One of the most critical challenges for

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1 Market Outlook STEVE MAXWELL Maxwell Financing Sources for Your Water Business One of the most critical challenges for any company young or old is developing and sustaining the proper financial backing and strength. Finding and securing the necessary funds to develop a new technology or new business line, to expand or perfect an existing product, or simply to sustain an ongoing business, is one of the most important tasks in running a business. Although there is a wide spectrum of financing sources and today, literally thousands of private equity investors who are excited about entering the water business attracting the right kind of capital and obtaining it at an acceptable cost can often be difficult and time-consuming. This article reviews the different sources of financing that are available to entrepreneurs and owners in this industry, and some of the pros and cons of each. FINANCING TYPES There are many types of financing available to entrepreneurs and start-up firms in the water industry. In today s environment, there is strong interest in this industry across the investment spectrum because of the vast challenges and opportunities presented by the global water industry and the increasing visibility of the water business. These run the gamut and include personal loans and sweat equity, credit cards and lines of credit, investors, venture capitalists, private equity investors, suppliers and customers, banks and credit institutions, government bodies and agencies, and public stock markets. Personal loans and sweat equity. Most entrepreneurs or developers of new technologies have traditionally gotten their start by not only spending long, hard, and generally unpaid months or years of labor getting the venture off the ground, but also by committing their own personal funds to cover the start-up expenses. Such entrepreneurs typically contribute their personal savings, life insurance cash values, second home mortgages and the like as they struggle to provide the necessary financing to get a new business up and going. Start-up ventures often draw upon similar financial contributions from friends, family members, and business associates, or they may use the unpaid contribution of specialized help or services from friends and associates in return for options or shares of stock in the company so-called sweat equity. These types of investments by friends or colleagues may not be worth much for many years to come, if ever. This approach can turn into an emotional tightrope for the new business developer, and this sort of early-stage financing and development can have long-term positive or negative implications for personal relationships. For every Hewlett-Packard that emerges from a garage, there are probably thousands of failed business start-ups that bankrupted their founder or wrecked friendships. Hence, relying too much on friends and family can be risky. Credit cards and lines of credit. Another initial source of funds for the start-up technology business may be from personal credit cards or lines of credit from commercial banks. It is easy to borrow MARKET OUTLOOK 107:7 JOURNAL AWWA JULY

2 against personal credit cards, and there are many business owners in the water industry who will tell you that they got their start by maxing out their credit cards. However, the primary credit card companies typically limit the total borrowing at a fairly low ceiling, and they usually carry very high interest rates. Personal Venture capital can offer an array of benefits to the entrepreneur but, like anything, it also brings some costs and risks. lines of credit from the neighborhood bank are more attractive overall because they have more reasonable interest rates, and terms can usually be negotiated, especially if the business venture is starting to show signs of potential future success. Investors. As a small firm starts to perfect and implement its business model, as it begins to have initial prototype product offerings available or pilot projects in operation, and as it begins to be able to demonstrate the commercial viability of its business proposition, a new range of potential financing sources begins to open up. High-net-worth individuals, or angels, as they are often called, can sometimes be enticed to invest more significant equity capital into small firms at a fairly early date. In many metropolitan communities there are angel networks organizations of such individuals who are seeking interesting and potentially profitable longterm investments and many entrepreneurs seek to connect with such organizations at an early stage. Obviously, the entrepreneur will have to convince a skeptical angel of the merit of his or her ideas and approach, and successful angel investors didn t get to their position by making many bad business decisions. On the other hand, there are countless wealthy individuals looking for investment ideas that are more attractive if also more risky than more standard investment opportunities available in the public stock markets and such. A typical angel investment might range anywhere from a fairly small amount up to several hundred thousand dollars, depending on the size and type of business. Such financing can be made in the form of a loan, but more typically the angel receives equity, or stock, in the company that if and when the company reaches commercial success may carry a very attractive return. All such early-stage investments inherently carry a high degree of risk. Some pay off later, but many don t. Venture capitalist organizations. If the business continues to grow, and as more commercial success is achieved, larger and more sophisticated institutions may start to be interested in investing in the venture. There is a gradational spectrum between wealthy individuals (angels) and true venture capitalist organizations. Venture capitalists, or early-stage private equity investors, typically start to come into the mix as the technology development venture becomes more proven and as its products or services begin to become commercially viable. Venture capital firms are typically organizations that raise a pool of capital from wealthy individuals or institutions and then invest it over some period of time. True venture capitalists have been instrumental in the successful commercialization of many of the most successful businesses in this country, particularly in the high-tech, medical, and environmental technology marketplaces. Names like Google, Yahoo, and ebay come to mind. There are hundreds, if not thousands, of true venture capital firms in the United States, managing funds that range in size anywhere from a few hundred thousand or million dollars at the low end to billions of dollars at the high end. Most technology developers, if they stay on a successful development track, will bump into the venture capitalist community at some point. Venture capital can offer an array of benefits to the entrepreneur but, like anything, it also brings some costs and risks. For the right deal, venture capitalists are willing to invest millions of dollars in order to get a venture going, and they typically receive stock and key decision-making participation on the company s board of directors in return. Having been through many similar start-up efforts in the past, venture capitalists can often bring valuable business acumen and expertise to the endeavor. In addition, such investors can also often bring good customer and marketing connections as well as networking contacts and credibility in the financial community. Investments by certain types of highly successful and respected venture capitalists can represent a feather in the cap for the start-up firm, conveying instant credibility in the marketplace. On the other hand, many entrepreneurs feel that venture capitalists under-value their businesses and want to receive an unreasonably high percentage of ownership in the business in return for their investment. Other business owners feel that venture capitalists attempt to exert too much strategic or even day-to-day control over the business even though they may not have long-term experience in the industry. And it s true many otherwise successful or high-potential young firms have floundered after venture capital investments, when conflicts between the owner and the investors have distracted the business, created crippling conflict within the organization, taken the company in the wrong market direction, or generally led to the creation of an unsustainable situation. Hence, while venture capital can be attractive, many start-up firms have found that it simply comes with too many strings attached. 24 JULY 2015 JOURNAL AWWA 107:7 MARKET OUTLOOK

