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Venture capital

Venture capitalists are experienced, professional investors who manage a fund, usually comprising 20 to 30 limited partners. "A venture capital (VC) firm is looking for a terminal event, say five to seven years down the road, when they can reap significant benefits (in excess of 30 percent) from their investment," says McAllister.

"Limited partners expect to get all their money back and a substantial return on the investment in 10 years," says Klank. "There's a lot of pressure in a VC firm to employ the money in the first five years and get cash back in the second five years."

How much of a return do VCs expect? "The general rule is five times return in five years," says Klank, adding that venture capital is not for everyone.

"Venture capital guys traditionally have been piranhas there to finance high-risk deals," says McAllister. "When financing high-risk transactions, the cost always will be highest for the owner." But the payoff also could be potentially higher.

For example, if you have a $4 million business and you receive an order to sell into all Wal-Mart stores, you'd need to raise a lot of cash quickly. You project that your company will grow to $25 million. You get a venture capital firm to invest $1 million because it sees the growth potential. In exchange, the venture capital firm expects to receive 20-percent ownership interest in your company. So by the time you reach $25 million, the venture capitalist has made five times his initial investment ($25 million x 20 percent = $5 million), but so have you. Your 80-percent ownership interest is now worth $20 million ($25 million x 80 percent = $20 million). "That's the leap of faith," explains Klank.

Mezzanine debt

As its name suggests, mezzanine debt is a hybrid or combination of equity and bank debt.

"Mezzanine investors don't want to own your company, but they may want a seat on your board. They will help finance acquisitions or expansions. There will always be a bit of risk, known as an air ball—the amount of money the company borrows that is not covered by hard assets such as inventory and receivables versus soft assets such as goodwill," says McAllister.

"Financing is a blend of many levels," says Klank. "It's almost like artwork. It's a puzzle on how to integrate and negotiate with various sources." Mezzanine investors will look at a company's past performance to determine its predictions (and risk) on future performance.

If a venture capital firm wants five times its money in five years (38-percent return on investment) and a bank offers prime plus 1 percent, which is about 6 percent, and a mezzanine investor offers 12 percent, those three sources balance out to returns in the low 20s. "Some people get sticker shock, but if you look at the blended cost of capital, the terms are not so bad," says Klank.

Overcoming hurdles to the marketplace

According to McAllister, financial markets are an exercise in group psychology. "The tech run-up was based on a herd mentality. Market frenzies are statistically unavoidable. And remember markets rise on rumors and fall on news," he says, explaining why when the Federal Reserve announces a drop in the interest rate, the impact is felt on the markets before the actual rate is cut.

Corporate profits have improved, low-interest rates remain (although that's not likely to continue), but the country and investors remain skittish. Unemployment remains high and as long as that continues, there's a feeling that all is not well with the economy.

But there's a silver lining for business. Fundamentally, if you're a lousy company, you shouldn't be able to get capital and succeed, according to the theory of economic Darwinism. "But a good value-related proposition should be able to transcend a bad economy to get money," McAllister says. e