THE MONEY TREE

May 01, 2006 9:30 PM  By

Growing a successful multichannel business, no matter what your background or market niche, is a daunting task. For starters, you’ve got to concern yourself with the everyday challenges of building and sustaining an enterprise in a fiercely competitive environment. What with developing a product platform, reliable distribution channels, a marketing plan, and a loyal customer base, there’s plenty on the table to keep even the most relentless entrepreneur busy.

To complicate matters, consider the developments that are placing unique demands upon multichannel merchant managers and drawing the line between leading players and the large crop of also-rans. Five years ago there effectively was no multichannel merchant market — just a group of forward-thinking catalogers and e-commerce pioneers looking to build upon the potential of their media. Now, thanks to rapid advances in technology and demand from increasingly sophisticated consumers, the growth options available to multichannel firms seem limitless. There are burgeoning consumer markets to enter, new cross-channel data and distribution technologies to explore, and increasingly, a steady stream of “big picture” opportunities — including potential acquisitions, investments, and partnerships — from which executives may forge a strategy to govern their expansion in the years to come.

With such an intense set of demands at their doorstep, senior executives must exploit the available opportunities, both routine and extraordinary, as their businesses gain traction in the marketplace. For companies accustomed to careful, organic growth, this is often where the optimism linked to the multichannel craze tends to fade — the costs associated with bold strategic thinking, after all, tend to be pretty bold in their own right.

The truth of the matter, however, is that there has rarely been a better time to initiate significant growth in this market. The key to that growth: financing.

The financing opportunity

To some, the very word “financing” provokes a sense of alarm. Financing means loss of control, additional risk, and worst of all, a new debt burden to shoulder. Depending on the individual scenario, however, the impact of a carefully crafted round of strategic financing can actually empower the business with the capital and flexibility necessary to carve out a unique position and advance that position when the marketplace demands.

Fueling the current financing opportunity is the sheer volume of available capital. The pool of funds available for investment in multichannel companies is deeper today than it has ever been — some estimate that as much as $100 billion in private equity financing is waiting to be invested. Given the industry’s growth prospects, a significant percentage of those funds could come to the direct and multichannel marketing sector. Several factors — including the feverish demand for attractive investments and the relative paucity of independent companies that have mastered the art and science of multichannel retailing — should make it easier for companies looking to advance their competitive positioning through outside investment.

What type of financing is right for me?

Just as no single growth strategy is optimal for all types of companies, no independent financing solution can meet the needs of all firms. Determining the pros and cons of each option — and ultimately the appropriate financing plan for your company — requires an objective assessment of your business’s standing in the marketplace as well as a concrete strategy for advancing its competitive position once the capital is in place.

Most financing opportunities can be divided into four primary categories:

  • Angel investors provide capital backing for small start-up companies or entrepreneurial enterprises. As angels tend to be single individuals — most often friends or relatives of the entrepreneur — their involvement is typically not appropriate for established companies seeking a significant infusion of funding. In conjunction with other investors, though, they may be helpful in bolstering a fledgling company or getting a business plan off the ground.

    PROS: Since angels are most often friends and families, the process of raising funds from them is often easier than with institutional investors. The due diligence process, for example — demanding comprehensive research into the marketplace and product demand as well as a detailed business plan — is rarely intensive, because angels are typically high-net-worth individuals who focus on backing the dream of the entrepreneur more so than the business model. What’s more, angel investment generally allows the entrepreneur to continue holding the vast majority of company equity, an opportunity that is rarely made available by formal investment groups.

    CONS: With limited resources, angel investors can’t usually support the company through additional rounds of financing if those become necessary. With some notable exceptions, angels rarely bring a high degree of sophistication or other necessary skill sets that are useful when launching and sustaining a new business. And given the role that personal contacts play in the investment, the involvement of angels can have a lasting negative impact on an entrepreneur’s personal life if the deal goes bad.

  • Venture capital (VC) comes in many shapes and sizes, ranging from prerevenue and early-stage investment through growth-stage capital (including rounds of financing dedicated exclusively to product research and development, expanding products and services, and accelerating sales and marketing). VC investment often comes so early in the corporate lifecycle that it is considered “pre — cash flow,” meaning that the company’s revenue stream has not yet been established; more often than not, this allows VC groups to invest without having to assume additional debt. Venture capital investors are most often private equity groups (though large corporations will sometimes dabble in the space) and are generally comfortable holding minority equity positions in their target investments.

    Because the traditional catalog industry is relatively mature, VC investment — which seeks high-growth industries — is not relatively common. VCs are much more prevalent in the integrated multichannel space, where Internet retailers in particular have succeeded in drumming up investor interest. Highland Capital, for example, recently invested in two companies: Blue Tulip, an Internet retailer of handmade cards, custom invitations, and other children’s merchandise, and SmartBargains, a general merchandise e-tailer.

