We continue to build our IPO team and today, we examine the role of a Big Five accounting and counsulting firm in the process. In doing so, we take a step back and look at the role such a firm plays in helping you finance your company - before, during and after an IPO. We take a special look at what awaits Israeli companies as they seek to raise capital in the US.
I am honored to have as a guest columnist Mario R. Dell'Aera, the Partner in Charge of KPMG LLP's New Media Practice. A leading Big Five firm, KPMG LLP is the US member firm of KPMG International. KPMG International's member firms have more than 103,000 professionals, including 7,000 partners, in 159 countries.
The last two decades of the 20th century have brought a whirlwind of change to business - from the deregulated climate that was ushered in to the United States during the 1980s, to the Internet and electronic commerce usage that has exploded in the 1990s, we have been witnesses to a new kind of economy.
Perhaps, though, it has been the advent of digital entrepreneurs that best defines this era, at least in the public's mind. Almost overnight, it seems, the growth in high-tech business has created legions of twenty-something multimillionaires: young men and women who had a technology-related idea, implemented it with a company, and went on to launch an IPO that raked in unheard-of amounts of capital.
In Israel though, high taxes, a cumbersome bureaucracy and a stock market that offers only limited access have driven many entrepreneurs overseas to the American capital markets. That begs a question-what kind of reception will they get when they approach the North American markets?
While the American economy is vibrant, the Dow's high levels don't really capture all of the elements involved in a venture. For example, the gestation stage ¾ when a business may be long on ideas but short on product and cash ¾ is a critical period. It is at this point that many entrepreneurs turn to outsiders for financing to take the company from being a concept to being something real.
But a high-tech company may face hurdles at this point. A traditional asset-based financier, like a bank, may hesitate to fund a high-tech startup because of the new company's lack of assets and low level of receivables. Unlike a manufacturing company, which has machinery and equipment that can be pledged as collateral, a high-tech startup's assets are often intellectual, not physical.
Additionally, a high-tech entrepreneur, who is often relatively young, may face further barriers because of the lack of a proven track record in business. It makes no difference that he or she may be a recent college graduate who simply hasn't been around long enough to establish a record.
This is not to say, however, that the door is permanently closed on bank financing. For one thing, each financial institution has its own lending standards. Also, a startup can always apply to the Small Business Administration for a loan guaranty, which
will effectively cover the bank for the guaranteed portion of the loan if the borrower does default. For today's breakaway leading companies though, this route can be a time-consuming, paper-driven process, which most entrepreneurs can ill-afford.
Another resource is a factor, or factors, who will purchase a company's receivables at a discounted price. Unfortunately, this approach is often not viable since an early-stage high-tech venture usually has little in the way of receivables.
Instead, one option is to turn to friends and family for financing. While these sources may be more forthcoming than, say, a financial institution, friends and family can often provide only a limited amount of funds. Additionally, if they are given stock in exchange for the funds, the company's owners must pay careful attention to Securities and Exchange Commission rules on offering and selling the stock.
Also, it's helpful to remember that a deal with close friends or family is never strictly a business deal ¾ there's also an emotional component. So if the business doesn't quite live up to expectations, the unsatisfied investors may still be in close contact with the entrepreneur, leading to unpleasant encounters.
"Then why don't I just use credit cards to finance my business," is a common question. While it's true that getting the funds will probably be easy, plastic comes with a high price in terms of interest rates, which can range from 13% to 20% a year. However, in the long run, this may be less costly than giving up equity in the company.
It is common, however, for high-tech companies to turn to venture capitalists for early stage financing. There are a number of advantages to this approach, although care must still be exercised.
Venture capitalists typically contribute funds in exchange for an equity share of the company. They also seek fast-growth businesses that give them the ability to cash out and exit after a three-to-five year period. High-tech companies, if successful, often meet these needs and are thus attractive to a venture capitalist.
Meanwhile, for the high-tech entrepreneur, venture funding provides relief from
the need to pay debt-related interest that can put a burden on cash flow. Instead, the owner trades away an interest in the business in return for strategic advice and marketplace connections as well as funding.
The deal sounds simple enough, but there is a caveat. While a venture capitalist may have done dozens of similar funds-for-equity deals, an entrepreneur's relative
inexperience could result in an agreement that affords him or her less-than-favorable terms.
Because of that, it's important to recruit an experienced financial advisor before seeking venture capital or other financing. It should be noted, however, that the process will include a painful investigation and will likely take longer than anticipated.
As the world increasingly becomes wired, opportunities for high-tech companies continue to grow at an exponential rate. Consequently, a person with a good idea and an entrepreneurial attitude may stand a fair chance of launching a company. But it's important, in the excitement of launching a new business, not to lose sight of the importance of finding sound financial backing that fits a particular situation.
Please note that the information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought.
My thanks to Mario Dell'Aera for his contribution to Enable.
Published by Israel's Business Arena on April 4, 2000.