LOHAS - The Money Hunt

The dot-com investing bubble may have burst, but capital for LOHAS-oriented business growth is still out there - for the right companies

Courtesy of LOHAS Journal, July/August 2001

By Nancy Nachman-Hunt

Leon Green has been thinking about how to grow his Aiken, S.C., eco-technology company, Environmental Control Systems, for years. He believes he has a groundbreaking, sustainable solution to the country's decreasing supply of landfill space.

Green's concept would not only increase a landfill's lifespan indefinitely, but would work especially well in areas of greatest waste-disposal demand, like the East Coast, where high volumes of refuse run up against high transportation costs.

"We are totally recycling the waste that is placed into landfills," he says. "We're doing it through controlled aerobic degradation (composting) and the efficient mining of the composted waste to separate out recyclables."

Green has the seed capital to develop his composting/recycling technology, but he needs between $3 million and $5 million to take it to market. Toward that end, he has investigated private placements, venture capital funds, so-called "angel" investors, joint ventures and mergers. His findings: Yes, there's money out there, but its cost is prohibitively high - up to a 50 percent annual return for investors.

His company has two basic choices, Green believes: either grow organically as it gets contracts - and risk losing the opportunity to capture the market for its technology - or pay the high cost of capital it needs to capture the market.

Faced with that rock-and-a-hard-place scenario, Green is plowing the middle ground. He's found that by building his volume of sales contracts, he increases the level of interest in his company on the part of investors. As their interest rises, the price of their money goes down. His target volume for sales contracts: $5 million.

"Trying to keep a company funded in this day and age is an interesting exercise," Green says. Interesting, indeed. As almost every growth-capital hungry LOHAS company knows by now, the investing landscape is not nearly as verdant as it was even a year ago.

Here's the bigger picture. While a recorded $103 billion in venture capital was invested in 5,380 emerging businesses in 2000, according to the Arlington, Va-based National Venture Capital Association (NVCA), venture investors started to head south in the fourth quarter of last year, as investments dropped 23 percent from fourth quarter 1999. It was the same story in the first quarter of 2001: Investments fell from $15.2 billion in the first quarter of 2000 to $11.7 billion, a drop of 23 percent.

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Standards Have Risen

Only about 3 percent of venture capital funding last year went into the two NVCA categories that encompass the majority of companies that play in the LOHAS space: energy-related businesses and consumer goods (covering such LOHAS-market subsectors as Personal Development, Ecological Lifestyles and Healthy Lifestyles).

But according to at least two private-equity fund managers, there is money to be had for LOHAS-growth. "There is a continued appetite on the part of those who really understand the LOHAS business to invest in leading, solid, profitable, sustainable businesses," says Brent Knudsen, a managing director at Greenwich, Conn., and San Francisco-based North Castle Partners, a private-equity capital firm that invests in LOHAS market companies.

Knudsen warns, however, that the acceptability bar for any deal is much higher today that it was a year ago. "There needs to be a billion-dollar-plus market opportunity now," he says. (The LOHAS market is conservatively estimated at $230 billion.)

That's not all. There also must be earnings. "Venture capital investors right now are wary of business that require large capital injections to get to profitability - which was the dot-com model of investing," says Roy Bingham, managing director of Health Business Partners in Providence, R.I., another private-equity firm that invests in LOHAS companies.

Currently the health food and beverage sector is attracting interest in the venture capital community, Bingham says. Dietary supplements companies, on the other hand, continue to suffer from bad press. To catch the eye of a venture capitalist, they must not only be profitable but have a "unique and projectable" product, Bingham says.

There also is money out there for complementary health care services, according to Bingham. "Investors are excited about this space. It's just that every time they get into the details, they see the failures of the last few years. If you want to raise money in that space, you'll have to address all the weaknesses in prior efforts," he says.

