Raising Capital

February 1, 2010

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Raising Capital

Cultivating the “Benjamin’s”

    According to economists, only Michigan has suffered worse from the Great Recession than Nevada. Nevada’s too-heavy reliance on gaming, sales tax and construction led us to this situation and economic development is on everyone’s mind.

    But how do you build, grow and sustain diverse types of businesses in a state with no money?


No Silver From the State

    Part of what has, for decades, made Nevada so appealing to business owners is its philosophy of independence – it’s fairly inexpensive and simple to start and run a business here, thanks to the absence of certain taxes and the typical bureaucratic red tape. There are fewer government employees to residents than almost any other state, which indicates a lack of government interference. And extending this laissez-faire philosophy further, the Nevada Constitution actually prohibits any state investment in companies and organizations, except for those which are educational or charitable.

    While there are arguably many benefits to a lack of government interference, from an economic development perspective, this can be problematic. Such investment could, perhaps, enhance Nevada’s ability to draw high-quality, job-creating businesses.

    According to those working in the trenches, this stipulation is fairly unique among states, and might possibly be complicating the recession’s effects further in Nevada.

    â€œAnecdotally, I hear from companies that New Mexico, Arizona and Utah are doing a lot more, providing loans and things, and people are somewhat acidic in their attitude, being frustrated with not being able to find money,” said Chuck Alvey, president and CEO of the Economic Development Authority of Western Nevada (EDAWN). “These people hear the state talking about needing to develop renewable energy and so forth, but the state won’t give them money to do it, so they see it as idle talk.”

    Such talk has twice in recent history led to ballot questions designed to change the Constitution’s ruling on the matter. “It failed both times, I think, because people didn’t understand it,” said Alvey, adding that there is no hard research that he knows of indicating that the rule has significantly affected economic diversification in the state.

    There are other issues complicating the struggle to find capital in Nevada—namely, that other traditional sources of funding are missing here, due to a general lack of competitiveness.

    â€œWe don’t have a major venture capital  (VC) firm located in Nevada,” said Dave Archer, CEO of the Nevada Center for Entrepreneurship and Technology (NCET), which he describes as a sort of “clearinghouse for programs available for starting or growing businesses in Nevada.”

    â€œVenture capitalists tend to invest in businesses that are geographically close by, usually within an hour or so driving distance. So the magnitude of investment is affected.” Archer explains that angel investors tend to invest up to about $1.5 million, while venture capitalist investment usually begins at $1.5 million; basically, that significant multi-million dollar investment is lacking in the state.

    Why no venture capitalists in Nevada? It’s a chicken-or-egg debate; many say there simply aren’t enough of the kinds of businesses that VCs like here, though it’s arguable that there might be, if there were a VC firm nearby.

    â€œOur state hasn’t been focused on those highly scalable organizations that can be highly ramped up with products or services that are universal, like software or medical devices, which can be marketed nationwide or worldwide,” explained Dennis Wengert, deputy director for the Nevada district of the Small Business Administration. “We aren’t a state that’s historically been conducive to that. There hasn’t been a state or private infrastructure from a financing point of view, so those companies aren’t attracted here.”

    Compounding the problem is Nevada’s economy; the Silver State is in too much financial trouble to think beyond subsistence funding. “There isn’t an appetite or ability to devote funds to that kind of economic development activity when local leadership is concerned with providing basic services … So I think it’s been somewhat of a detriment to diversifying the economy and attracting high tech here,” Wengert added.


Traditional Lending Sources

    It’s a cruel irony. “Banks are hesitant to loan in poor economic conditions, but poor economic conditions require some lending and cash flow in order to see progress,” said Wengert, explaining that there are two situations in which businesses look for capital: survival and expansion. A company in survival mode has little to no cash flow, cash reserves or unencumbered assets, while a company in expansion mode enjoys strong demand, as well as adequate cash flow, reserves and liquidity.

