Your Butt On The Line

Entrepreneur, July, 2000 by David R. Evanson, Art Beroff

Hate to burst your balloon, but you'll have to risk your money to raise money.

Brian Jersey had it all. A rising young executive, Jersey was the director of marketing for Prodigy Internet in White Plains, New York. There he had his own secretary and oversaw a $40 million budget, two ad agencies and a staff of seven. And he had the kind of salary and bonus package that came with the job--circa 1995, that is, before Internet option mania took hold of the country'.

Jersey says he was confident he could make a go of the venture. So confident, in fact, that he took a 50 percent pay cut (to $84,000)-- funded by his initial investors--to get the business off the ground. "It was a dicey move," he says. "My son was just two months old when I started the business, I was still paying off graduate-school loans. Despite my enthusiasm, I just knew that the $300,000 I'd raised from the initial investors would never be enough to get the business to the finish line."

Call it the inexplicable entrepreneurial spirit, but Jersey, now 39, chucked it--job security and all--in 1996 to start 1-800 BIRTHDAY, a reminder service that would also sell gifts. Jersey felt that 1-800 BIRTHDAY had the same potential as 1-800-FLOWERS, except in a niche that had yet to be exploited.

Jersey's first effort was substantial enough, however, to get investors to take 1-800-BIRTHDAY's business model seriously and throw in another $1.1 million in 1997.

But that wasn't quite enough, and without plenty of capital for marketing, the company ran low on funds, and things started looking grim. Nonetheless, Jersey personally guaranteed a $100,000 loan, ran up $50,000 of expenses on his personal credit card and began deferring his $84,000 salary. In short, Jersey put himself in a position where he had a lot to lose-- and the only way out was to succeed.

WHAT PRICE RISK?

Should his risk-taking strategy be considered ill-advised and dangerous? Not from the perspective of raising additional equity capital to fund the business, says Michael Reisert, president of the J. Michael Reisert Group Inc. in Fort Lauderdale, Florida. According to Reisert, who has been helping companies raise money for more than 30 years, "Where most entrepreneurs fail to raise capital is not putting themselves at a sufficient level of risk to entice investors to do the same." Remember, when a business fails, the equity investors usually take a hit on the full 100 percent of what they put in. With the service-oriented businesses of today, there are usually very few hard assets to liquidate. And what is left over from asset sales usually pays lenders, often at just cents on the dollar.

Reisert adds that when you consider most businesses are funded by angel investors, and not professional venture capitalists, the aversion to risk is even higher. "A venture capitalist is losing someone else's money," he says. "But angel investors are different. They're self-made. They often grew their own businesses the hard way. They have a real appreciation for positive cash flow. When you add it all up, they hate to lose money.

The ways entrepreneurs can put themselves at risk may seem fairly obvious, but Reisert says many entrepreneurs still think all they need to bring to the table is the idea and that outside investors should ante up for the "privilege" of investing. In truth, however, the, entrepreneur must finance that idea with whatever funds he or she has available-- whether he or she has $5,000 or $500,000. By doing so and taking on some risk, the entrepreneur makes the venture viable for outside investors. Here are some reliable, albeit hair-raising, techniques:

* Liquidate savings.

If you've got it, give it up. There's just no way an investor is going to put in tons of capital that's totally at risk while all or part of your nest egg sits safely in CDs and blue-chip stocks.

* Take out a home-equity loan.

Investors love this one because they know that nothing makes an entrepreneur work harder or smarter than the prospect of the bank repossessing his or her home.

* Get a bank loan.

If you can actually get a bank to lend you money, you'll be demonstrating the kind of chutzpah investors like. Why? Because any bank loan will require a personal guarantee, or the guarantees of friends or family members, which tells investors that somebody else is at risk as well.

* Sell a vacation home.

Is there a risk in selling a vacation home? Not really. However, it can still mean a lot to investors because it shows you've given up part of your lifestyle for the business. More important, the only way to get back to that lifestyle is to succeed.

* Take out a margin loan against your stock holdings.

If you have, say, $100,000 in blue-chip stocks at a brokerage house, the firm will give you a loan of up to $50,000 almost instantaneously--assuming you have applied for, and received, so-called "margin privileges." Margin loans are relatively cheap, usually prime plus one to three points, and perhaps the easiest loans in the world to secure. They're also probably the most dangerous. Here's why: If the value of the blue-chip stocks collateralizing the loan falls from, say, $100,000 to $75,000, the brokerage firm will ask you for cash to make sure the "coverage ratio" of the collateral remains at 2-to-1. In this example, it would ask for $25,000 in cash. If you don't deliver the cash in short order, the brokerage firm will sell what stocks you have left and pay off the loan. The sale of the stocks could trigger enormous capital-gains taxes, with the whole scenario causing untold financial problems. Once again, it's this act of risk exposure that not only funds businesses but is critical for attracting the othe r investors that will be needed down the road.