3 There are numerous directories and listings of venture capital organizations, which the entrepreneur can contact at the appropriate time. Different venture capitalists have different investment minimums, revenue expectations, and deal parameters that they will accept. Some venture capitalists will invest in any type of promising business, while others develop industrial specialties or a specific end-market focus. As the visibility of the water market has increased over the last two decades, the number of venture capital groups interested in the industry has also grown, and almost all investors seem to be positively inclined toward opportunities in the water business. So for promising new service or product firms in the water industry today, it is not difficult to find venture capital investors who will at least be willing to give the concept a serious hearing. Private equity investors. After venture capitalists, as the start-up firm continues to grow, proves out its business model, and starts to build revenues and earnings, a much broader array of private equity (PE) investors may become interested in the business and represent potential sources of further financing for the company. Although PE groups are obviously looking for highly attractive returns on their investments, they tend to shy away from the earlier-stage and riskier investments that the true venture capitalists traditionally seek. PE firms typically look for more established businesses that already have substantial revenue and, it is hoped, increasing earnings for whom they can provide growth capital. In the water industry, such investors have often stepped in, when an original business founder is retiring to assist in a partial or total ownership transition, or when the entrepreneur decides it is time to roll together with a broader consolidation effort in the industry. The PE business as a whole has grown explosively over the past decade or so, and there is a vast number of PE investment groups in the United States interested in the water industry, providing a dizzying array of different investment vehicles and options, and focused on different geographies, end markets, or technologies. The exit strategy for such investors is typically an initial public offering (IPO) or a sale to a large intra-industry or strategic buyer. (See Journal AWWA, January 2006, for a more detailed overview of PE investor interest in the water industry.) Suppliers and customers. Suppliers or customers can also represent an implicit source of financing for earlystage ventures. Careful management of short-term MARKET OUTLOOK 107:7 JOURNAL AWWA JULY