Renewable energy companies also can quicken an investor's pulse. For instance, in March, Triodos PV Partners, an Arlington, Va., and Netherlands-based private-equity firm, formed Solar Development Capital, a 10-year, $28.8 million fund dedicated exclusively to investing in solar photovoltaic companies.

But venture capital markets generally take their cues from the public markets and, as industry executives are well aware, those funding avenues have been narrowing for some time. At the moment, however, the public markets appear to have allowed a sliver of light to show through the intial public offering (IPO) window for some LOHAS companies - especially those in the renewable energy space.

Because of the current energy crunch, this summer might be a very good time for certain renewable-energy companies to take another look at the public markets, opines Namrita Kapur, an energy analyst with Bost-based investment bank Adams, Harkness & Hill.

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Focused Strategy Essential

"Today, generation-technology companies such as solar and fuel cells are hot," Kapur says. "These are companies that are founded on real technology. They are companies addressing a problem that is not going away."

But, she warns, those companies need to have a focused strategy about how to make the transition from R&D to commercialization. "It hurts to have wonderful technology and still have the scientists who developed it running the company," Kapur says. Keep the scientist as chief technology officer, she suggests, but get someone experienced in manufacturing and general management to run the show.

The LOHAS consumer-products sector also has the public markets salivating. However, there are few publicly traded companies operating in the space, other than Gaiam (GAIA), a lifestyle products company based in Broomfield, Co. That may not be the case for long. San Francisco-based Wholelife, Inc., owner of the 19 year-old WholeLife Expo, is on the trail of $10 million in financing to fund a rebranding effort that could put it in competition with Gaiam. Cherie Arnold, CEO of Wholelife, says her company will use its Wholelife brand to expand into publishing and adventure travel to complement its trade and consumer expos. In addition, to courting private-equity investors, "We're looking at doing a reverse merger and a public offering," Arnold says. "We're a few months from getting what we need."

Analysts say the key to taking a company public today is the ability to attract institutional investor interest. To garner that interest, a company must have at least $80 million in market capitalization. The magic number, however, says Adams, Harkness & Hill analyst, Scott Van Winkle, is $100 million. Van Winkle cites the example of specialty coffee maker Green Mountain Coffee (GMCR). "Once it achieved $100 million in market capitalization (a gain of more than 300 percent since September 2000), its stock went up exponentially," he says.

Private companies in the LOHAS space that could garner that kind of market cap right now are such natural foods stand-outs as Londonderry, N.H.-based Stoneyfield Farm and Clinton, Mi.-based Eden Foods.

But other venture capitalists and public market analysts say the chances of getting money from most of their investors is slim. "In LOHAS, or sustainability-based sectors in general, equity capital has come from family, friends credit cards and angels. That's how 99 to 100 percent of the companies get equity capital to grow," says David Kirkpatrick, managing director of the Durham, N.C.-based Sustainable Jobs Fund, a $17 million community development venture capital fund that counts among its investors the U.S. Treasury Department and Bank of America.

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Angels Still Investing

Kirkpatrick's Sustainable Jobs Fund is perhaps an exception to that rule. It invests primarily in environmentally friendly businesses that have job-creation capability, while occasionally funding Internet companies. Most recently it led an investment round of $1.8 million in CitySoft, a Watertown, Ma.-based website management company that recruits its employees from inner city neighborhoods.

For many smaller companies in the LOHAS marketplace, angel investors are where the money is. According to Angel Advisor magazine, it's estimated that there are 7 million Americans with investable assets of at least $1 million each; in a decade, the number of millionaire investors in this country is projected to quadruple to more than 25 million. Angel groups funded more than twice as many companies in 2000 as they funded in 1996. In a typical round, a start-up company receives about $350,000 from angel networks, the magazine reports.