    â€œWe’ve got a public perception that a company in survival mode should get a loan,” said Wengert. “But in the last two years in Nevada, so many companies have been in survival mode, trying to get loans, while banks are in the business of loaning to expansion-mode companies.”

    Wells Fargo, the nation’s largest small business lender, considers “the Five C’s of Credit” before offering a business loan, explained Nevada’s Vice President of Communications, Natalie Brown. These are: 1) Character (What impression does your credit make on the lender, or how trustworthy is your credit record?); 2) Conditions (How, precisely, will the money be used?); 3) Capital (How much of your own capital have you invested in the business? “Having your skin in the game sends the message that you are committed to making your business succeed,” said Brown.); 4) Capacity (How, precisely, will you repay the loan?); and 5) Collateral (What forms of repayment security can you provide the lender?) A sixth “C” may play a significant role as well; longtime Customers may fare better—a preference that’s fairly standard among bankers.

    Bill Uffelman, president and CEO of Nevada Bankers Association, said that while the perception is that banks aren’t lending, the problem lies with loan applicants, and a general lack of interest in what they’re selling.

    â€œPeople aren’t spending money; even people who are doing okay financially are sitting tight, reluctant to spend money because their neighbors got laid off and they’re wondering whether they’re next. So there’s a question of confidence, and a lack of spending. That’s resulting in a lack of credit-worthy projects, and borrowers who wouldn’t just be digging themselves further into debt,” said Uffelman. “And I’m not going to make a speculative loan as a banker. I’d be called up short by regulators and stock holders. If you have a track record as a successful business person who’s made good decisions, and you’ve banked with me for 15 years, I’d probably be more willing to make that loan. And with the Small Business Administration (SBA) guaranteeing a percentage, I’d be even more willing.”

    To make lending more palatable, the SBA reduces risk by guaranteeing two types of third-party business loans: 504 loans geared toward hard, durable assets, and 7(a) loans intended for all other capital needs. Through the American Recovery and Reinvestment Act (ARRA), guarantee levels were increased to 90 percent through 2009, although there’s a movement within Congress to reinstate and extend that increase.

    â€œIt’s important to understand that banks want to lend,” said Uffelman. “The problem is finding borrowers who want to borrow, with qualified projects and qualified credit.”

    Wengert said that 75 percent of Nevada’s community banks lost money during the third quarter of 2009. “That’s a lot of lending capacity sitting on the sidelines because they can’t take the risk of making loans in an uncertain economy, where many indicators say we haven’t truly reached bottom yet.”


Connections to Capital

    Rounding up all the state’s sources of capital is a weighty task, but it’s one that the Nevada Commission on Economic Development is undertaking now, in its Capital Continuum project. The NCED has identified a few grant sources as part of the project: four ARRA grants aimed at clean energy and energy efficiency projects; two U.S. SBA programs targeting scientific research and development projects; and several $1,000 grants from the Idea Café, a private organization that supports innovation and originality among current and future small business owners. ARRA money is generally intended for “shovel-ready” projects, which excludes many startups.

    Additionally, the NCED serves as a referral hub to other capital sources or organizations offering business assistance. Executive Director Michael Skaggs says the NCED is closely monitoring the state economy, and has found that the national credit crisis has affect Nevada’s ability to draw and retain businesses.

    However, Skaggs alludes to an uptick in foreign investment that he and Lieutenant Governor Brian Krolicki have helped to broker—in particular, from the Chinese. “Recently, about 25 business people from China flew here and we put technologies in front of them,” said Skaggs. “We’re showing them things that are economic stimulus-types of businesses, so we’re matchmaking … foreign sources are one way, I think, that we’ll get out of this mess.”


Renewable Energy

    There are actually quite a few investors and lenders looking for highly scalable, high tech, high-paying job generators. One such organization is the Nevada Institute for Renewable Energy Commercialization (NIREC). Primarily funded by the Department of Energy, as well as some private funding, NIREC invests in clean energy, energy efficiency and conservation technologies.

