In the beginning, Paychex was about not getting paid, providing an object lesson in fast-growth small and medium-sized enterprises’ (SMEs) cash-starved travails.
Today, the Rochester, N.Y.-based payroll services provider is a US$500-million-a-year business with 100 facilities. But for five long years in the 1970s, Paychex was a $0-a-year business with zero facilities.
“I started with a goal of 300 customers and about $3,000 in cash,” says CEO Tom Golisano. “That lasted six weeks.”Spurned by traditional sources, gazelles are tapping “angel investors,” venture capitalists and economic developers to bankroll their expansions. Spurned by traditional sources, gazelles are tapping “angel investors,” venture capitalists and economic developers to bankroll their expansions.
In the beginning, Paychex was about not getting paid, providing an object lesson in fast-growth small and medium-sized enterprises’ (SMEs) cash-starved travails.
Today, the Rochester, N.Y.-based payroll services provider is a US$500-million-a-year business with 100 facilities. But for five long years in the 1970s, Paychex was a $0-a-year business with zero facilities.
“I started with a goal of 300 customers and about $3,000 in cash,” says CEO Tom Golisano. “That lasted six weeks.”
With that, the wolf became Paychex’ permanent doorman. Golisano maxxed out credit cards, took out myriad consumer loans and even recruited an army of relatives as unpaid assistants.
Finally, 254 weeks after the $3,000 evaporated, Golisano had 300 customers, and Paychex, along with its CEO, started the steep climb out of debt. For those first five years, Golisano received no salary.
Paychex’ experience typifies fast-growth SMEs’ startups, when ideas totally outstrip available capital. Moreover, even fast-growth SMEs surviving the hardscrabble shift from concept to actual business must still secure further funding for the facility expansions imperative in making it.
Scimitar Golf illustrates how quickly real estate appetites can turn voracious. A mere nine months after its December 1997 opening, the manufacturer was racking up monthly sales of $1.5 million-plus, forcing Scimitar to erect a real estate empire on the fly: It rapidly set up a 150-employee manufacturing plant in Garden Grove, Calif.; opened telemarketing operations in Carlsbad and Irvine; and established a nationwide direct sales dealer network. Growth was so fast, in fact, that Scimitar had to buy out adjacent leases in Garden Grove, relocating those firms in other business park space.
Scimitar’s continuing struggle with rapid expansion has been a very expensive proposition, says Anthony Candell, one of the company’s five cofounders. “We’re constantly hiring more sales, marketing and manufacturing people, buying more raw materials and stocking more inventory,” he says.
Expansion Capital Elusive
Scimitar, however, successfully secured the capital to fund its initial rapid expansion. Its proprietary process — “tri-matching,” which produces individually customized clubs — struck a chord with consumers and investors alike.
Few fast-growth firms, though, are so fortunate. For most, the search for all-important growth capital turns desperate. While commercial banks are essential in funding established firms’ projects, they’re ill-suited for small business expansions. Using other people’s money, banks want solid collateral and stable cash flows exceeding loan-servicing costs — just what small firms don’t have.
That’s where non-traditional financing sources like venture-capital funds and “angel investors” come in. Such sources are greasing fast-growth SMEs’ expansion skids, as demonstrated by PricewaterhouseCoopers’ (PWC) “Trendsetter Barometer” research on U.S. fast-growth firms, gleaned from a CEO survey at 1998’s third-quarter end. Among those firms, who’ve sustained annual revenue growth of 20 percent-plus, 25 percent of high-tech companies planned to pursue “non-traditional financing” over the next year.
And even such established high-growth SMEs, PWC’s research underscores, can’t rely on ready investors: “Lack of investment capital” was cited as “a potential growth barrier” by 26 percent of high-tech firms and 14 percent of non-high-tech operations.
Such problems are endemic among fast-growth SMEs. Orange County, California’s 35,000 gazelles, for example, face a capital shortfall of some $5.4 billion, according to a recent California Research Bureau study.
Where Angels Tread
Angel investors (named for their roots in financing Broadway musicals) are arguably the kingpins of fast-growth SME funding, especially through loan guarantees. U.S. investor angels, for example, funnel some $20 billion a year into fledgling ventures, according to research estimates.
Finding angels, though, isn’t easy. Most are multimillionaires wary of calling attention to their wealth.
Company location also plays a role in accessing angels, who usually invest within 100 miles (160 km.) of their homes.
Such proximity turbocharged growth for Huntsville, Ala.-based Time Domain (www.time-domain.com). Time Domain founder Larry Fullerton patented his technological breakthrough — “Micropower Impulse Radar” — way back in 1987. But the idea languished as Fuller migrated from Arkansas to Mississippi to Alabama.
Then, while working as a Marshall Space Flight Center consultant, Fullerton shared his idea with another worker, Ralph Petroff. Owing to his father’s success as a NASA engineer who worked with Wernher von Braun, Petroff came from a capital-flush family.
Ralph Petroff jumped in, calling Fullerton’s invention “the information-age equivalent of oil in the industrial age.” The Petroff family bankrolled the idea, transforming Time Domain from an office-less idea to a 50-employee firm located in prestigious Cummings Research Park. (Ralph Petroff became Time Domain’s president and CEO, while Fullerton is chief technology officer and still owns 20 percent of the firm.)
Time Domain’s experience also underscores that angels tend to form choirs: Numerous other outside investors have queued up to invest some $26 million in the company. More investment is likely, as Time Domain’s profile soars with the potential multimillions in royalty dollars that could come from its successful challenge of a similar 1995 patent filed by the U.S. Energy Dept.’s Lawrence Livermore Laboratory.
• America’s Business Funding Directory (www.businessfinance.com); |
Web Matching and Structuring
The World Wide Web, through a number of “investor matching” sites (see box above), is lubricating promising new firms’ links with angels and venture capitalists. Capital-seeking firms are listed for fees generally below $200.
“Existing entrepreneur-investor matching mechanisms are unsophisticated,” says Bill Tucker, who early this year created Elevator.com. That’s true, but such services are too new to gauge their efficacy. Nonetheless, the America’s Business Funding Directory site, online since 1995, reports 10,000-plus businesses per month using its capital search engine.
Enamored with fast-growth SMEs’ job generation, economic development groups have also become major expansion capital players. Many development groups now offer networks linking area entrepreneurs and investors. In addition, many provide free counseling, which can be a major factor in navigating investor-related issues like structuring corporate operations.
For example, establishing a U.S. limited liability company (LLC) allows for foreign investors; allows losses to be deducted from regular income; and permits multiple stock classes (e.g., for key employees and individual venture-capital rounds). In addition, LLCs’ “single tax” structure usually yields higher asset sale prices and ups sellers’ proceeds. (An LLC’s tax structure, however, discourages tax-exempt institutional investors.)
Consulting with savvy attorneys and accountants is obviously essential in finding expansion capital. Even so, some fast-growth SMEs have proved to be paragons of inventiveness.
For example, Hahnemann Laboratories, a San Rafael, Calif.-based homeopathic medicine manufacturer, was stymied after bankers, angels and venture capitalists all declined to finance a manufacturing expansion to provide nationwide product distribution. So Hahnemann contacted each of its 28,000 customers, offering stock in exchange for individual investments of $2,000.
Hahnemann, it turned out, got more than the $400,000 it needed for its manufacturing expansion. Customers ponied up $477,000.
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