“Private Equity and Angel Investment”

As a new author to entreVIEW, I wanted to write about a topic near and dear to the hearts (and pocketbooks) of entrepreneurs—money! While private capital raising remains tough, there has been a shift to alternative asset classes and the “private equity” landscape has been robust.  

Depending on the type of business and on the amount of money needed to begin or continue operations, equity financing may be the only capital available for your start-up. However, it doesn’t hurt to know and understand a little about private equity funds, which could be a source of later stage capital or an exit. What follows is a summary of what we mean by private equity. 

Simply put, a private equity fund is a collective investment vehicle used for making equity or debt investments. Some common attributes: 

• Usually structured as Delaware limited partnerships. Under this framework, the fund is not subject to taxation on its income or gains but limited partners (“LPs”) are taxed based upon their share of the fund’s profits or losses.

• Managed by a general partner (“GP”) with capital raised from institutional investors, universities, insurance companies, foundations, endowments or high net-worth individuals. 

• Key economic incentives for the GP are the management fees and the carried interest, which is a share of the profits of the fund’s investments (typically 20%), usually with some minimum rate of return (typically 8-12%) before the GP shares in the success.  

• The key economic incentive for an LP is the opportunity to earn a high rate of return on their invested capital through access to a diverse portfolio of investments that are made by experts. 

As with so many things, there are a host of regulations that apply to these funds, including the Investment Company Act of 1940 and possible registration under the Securities Act of 1933, if there isn’t an available exemption like Regulation D, which is often available in offerings to accredited investors.

Investing in private equity funds allows groups of sophisticated investors to pool their resources to mitigate the customary risks associated with investing while attempting to maximize the synergy created by the collective “thought equity” of the LPs. These investors are known as “angel investors.” Angel investors are accredited investors who invest in businesses in exchange for convertible debt or an ownership stake in the business. These individuals or institutional investors conduct their own due diligence and make their own determinations about individual investments (like the “Sharks” on “Shark Tank,” without millions of people watching).  Like “Shark Tank,” angel investors will often make investment decisions based upon a personal interest in the business or the entrepreneur. 

Of course, nobody should take money from angel investors without their eyes wide open about the potential perils. Alignment of interests between the entrepreneur and the angel is critical (e.g., what type of exit in what timeframe?). For this reason, remember that raising angel capital can be like getting married. Make sure that each side has done their due diligence so their eyes are wide open to problems (like whether to leave the toilet seat up) and defined their rights and obligations (sort of like a pre-nuptial agreement) to ensure that everyone is on the same page. At the risk of sounding self-serving, getting your lawyer involved early in the dialogue is a good idea.

Taking on the right angel investors can actually have many positives in addition to securing capital needed to build your business. The ideal angel investor will be someone who has experienced success before (and has not just been born with a Silver Spoon) and who brings contacts and relevant expertise. With interests aligned between investor and entrepreneur, all parties should have the incentive to see the business succeed.

The Games HR is Playing

Let’s face it. The HR department isn’t typically filled with the go-to techies in your office. Usually HR lags more than a bit behind the curve on technology adoption – primarily because HR isn’t usually a profit center so acquiring new technology can be an uphill battle from the get-go. But there’s some really, really cool stuff happening in HR tech.  My favorite is gamification.

Gamification is starting to pop up everywhere in HR, and that should be no surprise. With everyone from my 6-year-old to his grandma playing Angry Birds or Candy Crush, new and established companies are finding gaming as a way to transfer detailed information to a wide variety of employees. By using a game, companies can engage employees and potential applicants in something fun and educational. Just like Where in the World is Carmen Sandiego? (and its catchy theme song by Rockapella) taught me geography.

How about using a game like Farmville to attract your next Restaurant Manager? Marriott Hotels did just that.  By placing a game on their Facebook careers page permitting potential applicants to test their restaurant managing skills – complete with purchasing ovens, hiring chefs, and selecting produce – Marriott engaged thousands of potential applicants before they even submitted an application. Plus, applicants could self-evaluate whether they’d even be good at the job. (I’m awful and should not apply.) 

But gamification isn’t just coming from big companies, entrepreneurs are developing games too. Imagine training folks on ever-changing and complex concepts using a video game. Cool, right? That is exactly what VitalSims is doing – using video game simulations to teach doctors and nurses how to treat the chronic disease of diabetes. Because diabetes treatments are evolving, training care givers can be tricky. With gaming, the sometimes tedious task of reading scientific journals can be supplemented with gaming simulations providing richer and more meaningful training. By partnering with HealthPartners and the University of Minnesota, VitalSims has developed their gaming simulations to be as up-to-date as possible so patients receive the best possible care.