    â€œWe’re an early stage investor,” said President and CEO Jim Croce. “We provide money and support in the form of commercialization services, and take equity in companies, working with them to raise public and private capital. So we’re a long-term investor, and we’re very hands-on. Our mission is to accelerate the process of taking these clean energy innovations from the lab to the marketplace.”

    After making an up-front capital investment (typically around $150,000), NIREC assigns an entrepreneur-in-residence or seasoned business person to work alongside the inventor to ensure that the technology continues reaching milestones, a thorough business plan is formed and impressive presentations can be made to angel investors.

    â€œClean energy projects continue to enjoy a good level of both public and private sector support. Globally, it has grown [five-fold] between 2004 and 2008 … Clean energy, for the first time ever, became the fastest growing segment of venture capital, ahead of software and biotech, in the third quarter of 2009,” said Croce. Still, renewable energy isn’t always fail-safe in securing capital; 2009 should see a year-to-year drop of 20 percent in worldwide investments.

     â€œWe have a number of challenges in Nevada in terms of competitiveness in attracting private capital and trusted entrepreneurs who effectively manage money. We have a long road ahead in terms of becoming competitive with other states who are actively stimulating investment,” said Croce. “I’d say Nevada needs to really get more organized as a state as to how we build up early-stage capital formation.” Croce adds that with the 2009 investment drop and no venture capital here, many needed technologies aren’t making it to the marketplace, translating to missed economic opportunities.


Funding for Micro-Businesses

    The Nevada Microenterprise Initiative (NMI) is another important source of early-stage investment. This private non-profit community development financial institution helps individuals find to-market money and become self sufficient, explained Anna Siefert, operations manager for the Southern Nevada office (NMI is also located in Reno). NMI works with individuals looking to start or grow businesses, offering management and business development training and coaching from experts.

    Additionally, as an SBA resource partner, NMI hosts the state’s only microlending program, utilizing SBA funding to offer loans of up to $35,000 to startups or existing businesses. Any type of microbusiness (a business with 5 or fewer employees that lacks access to conventional lending sources) is eligible, except for adult entertainment, gaming, real estate investment and multilevel marketing.

    How can NMI afford to take such a risk? “We can’t afford not to,” said Siefert, pointing to a 2007 study that found that 193,000 businesses in Nevada are microbusinesses. “Without this program, where do they go? They can’t survive—especially now.” Thanks to the NMI’s thorough counseling, defaults on these “risky” loans are only about 7 percent.


Bridging the Gap

    In this same vein is C4CUBE, a business incubator comprised of two organizations: CUBE, a milestone-based advisement and shared resources non-profit, and C4 Venture Accelerator, a for-profit organization that assists with finding and securing investments. “Our mission is to work with entrepreneurs and investors to increase job creation, and help entrepreneurs find resources to develop sustainable businesses,” said Ky Good, managing director and co-founder. Unlike NCET or other referral organizations, C4CUBE actually explores entrepreneurs’ qualifications and the scalability of their ideas, helps them get patents and become incorporated, and helps locate funding.

    Upon graduation from the University of Nevada, Reno, Good saw a need to bridge the gap between idea and industry. “Typically, entrepreneurs don’t know how to take their ideas to market, how to find funders, etc.,” he said. “Most investors are looking for steady deals, and most entrepreneurs are looking for capital and advice. Combining the two provides a vehicle that enables investors to see companies and reduce their risk.”

    C4CUBE’s access to investors around the country makes them an important connection for business owners. Additionally, Good and Executive Director Norman Smith have established a Reno chapter of the U.S. Angels, a Palo Alto-based angel investor group, and are working to eventually bring a venture capital firm to Nevada.