4 assets and liabilities an art at which most entrepreneurs quickly become pretty accomplished can help implicitly use the capital of both suppliers and customers to help finance the business. Delaying the payment of bills as long as is practical can effectively help turn the supplier into a short-term financier of the business. As the company grows and as it increases its equity value and earnings, its ability to borrow also expands. Paying careful attention to the rapid collection of customer receivables and maintaining low inventory levels can allow the entrepreneur to keep as little cash tied up as possible. More significant may be the opportunity for more explicit financing from outside parties; if customers really want to see the new product developed, they may be willing to help provide funds in a more direct way as well. Likewise, if the start-up venture could be a substantial new customer, vendor firms may also be willing to provide various forms of effective short-term financing. Commercial banks and credit institutions. Traditional commercial banks and other types of credit institutions are typically used by almost all small companies, as well as larger and established companies. At an early stage, some firms may be able to obtain only a short-term line of credit. In this type of financial arrangement, the bank lends money on a short-term and variable-rate basis to help the firm smooth out fluctuations between its receivable and payable balances, meet payroll requirements, and support inventory and purchasing when the company s own revenues and financial well-being may be somewhat variable from week to week. Short-term debt is typically used to describe borrowings that are repaid within a year, whereas long-term debt may involve larger sums of capital to be repaid over a several-year period. Banks and other credit institutions may also lend money in amounts that are tied directly to one or another of the assets of the company; for a small firm, the primary asset is often its accounts receivable. Lenders may factor the receivables that is, they may assume that a certain percentage of the receivables could be collected in the event of a business failure and be willing to lend that amount of cash to the business. But as the company grows and as it increases its equity value and earnings, its ability to borrow also expands. As its financial reputation begins to solidify, its credit rating will improve, and it may undertake larger and longer-term borrowing from commercial banks and lending agencies. Examples of larger or one-time financing needs might include the construction of a new manufacturing facility or the acquisition of another firm to complement the existing business. Interest rates on long-term loans vary as a function of the credit-worthiness of the borrower but also tend to fluctuate up and down as a function of other macroeconomic factors and trends. The use of long-term debt varies widely among companies; some more traditional or conservative firms prefer to operate largely on equity capital and keep their borrowings to a minimum, while other, perhaps more aggressive, firms believe they can grow more quickly and create more shareholder value by borrowing more in order to finance faster growth. Government bodies and agencies. It should also be noted that the federal government, as well as state and local government bodies and agencies, has monies available to fund new technologies and to help new businesses get started. The Small Business Administration (SBA) unit of the federal government was created specifically for this purpose, and many successful water companies have at one time or another benefited from SBA loans. The US Environmental Protection Agency has numerous programs geared to helping promote the development and growth of new technology ventures. Many water treatment firms have grown out of research and development efforts that were originally funded by NASA or other science-based organizations of the federal government. A full review of the various types of grants, technology development programs, and technology certification efforts provided by various government agencies is beyond the scope of this article; however, there are numerous grants and sources of financing available from the government, particularly for an area with pressing needs like the water treatment and purification business. Public stock markets. Although relatively rare, some smaller and start-up-type ventures are able to obtain financing by going straight to the public stock markets through initial public offerings (IPOs). Typically, in today s market, a firm needs to have at least $100 million to $200 million in revenue before even starting to think about conducting a sale of stock to the public and becoming traded on the stock exchanges. However, occasionally if a new firm has great technological promise or addresses a booming new market early-stage IPOs may be possible. Unfortunately, in the few recent cases in which this has occurred in the water industry, the result has not been a happy one. Too many firms have managed to go public primarily on the basis of short-term investor excitement or unrealistic expectations, and most of them have not been successful. In the water industry and across the board, IPOs are much more typical years later, 26 JULY 2015 JOURNAL AWWA 107:7 MARKET OUTLOOK

5 after the company has matured and grown into a larger and more integrated business, when the initial founders and investors are seeking a way to acquire cheaper long-term growth capital or to liquidate their hard-earned investments. STRIVING FOR SUCCESS Developing a successful business in the water industry obviously requires a new, different, and demonstrable product or service idea, but it also requires the business acumen and the necessary financial backing to get that new idea off the ground. Finding the right kind of funding is a critical part of success, and it is never an easy task. The right kind of financing depends on the specific situation of the company as well as the individual preferences and philosophies of its owners and no investment ever comes without some sort of strings attached. But given the vast challenges and opportunities presented by the global water industry and the increasing visibility that the water business is experiencing, there is a very strong interest in this industry from across the whole investment spectrum. Entrepreneurs and start-up firms in the water industry with a good product or service idea and a strong business plan should not go hungry. There are lots of investors out there interested in helping you build your business. Steve Maxwell is managing director of TechKNOWLEDGEy Strategic Group, a Boulder, Colo.-based management consultancy specializing in transaction advisory services and strategic planning for the water industry. Maxwell writes the annual Water Market Review, a comprehensive summary of trends and developments in the world water industry, and is also the author of The Future of Water, a book published by AWWA. He has advised dozens of water firms on strategy and transactional issues and can be reached in Boulder at (303) , maxwell@ tech-strategy.com, or via Journal AWWA welcomes comments and feedback at journal@awwa.org. MARKET OUTLOOK 107:7 JOURNAL AWWA JULY