If you think gamification will only work on your young, male employees, think again. Video gamers are much different than you think. The demographics are astounding: 45% of gamers are female and 68% of gamers are over 18. In fact, almost twice as many females play than teenaged boys. Female gamers are not mythical creatures!  While not everyone may be tracking down drug dealers in Grand Theft Auto V, you may hear your HR department advocating for some gaming soon.

A Post by Kate Bischoff, Guest Blogger

What: Laura Hillenbrand, Unbroken: A World War II Story of Survival, Resilience, and Redemption (New York: Random House, 2010)

Why: A case study in the strength of the human will in the face of unimaginably horrible circumstances.

I know some entrepreneurs. I know that it’s not an easy life. For every exhilarating victory, there may be countless agonizing setbacks, enough to make a person downright gloomy. But there is one characteristic shared by successful entrepreneurs that protects them from—or perhaps blinds them to—the downsides, a quality that keeps them going when the going is tough. That quality is perseverance.

Laura Hillenbrand’s Unbroken is not, by any stretch of the imagination, about business.  It’s not about products, markets, or money. It isn’t about achieving goals, unless you count just staying alive under unimaginably horrible circumstances to be a goal. It is, however, about perseverance, about doing what you need to do to get where you want to be.

This book was Time Magazine’s Best Nonfiction Book of the Year for 2010, and for good reason. In a nutshell, an Olympic runner joins the army air corps in 1941, crashes while on a rescue mission, is lost at sea for over a month, is captured by the Japanese, is beaten savagely and repeatedly while in captivity, and returns home at the end of the war to a raging case of PTSD, which he overcomes to lead a long and productive life.  He is, in fact, still alive, and at age 97 is working with his close friend Angelina Jolie to film his story.

If you’ve hit a bad patch, maybe this book will help put things in perspective. 

Follow-Up on Food For Thought

In my first entreVIEW post, I wrote about the Kickstarter campaigns of Travail and Birchwood. The New York Times recently published an article on the increased skepticism toward crowdfunding. The article highlighted two small business owners in Brooklyn who needed funds to relocate their business because their landlord increased their rent by more than 500%. To help alleviate the financial stress, they decided to start a crowdfunding campaign on Kickstarter. The business owners did receive some support, but a majority of the responses they received were negative.

Some of the critics of crowdfunding disapprove of business owners asking customers to provide funds for their projects, arguing that they are asking for “hand-outs” when they may have other means to achieve their financial goals. But others defend the practice as providing the opportunity to financially support a business that adds value to the local community in exchange for a gift and/or service from the business. In the conclusion of the documentary “Food, Inc.,” the narrator states that we vote three times a day on how we want to have our food processed. The same rule applies here—we can vote with our wallets to reward the businesses we value. 

I’m glad that the Twin Cities community has shown that it values Birchwood. Birchwood surpassed its goal and raised $112,126 in its Kickstarter campaign. The purpose of its campaign was to raise money for a much-needed expansion of the restaurant. I recently went to Birchwood for dinner (I had the black bean quinoa burger and a slice of key lime pie – yum!) to have one last meal before they close for the next ten weeks. Before they closed this past weekend, they asked customers to “leave your mark” on a piece of the original Birchwood that will be torn down during construction (see above). If you can’t wait until the renovation is complete, Birchwood will be operating a pop-up at nearby Verdant Tea on March 1st.

I look forward to visiting Birchwood when it reopens this spring!

Angel Tax Credit Update

Just as I was working on my latest entreVIEW post trying to avoid any “legal topic,” I felt compelled to provide an additional update on the Minnesota Angel Tax Credit. I know that, in his cold weather musings only earlier this week, fellow entreVIEW author, Max Bremer, mentioned that the total $12.2 million allocated for the credit in 2014 would likely run out before the end of March. His prediction of only a couple of days ago seems prophetic. In the last week, the dollars remaining for allocation have decreased from $5.4 million to $4.1 million. 

In addition, the folks who administer the program (who, fortunately, often don’t act like regulators and really try to be helpful to people trying to access the program) have begun sending out correspondence to recent applicants to the program telling them that there’s a decent chance that, by the time they’re qualified, there may not be any remaining funds to allocate.  The correspondence states, “Because certification fees are non-refundable, we want to give you this opportunity to tell us that you do not want your application processed and to return your application fee check.”

Avid non-lawyer entreVIEW readers may be glad about this development because we’ll be left with one less legal topic about which to write and we’ll be forced to contemplate current events, musical theatre, books, and pop culture (or even, occasionally, a comic strip)!  

While I can assure you that such topics will undoubtedly be addressed on these pages in the coming weeks and months, the Angel Tax Credit conversation for 2014 is far from over. The same correspondence from the administrators to applicants also says: “Although we may run out of our current supply of credits shortly, the 2014 Minnesota legislature will be considering whether to extend the Angel Tax Credit program and whether to provide it with additional funding for this program year.  However, we will likely not know the outcome of this until mid-May.”