That doesn't mean, however, that angel investor capital for LOHAS companies is easier to get than venture or public capital. "It's always been hard for LOHAS companies to get money," says Woody Tasch, chairman and CEO of Investors' Circle, a 9 year-old national angel investor network that funds socially and environmentally responsible companies. "The good news is that we're not directly influenced by the (Internet) bubble burst. By and large it was a wave that crashed over us and we came back up on the other side."

Investors' Circle invests in everything from women-led and minority-owned businesses to organic and natural foods companies to educational software developers to renewable energy companies. Deal sizes range roughly from $500,000 to $2 million, Tasch says. "Our median investment is $225,000 from two or three people into one round of financing. Angels tend to put in hundreds of thousands, not millions."

The network holds what it calls "venture fairs" in various locations around the country. There, a dozen or so prescreened companies deliver their pitches to about 100 potential investors. The investors then meet separately to evaluate the presentations. At its recent fair in New York, Investors' Circle members heard presentations by companies touting everything from breakthrough wastewater treatment technologies to an Internet portal for corporations and government agencies.

With today's angel investors, LOHAS companies should expect a slower funding cycle than they would have a year ago, financial consultants say. "I hear stories of dot-comers talking about their experience getting their businesses going," says Daniel Robin of Intergrated Investments International., a Santa Cruz, Ca.-based, consulting firm that assists angel investors in placing capital in early-stage companies that value sustainability. "They say, 'It was the hardest six months of my life.' Six years is the more likely scenario (for fledgling companies in general)."

"Lots of investors have been stung," Robin continues. "To not make the same mistakes twice, they are going to be taking a cautious approach." Integrated Investments International helps find funding for companies that need from $50,000 up to $20 million in capital - somewhat higher than the average angel investment.

There's another avenue for capitalizing growth that may often be overlooked by companies - the good, old-fashioned loan. A loan can be an interim funding strategy that works, especially to tide a young company over as it looks for investors, according to Tim Own, executive officer of Vital Systems, a Napa, Ca., natural building and design company that works with sustainable building materials such as straw bales, earthen plasters, bamboo and reclaimed and recycled wood.

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Foundation Funds "Mission-oriented" Companies

Vital Systems negotiated a $75,000 loan from the San Francisco-based Rudolph Steiner Foundation. "We'd been in operation for three years without any start-up capital. Part of what we were looking for was working capital and also to get the funds to begin to develop our solicitation for investors," Owens says. "We found (the foundation) really good to work with because they were willing to come out and see how they could fit with us."

The Steiner Foundation loans to nonprofits primarily, but occasionally works with selected "mission-oriented" for-profit companies, according to the foundation's development director, Sara Ellis. "Our mission is to bring spirit to the way the world works with money. We want people to be thinking about their values when they invest," Ellis says.

Terms of the foundations typical loan are five years, with an interest rate based on U.S. treasury bill rates. The foundation has loaned as little as $10,000 and as much as $4 million to projects that fit its criteria.

Owen says that he initially considered pursuing a far higher level of start-up capital, but thought better of it. "We scaled back our process and start-up goals in a way that they can prove themselves viable," he says. "If sustainable companies like ours are to be funded genuinely, they need to be both pragmatic and humble in their origins."

He's right. A good idea and the right values aren't enough in the current market, financiers say. LOHAS companies better come to the negotiating table with a solid business plan and a professional attitude, financial consultants agree.

"LOHAS entrepreneurs think that because they position themselves as responsible, investors will look at them differently," says Steve Schueth, president of the First Affirmative Financial Network, a national network of investment professionals headquartered in Boulder, Co. "No investor I am aware of is going to consciously invest in a deal they don't think is good business. The fact that a deal is positioned as responsible, or LOHAS, is a plus, but it doesn't make up for an otherwise not very good deal. LOHAS is a way of narrowing the universe, but within that universe investors are still looking for the best deals. Movement and mission are frosting on the cake, but you've got to have the cake."

Ask Leon Green. "If you've got a proven track record of sales and contracts, a good management team and potential for growth," he says, "access to capital is much easier."

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