Utah entrepreneurs face venture hurdle

By John E. Richards
Brigham Young University
Published: Sunday, April 29, 2007 12:22 a.m. MDT
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Entrepreneurs often seem surprised that the law of supply and demand, an immutable law of economics, also applies to raising money for their entrepreneurial ventures. This revelation seems to befuddle those who somehow want to have their cake and eat it too when it comes to raising money for their business ideas.

Some well-intentioned folks have tried to force-feed the "California way" of funding companies on the Utah venture ecosystem. These proponents of the "Silicon Valley way" think that the risk of entrepreneurship should be pushed more to the investor. After all, that's how it's done in California.

In Silicon Valley, for example, entrepreneurs command much more negotiating power in the venture funding process than here in Utah. This seems to surprise many who come to Utah and want to raise money for their latest whiz-bang business idea. They do not understand why the Utah entrepreneur cannot get the same terms as the Silicon Valley garage inventor.

What is the difference? Well, the typical early stage deal in Silicon Valley is a "preferred convertible debt" deal where the company gets, say, $500,000 and signs a promissory note and convertible loan agreement. As a result of this agreement, the investment will automatically convert to preferred stock at a valuation equal to 20 percent lower than the next round of investment. This deal favors the entrepreneur because he does not have to prove a value in the present and he gets the money now at some future inflated valuation. What a deal!

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In Utah, most experienced investors will scoff at such terms unless the deal is "hot." The typical convertible debt deal in most of Utah is structured much differently:

• The $500,000 is loaned for a finite time period, usually 2-5 years.

• The cash is loaned at an interest rate of 8-18 percent.

• Terms often include a regular cash payment of interest or even principal and interest.

• At the lender's option, the loan may convert at a price fixed at the low valuation at the time of the loan disbursement.

What a difference!

Of course, this difference should come as no surprise to those who are familiar with the law of supply and demand. Utah has an unusually high entrepreneurial activity rate per capita compared to most areas. Yet Utah is relatively small in terms of investment capital available to new or emerging entrepreneurial ventures. Thus, demand for cash is high and supply is low. That means the supplier has more power or leverage in the negotiations. This is a law of economics that is universal and obvious.

This effect is exacerbated when the entrepreneur seeks financing in a crowded field and has not allowed enough time to go through the traditionally longer-than-expected process of raising capital. Now the entrepreneur seeks money in limited supply and has limited time to strike a deal. The price just went up! Aren't those economic realities annoying?

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