We learned at a meeting with key legislators and supporters of the program in early December that communication with elected officials is an important part of ensuring ongoing (and increased) support for the program. Please consider contacting your representatives (if you don’t know who they are you can find out here). You should deliver personalized correspondence but, for your convenience, a draft letter that was put together on the subject is available for download here.

My apologies if you only read this post because you were hoping for an entrepreneurial spin on something unrelated to the law. As your reward for reading all the way to the bitter end maybe this will tide you over until my next post.

Random Thoughts on the Heels of Another Cold and Snowy Winter Day…

Is it just me, or has the financing activity for early stage companies picked up recently? I don’t have any empirical data to support that observation, just some anecdotal evidence. We are working on several financing transactions right now, including a later round preferred offering (where the largest investor is reinvesting and committing significant new capital), two series A financings, two convertible debt financings, and several other private financings, all of which (fingers crossed) will probably close in the next few weeks. 

I haven’t noticed any particular trends with this activity. From an industry standpoint, the companies raising money are fairly diverse (clean tech, medical device, nanotechnology, health care IT, health and wellness, financial services and others). The investors in these deals are also fairly diverse, including a large public company, venture capitalists, angel groups, individual angel investors and friends and family. The Minnesota angel tax credit is being used in connection with some of these offerings, although not for all of them. That could be playing a key part in this recent uptick in activity, as investors and companies try to close deals while the angel tax credit is still available.

Speaking of the angel tax credit, as of last week only $5.4 million in credits remain for 2014.  If you’ll recall, the legislature allocated $12.2 million for tax credits this year, but as of February 14th, $6.8 million had already been allocated to qualified investments. At that rate, all tax credits will be fully allocated by the end of March. Some of the early allocations are likely attributable to investments that otherwise would have been completed at the end of last year and were postponed to take advantage of this year’s available credits (last year’s credits expired in early May). Obviously, if you are hoping to take advantage of the angel tax credit this year, you should plan to have your investment completed in the next few weeks.

Nice obituary in Sunday's StarTribune about the life of legendary entrepreneur Horst Rechelbacher, founder of Aveda and Intelligent Nutrients. I find rags-to-riches stories such as his inspirational. His life should provide good lessons to all aspiring entrepreneurs.  

The Star Tribune also ran a nice story about the Abdo family in Monday’s paper. The Abdos have had several successful businesses and are well known in the local entrepreneurial community. As a professional who sometimes struggles to balance work and family life, it’s warming to read a story about a family that is doing it right.  

Finally, if you’re like me and just a little tired of this winter, there is some good news on the horizon. The Twins pitchers and catchers are reporting today (in presumably a snowless Fort Myers), with the rest of the team scheduled to start spring training at the end of the week.  Baseball and warm weather will be here before we know it!

The Olympics Remind Us That Life Isn’t Fair

As we approach the Sochi Olympics, I thought the U.S. Figure Skating Team could provide us all with another lovely reminder that life isn’t fair.  In full disclosure, I was a competitive figure skater once upon a time, and I probably understand and appreciate this quirky sport more than most.  That being said, this year’s Olympic team selection process reminds us that there are unpleasant and somewhat controversial parts to it.

The U.S. Olympic women’s figure skating team generally has two spots to fill, or three if a U.S. skater medaled in the prior year’s World Championships.  This year we have three spots to compete in Sochi.  Typically, we host a National Competition that determines the two or three members of the team.   Whoever places in the top two or three in that two-part competition (short and long program) goes to the Olympics.

There is an exception in that a committee can override that placing, and send the people they choose instead. This is what happened this year.  The committee chose to send the women placing first, second, and fourth—instead of the third place winner.

Surprisingly, this happens somewhat frequently.  The committee is charged with the difficult task of choosing our best representatives for international competition, and the people with the best potential to win a medal.  Interestingly, though, the woman placing second (Polina Edmunds) is only 15 years old and has no real international experience.  But the third place finisher, Mirai Nagasu, the one staying home, placed fourth in the 2010 Vancouver Olympics and has plenty of international experience.  The fourth place skater, Ashley Wagner, fell twice in what some would call an “embarrassing program” at Nationals.

What does this demonstrate?  Life isn’t fair.  You can prepare your whole life for something, and still not get there.  You can do all the right things, perform under pressure countless times, and do exactly what you are supposed to do on the day you are supposed to do it—and you still end up sitting on the sidelines.  We can land the perfect pitch (or at least a third place performance), and have someone’s “potential” still win.  We are often judged on perception, history, potential, and in the context of others’ bias—in figure skating and in life.

I didn’t mean for this to be a completely defeating post, just a reminder that we have to be ready to adjust to the Russian judges in life.  We have to prepare diligently, perform under pressure, nail the pitch, and demonstrate prior success along with future promise. On the other hand, we may not be judged entirely on one bad skate.