FUNDING: Start-ups get "e" for effort in planning

Who wants to be an Internet millionaire? Almost everybody, it seems, if the flood of mail reaching the offices of City venture capitalists each morning is anything to go by. One estimate puts the number of e-business plans sent out at one thousand a month.

And even that figure may be an under-estimate. Durlacher Corporation, the stockbroker that has turbo-charged its share price by acting as an Internet incubator, reports that it alone receives ‘hundreds of unsolicited proposals’ every day. But it also says that only around one in 20 of these proposals gets past the most basic due diligence exercise. So most would be e-business millionaires end up filed in the rubbish bin.

Even so, there is lively activity on all fronts, particularly the AIM and Ofex markets. For example, ActiveIntranet, a company with a software suite that helps companies build intranets, raised £2.1m on Ofex, valuing it at £11.6m. Meanwhile, Internet and media incubator and investment company Cube8.com’s float on AIM was four times over-subscribed, with the amount raised rising from £7m to £10m. This gave the company a value of £55m.

So what separates successful e-businesses from the hundreds of proposals that never make it? One thing is clear: the rules of business aren’t suspended just because the company is a dot.com – although the judgement of the investors may be.

‘The disciplines of putting a well-supported business plan together are the same for the manufacturer of widgets as they are for a dot.com company,’ says Malcolm Holt, managing director of matchco, an Internet service that is designed to link entrepreneurs with venture capitalists. ‘The structure for doing the business plan is no different,’ he adds. ‘But, on the other hand, the funding sources have a great appetite for new opportunities that are e-commerce related.’

Quintin Barry, partner at Deloitte & Touche corporate finance, agrees that it’s important to present a well-researched business plan to venture capitalists. ‘Would-be entrepreneurs need to get the fundamental building blocks of their business in place,’ he says. ‘They must identify a business model which can be profitable; and be able to explain why it is a sensible model; and why it is one in which there are barriers to entry for other competitors. I would expect to see a business plan that had been researched and market tested – and also a plan that had something unique about it.’

Barry adds that one of the biggest weaknesses of many e-businesses is a failure to present a balanced business team. ‘We often see proposals that don’t have sensible management teams behind them,’ he says. ‘They don’t have the experience to carry off the proposition they’re making – and the rules of venture capital don’t change simply because they’re a dot.com.’

Another key part of the kind of plan that venture capitalists are looking out for is the exit strategy. Increasingly, they want an early exit. ‘I think the importance of getting out quickly comes down to being able to defend the position of the company they’re investing in,’ Barry says. Defence might involve using either cash or paper to buy rivals or move to a position where the venture capitalist’s initial investment becomes tradeable.

The latest Deloitte & Touche Private Equity Confidence Survey found that nearly three-quarters of venture capitalists expect to make funds available to firms developing an Internet strategy. But Barry says there are two distinct situations. The first is the dot.com start-up, the second is where an established business is developing an Internet presence – converting itself from a bricks and mortar to a ‘clicks and mortar’ business.

Barry suggests that the number of pure dot.com deals has doubled or trebled over each of the past three years, with the sums of money going into each doubling and trebling, too. ‘The result is that this year the amount of cash invested by venture capitalists in dot.coms will be many hundreds of millions of pounds,’ he says.

But, says Barry, many venture capitalists are also waking up to the fact that they have historic investments in companies whose future will be compromised if they don’t develop effective Internet strategies. Hence, the growing interest in funding clicks and mortar deals.

Yet despite the rise in the number of both clicks and mortar and dot.com type deals, there are complaints from both sides – the entrepreneurs and the venture capitalists – that they don’t understand each other.

One of the problems that Holt identifies is that many of the dot.com entrepreneurs are so young they’ve not had time to show a track record or develop the kind of management team around them that gives a venture capitalist that warm glowing feeling that the money will be safely husbanded.

‘If you go back in time, somebody who was launching their own business would probably be older and have already learnt the tricks of the trade in their market,’ says Holt. ‘But because of the relative ease of moving into e-commerce, you tend to get one or two people coming forward with an idea.’

That raises another issue – whether the entrepreneurs are seeking start-up or second-round funding. ‘The second kind of funding requirements are more in line with what funders in the UK are used to,’ says Holt.

Yet dot.com entrepreneurs have also complained that venture capitalists don’t understand the unique nature of e-commerce. Certainly, there might have been a lot of truth in that two years ago and some last year. But venture capitalists have shot up the e-commerce learning curve at a fair rate of knots in the past few months.

Despite this, there is still a mismatch in one crucial area – the scale of investment needed for a start-up. The days when a venture capitalist couldn’t be bothered to look at anything under £50m have started to change – but only slowly. Few venture capitalists recognise that the funding requirements of a business built on ideas and knowledge will be fundamentally different from one founded on buildings, plant and machinery. That means they need to find ways to fund more small deals – more cost-effectively.

UK venture capitalists had better hurry this way, too. US venture capitalists are eyeing the Europe market for bargain deals now that the cost of investing in the US has soared sky high. ‘They understand the market and it’s cheaper for them to buy their investments,’ warns Holt.

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