Angel Investors

    There are roughly 400 angel groups around the country, with several privately funding and coaching entrepreneurs around Nevada. Their motivations, however, aren’t entirely benevolent, as William Botts, chairman of the Vegas Valley Angels, explained. Botts and his fellow investors, currently numbering around 35, essentially pool their private, discretionary dollars (they must have at least over $1 million in net worth or an income of more than $300,000/year) in companies they feel will provide a worthwhile return on their investments. Since 2003, said Botts, the Vegas Valley Angels have made 14 investments totaling $12 million, in companies ranging in size and specialty, from high tech to low tech.

    Botts explains that, unlike VCs, which tend to invest in lower-risk, higher return propositions at a later stage in a company’s development, angels invest earlier on, taking on greater risk for potentially higher returns. “Angel investors are looking automatically at about a 50 percent failure rate,” Botts said. “You’re all hoping for one home run.”

    Obviously, the likelihood of eventually making those returns keep angels investing. But Botts points to another reason: “A number of members in most angel groups have built companies and want to give back to their communities. They’ve been successful and know they can help.”


Getting Creative

    Financial advisors can offer some insights into other creative funding solutions. Evan Kirkpatrick, senior investment consultant with LBG Advisors, a financial advisement firm, says that private funding may be appealing. “We have access to non-traded debt financing funds that provide secured loans to small and mid-sized companies,” he said. “These funds generally aim to become Independent Public Offerings (IPO) or merge within five years, but in the meantime serve as an alternative to bank loans.” Financial advisors, he said, can counsel business owners about these and other funding solutions.

    It’s also possible to tap 401k and IRA accounts for needed capital, depending on how the accounts are set up, explained Stephen Brock of Public Company Management, a Las Vegas-based consulting firm that specializes in helping small businesses raise capital. “Individuals can self-direct a portion of their retirement funds into startups that are building themselves to go public, so they can receive stock certificates with their self-directed funds,” said Brock. Because this is a complicated process, an investment advisor would need to guide anyone interested through the process.

    Brock’s specialty, however, is in helping companies to become IPOs in order to raise capital through the Nevada State Registered Offering (NSRO) program—Nevada’s answer to providing its businesses with investment capital. Through the NSRO, companies can legally register and distribute shares of company stock to Nevada residents and qualified visitors. Though not for everyone—eligible companies must have $1 million in sales with the prospect of $2 million by trading time—the NSRO makes it possible for certain companies to raise up to $1 million in just months.

    Though such a program isn’t unique (many states have similar offerings), Nevada doesn’t place restrictions on who can invest in what; issuers are simply required to disclose their financial information, and investors are left to their own devices to determine where, and how much, to invest. Plus, Nevada allows companies to advertise stock sales, which is forbidden elsewhere.

    â€œThrough this route, companies can use their stock for compensation, expansion dollars and benchmarks for how they’re doing—if you’re private, it’s hard to know what you’re worth,” explained Brock. “You can also use the stock to buy out other companies, so having the stock allows you options, where being private limits you. But it’s not for everybody.”

    It’s not for every investor, either. After all, many such companies have been turned down by other lending sources. “If a company has a way to show the investor how to get their money back and then some, it should have a better response,” said Brock, pointing out that through the process of filing for the NSRO, and being under the SEC’s watchful eye, a company is vetted and deemed viable—not that there aren’t companies that abuse the system. “In any investment, you should do your research. You can’t rely on good tips, or the fact that everyone is running for the same investment. You should always do your due diligence and decide if the company’s management is right for you.”

Capital Interests

    While the state’s independent business spirit can often be called a drawback to drawing and growing diverse businesses, many say that this same spirit has brought us success in the past, and will again, eventually.

    Plus, many believe better financial times are around the corner, which may make raising capital a bit easier. “Once people see new housing, visitor volumes picking up and unemployment lowering, I think the demand situation will turn around and the lending environment will become closer to normal,” said Wengert.

    â€œI’m not an economist, but what I sense is that there’s pent-up demand,” said Chuck Alvey. “Investors have been sitting on the sidelines, and I’m sensing that it’s coming together. They don’t want to sit on their money anymore.”

Jessica Santina
Jessica Santina is a freelance writer based in Reno.

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