10 million with cash flows of $2-$10 million. Duncan says, “We ensure the company is scalable, the management team has depth, and they have a ‘distinctive competence.’”
Capital calls are issued when an investment is ready to move forward after due diligence has been finalized. Azalea considers approximately 25-30 deals each month with only 3-4 investments made per year. Sage Automotive and Spartan Foods of America, Inc. are just two of the local companies in which Azalea has invested. “We needed capital for the company and all of our credit lines were exhausted. We had previously worked with Pat [Duncan] and there was a mutual trust, making the partnership easy,” says Tim Baliker, president of Spartan Foods. “Azalea support and resources allowed us to run the business while they dealt with the banks, helping open up our avenues for growth.” After a four-year ownership period, Azalea sold their interests in December 2009. “It was a terrific situation and very successful sale,” says Baliker. “Azalea positioned us to use our talents effectively to foster long-term growth.”
The Capital Corporation, a middle market investment banking firm, was founded in 1991 by Dan Adams. Having worked in a large national bank, Adams saw a need for high-end investment options in the Upstate and Southeast region, and he worked diligently to provide access to blue-chip caliber expertise for smaller companies. Now, with over $3.5 billion in closed transactions, The Capital Corporation is one of the most successful middle market investment firms in the nation. The firm is on pace to speak with executives of 700 different private companies per year.
The Capital Corporation provides three types of transactions: sellside, buyside, and financing. “If a company is interested in forming and executing an exit strategy, we run a complete sellside process for them including a go-to-market strategy, comprehensive buyer lists, marketing collateral, a healthy auction environment, and marketing, due diligence, negotiating, structuring, and closing phases of the sellside process,” says Adams. He adds, “We look through the lens of a buyer when deciding whether to represent a sellside client. We analyze customer concentration, market size and growth, profitability margins, degree of scalability, supplier concentration, etc. From a qualitative perspective, we aim to understand the seller’s motivations, the seller’s expectations in terms of value, structure and timing, management strength, business niche, barriers-to-entry, competitive landscape and other criteria.”
The Capital Corporation is industry-agnostic, offering service to a variety of industries and augmenting its investment banking deal teams with industry specialists within the firm’s proprietary network. Clients typically have cash flows ranging from $1-$10 million. “These companies have outgrown the abilities of business brokers but are too small to secure blue-chip investment banking services,” says Adams. “We have built a robust network within this niche, bringing Wall Street caliber investment bankers downstream without the overhead and inflated prices of Wall Street.”
The Capital Corporation’s newest member, from the blue-chip investment bank Nomura, joined the firm as Principal, bringing with him an expertise in i-banking, operational and consulting perspectives. “Having worked in England, Italy, Canada and the U.S. and fluent in three languages, he will be a tremendous resource for Greenville, as the investor landscape has become increasingly global,” says Adams. A small investment bank by design, The Capital Corporation exercises great selectivity in choosing clients. “Running a sellside process requires a meaningful commitment from both our client and us to ensure the right ‘fit’ exists to facilitate future success,” says Adams.
IS THIS THE RIGHT TIME? IMPLEMENTING AN EXIT STRATEGY
Planning makes perfect, but in many times, business owners spend more time in start-up and day-to-day operations without ever considering their retirement or departure. Business owners often hesitate to entertain this during the course of their career, but it is a vital part of realizing true success when it’s time to move on. Planning provides options that will keep an owner in the driver’s seat of the company’s sale, leading to a more profitable deal. “It’s not uncommon for hundreds of man hours to be invested in planning the launch of a new business. Ironically, the majority of business owners haven’t spent more than a fraction of that effort planning their exit,” says Adams. “There is a big difference between ‘creating’ value and ‘capturing’ value. Many business owners have worked years, often decades, to create value within their company, but until they successfully exit their business, they have not captured the value that they have worked so hard to create.”
Business owners not equipped with a sound exit strategy inherently assume a heightened level of risk of experiencing many common pitfalls revolving around the deal structure, the due diligence process and a correct business valuation. “Selling a business is a full-time job in itself, and owners attempting to prepare a sellside agreement in conjunction with running day-to-day operations can lose control of the deal. The idea is to create an auction-like environment with multiple folks interested in buying the business. With only one interested party, the owner loses power over the deal and, consequently, money in their pocket.”
Adams advises business owners to assess their end goals and expectations of selling the company. Retirement, economic uncertainty and industry trends are all critical factors in the decision. Generational considerations occur as retirement approaches with no succession plan. Economic “hiccups”, a tough competitive landscape, and a hesitation over Washington D.C. politics have also caused uncertainty, prompting many to consider selling. An expectation of rising capital gains tax by the end of 2012 has also caused many to pause and consider selling.
The Capital Corporation has instituted a thorough process for establishing a company’s exit strategy, beginning with an in-depth transfer of knowledge between the CEO and leading industry experts, compiled into a comprehensive portfolio detailing the opportunity. A targeted buyer listing is rendered to close the deal with the owner’s best interests represented.
“With small businesses generating 64% of all new jobs in the U.S. over the last 15 years, it is important angel investors remain accessible to entrepreneurs. Economic shocks transpiring over the last several years have many wealthy individuals more gun shy on investing money into higher risk start-ups, which could have negative future implications on both U.S. job creation and the pace of U.S. inventions,” says Adams. UCAN strongly advocates the passage of the Bill Wylie Entrepreneurship Act in South Carolina, legislation that establishes a state income tax credit of 35% on investments in qualified start-ups to help South Carolina become more competitive with neighboring states.
“South Carolina needs to join the 30 other states that have implemented or are pursuing angel investor tax credit programs. We are barely on the venture capital radar and far behind the progress of our neighbors,” says Dunbar. “The state’s angel groups currently have less than 100 total members while there are more than 100,000 accredited investors in South Carolina who could be providing angel capital.” Georgia enacted its “Angel Investor Tax Credit Bill” in 2010, giving investors a 35% credit while North Carolina’s “Qualified Business Investment Tax Credit” passed in 1987 gives a 25% credit. According to the Qualified Business Venture Tax Credit Fact Sheet, North Carolina has attracted more than $2 billion in capital since 1999 and created 650 jobs with average wages of $59,000.
“We must cultivate a pipeline of viable entrepreneurial companies with the potential to generate significant growth and jobs. Angel investors are stepping into a very challenging capital gap to help make that happen,” says Dunbar. “It’s a natural progression: by lowering the barriers for accredited investors to invest in start-ups, we can attract and educate more angel investors, who can provide the fuel for entrepreneurs to be successful, which will in turn attract more and more capital into the region.”
So what advice do these investment groups extend to entrepreneurs? Dunbar says it’s important for entrepreneurs to do their homework and accurately assess investor expectations and requirements.
“Entrepreneurs must understand where their company falls in the capital sourcing landscape, and then pay attention to the parameters and objectives established by various capital providers. It is important to target the right kind of investors who could be viable candidates to fill the company’s capital needs for its current and projected stage of development.”
Duncan reiterates that like Azalea Capital, many investors have capital to be utilized and are currently seeking promising innovations and good management teams to back. “At Azalea, we do not look to run the company itself but leave that to the current management team, instead seeking to help the team execute growth strategies more efficiently. Having the opportunity to step in, in a supportive role, and help a business owner with his ‘baby,’ growing it and creating value in an effort to achieve his ultimate goals, creates a terrific element of personal satisfaction. That truly is the American dream.”