    PROS: In many cases, venture capital is the ideal type of financing for an early-stage, fast-growing enterprise. VCs assume that only a small portion of their investments — perhaps just one in 10 deals — will achieve spectacular results and thus understand that business models may change midstream, providing entrepreneurs with a significant degree of flexibility in managing the business. Investors also realize that additional funding is often required to enable the business to meet its potential and often lead the charge to secure the next round of capital. VC investments are typically structured as all-equity deals, which frees the business from the burden of debt and the commensurate interest payments. And perhaps most important, entrepreneurs may only have to give up a minority interest in the business to secure VC backing.

    CONS: Relative to angel investment, VC involvement demands a high degree of owner accountability and internal controls. In exchange for financing, institutional investors demand equity; VCs may start with a minority position (as low as 25%-30% of the company’s shares) but will accelerate their position if additional rounds of financing are needed (to 90% or more, if required).

  • Buyout groups are typically private equity investors focused on later-stage, revenue-generating businesses. These groups will also provide growth capital but are primarily focused on acquiring the majority of the equity of an enterprise, thus providing significant liquidity to the selling shareholders. Hedge funds are also beginning to participate in buyout activity.

    In recent years buyout groups have played a significant role in the multichannel retail space. Notable deals include Golden Gate Capital’s recent acquisitions of Norm Thompson, Appleseed’s, and Draper’s and Damon’s; American Capital Strategies’ buyout of Potpourri Group; and Reliant Equity Investors’ acquisition of Paragon Gift Holdings.

    PROS: Private equity investment often sets the stage for more-lucrative financing opportunities down the line; sophisticated institutional investment, for example, is often required prior to an initial public offering (IPO) or a sale to a strategic buyer. For high-growth opportunities, new equity investment will still come without debt, allowing the company to reinvest in the business with its available cash flow instead of making interest payments.

    Perhaps the biggest advantage of the buyout is the classic “two bites at the apple,” meaning an owner can sell the majority of his business (roughly 60%-80% of the equity) and generate significant personal liquidity while keeping the remaining equity interest under the tutelage of a professional investor. Then, when the even larger business is sold again (either to another buyout group or to the public in the form of an IPO), the owner enjoys a second liquidity event — this one often larger than the first.

    CONS: Buyout groups (other than growth investors) strive for majority equity positions. Strong, stable management teams are considered critical for buyout groups, so if an owner wishes to exit the business after its sale — or worse, recruit the existing executive corps to join him in a new venture — then a sale to a strategic buyer is probably a more feasible option. The buyout group will often use leverage (such as debt) to strengthen its returns on the business; as such, consistent financial performance is critical.

  • Initial public offerings represent an unlikely financing option for most multichannel merchants. While the IPO is often recognized as the most high-profile financing option — providing a significant infusion of one-time capital to pursue organic growth or make acquisitions — a public company must meet a number of stringent conditions and costly corporate compliance and disclosure guidelines set forth by the Sarbanes-Oxley Act and other financial regulations. And unless a company is of significant size (with annual revenue of more than $500 million, for example), analyst coverage by investment banks will wane — and the stock will likely languish. The end result: Selling shareholders have public company stock with few further liquidity options.

    PROS: The IPO is the ultimate liquidity event. Assuming that industry analysts provide appropriate coverage following the offering — focusing attention on the company and thus heightening its appeal as a potential investment opportunity — a company may look to subsequent offering rounds for additional funding.

    CONS: More often than not, industry analysts turn their attention to larger companies. At the IPO, selling shareholders typically sell only 30%-50% of their shares; a secondary offering will therefore be necessary to achieve full liquidity, and this becomes attractive only if analyst coverage (and company performance) have driven market interest in the business. Finally, it is expensive to be public, with time-consuming and costly government filing and compliance requirements biting into company resources that may be better applied to strategic opportunities.

What investors want

In an already-aggressive mergers and acquisitions marketplace, the role of VC and other financial investors in the multichannel merchant industry has grown. They were involved in 38% of the deals conducted last year, up from 22% in 2004.

Private equity investors are generally attracted to the fundamental elements universal to all well-run businesses: a stable, experienced management team; a sustainable business model; and sizable growth opportunities, to name a few. Many private equity groups are also looking for “platform” opportunities — strong, stable companies with a tremendous long-term upside upon which they may add on smaller companies (thus filling in product, channel, or customer gaps) through acquisition.

What can you do to prepare your company for a round of financing? Start by assessing the marketplace and solidifying your company’s value proposition. You must also determine what your goals are going forward. Financial investors seek sustainable, growing enterprises. If you are seeking outside investment, your financial records must be in shape, your business and marketing plan must be grounded in facts and research, your growth prospects must be significant but achievable.

In the end, the benefits of effective, well-managed financing can make all your business-building worthwhile — and the process need not be so daunting, after all.


Michael Petsky is a partner at Petsky Prunier, a New York-based investment bank providing merger and acquisition advisory services to sellers and buyers of multichannel merchants and related companies. Michael Grant is a managing director at Petsky Prunier affiliate Winterberry Group, a direct marketing strategic consulting and research business.