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It takes money to make money

By TOM W. GLASER

© St. Petersburg Times, published May 3, 2001


art
[Times art: Teresanne Cossetta]
Samuel Colt was an industrious young man, but he was a mediocre student. Born in Hartford, Conn., in 1814, he worked on his father's dye and bleaching company from 1824 to 1827 and again from 1831 to 1832. In between, he was sent away to sea on the brig Corvo bound for Calcutta from 1830 to 1831. The 17-year-old boy was fascinated by the ship's equipment, and either the windlass or the ship's wheel caught his attention because of a device that secured it by a special locking mechanism. Inspired by that, he returned home with a hand-carved wooden model of a revolving firearm.

He spent several years experimenting with his design and was finally granted a patent in 1836. He organized several investors and set up shop in Patterson, N.J. Some of his firearms made their way down to the brand new Republic of Texas, and were greatly admired for being able to fire five times without reloading. Sales were slow, though, and in 1842 the Patent Arms Manufacturing Company closed, auctioned off much of its equipment and filed for bankruptcy. Sam, however, was at that moment in the wilds of Florida, demonstrating his firearms to the troops engaged in the Second Seminole War. Caught unaware by the turn of events, Colt had to sell his samples just to raise enough money to get back home. Colt then worked at getting the U.S. government to buy his underwater mines, waterproof ammunition and the telegraph, in association with Samuel F.B. Morse.

In 1846, Capt. Samuel Walker of the U.S. Dragoons (formerly of the Texas Rangers) approached Colt with a proposition. The Patterson revolvers had been fairly small, and what Walker wanted was a pistol that would knock a Comanche off his pony at 100 yards and stop a Mexican cavalry horse at full charge. Colt and Walker worked out a design, but Colt had no place to build it. He turned to Eli Whitney Jr., the son of the inventor of the cotton gin and, more important, the inventor of standardized interchangeable parts at his factory in the modestly named town of Whitneyville, Conn.

These new guns were such a success that Colt began getting government orders and attracting new investors. The rest, as they say, is history.

In an earlier chapter it was mentioned that cash is generally the least important form of capital, because capital is defined as anything that produces wealth. The bankruptcy of Colt in 1842 forced the sale of his capital goods -- the machines in his factory. But when you're trying to start a new business as an entrepreneur, what you need is cash, and a very special kind of cash. It's called venture capital, and as the name implies, those who have or control this capital want to invest it in a new, innovative and promising business, or venture.

What that business is promising, of course, is profits. Those who control the venture capital want a return on the investment, whether it's their own money or the money of a consortium of investors. They will want to look closely at your business plan and speak with you and your team about your prospects.

There are several ways the business can organize and raise money to operate. The first, and the most common in America, is the single proprietorship, where one person owns the business. He or she gets to keep all the profits -- but he or she also gets to bear all the risks alone, too. The ability to raise funds is essentially limited to the income from the business and his or her own resources.

Another business organization is the partnership. Under this sort of organization, the risks are shared among the partners -- but so are the profits, in proportion to what percentage of the partnership each partner owns. And although their pool of resources will generally be larger, it is still limited.

The third type of organization does the most business in America in dollar volume. That is the corporation. The business itself becomes a legal "person" who can sue and be sued -- but not the employees or investors of that company. Their losses are limited to their investments. Moreover, as the company grows, the investments can as well. The company sells percentages of ownership called stock certificates. These may be purchased in as many or as few numbers as the investors wish to put at risk.

Risk is the key. The more risk, the higher the cost of the money. The lower the risk, the safer your investment, the lower the cost of money, which is interest. So the worse your business plan is, the less you've thoroughly thought out your business, the less likely you will be to attract investors.

Some investors prefer the profits without becoming involved in the day-to-day operation of the business. These may become what is known as "silent partners." "Active" or "participating partners" not only buy a portion of the business, they also buy a portion of the management to ensure their investment. This typically does not happen in a publicly held corporation, which means that its stock is sold on the open market. Normally, the only time the stockholders get involved with the company business is at the annual stockholders' meeting, and then the involvement is often only attending the meeting.

To sell stock in your company, you first have to value your company, so you know the value of what you're selling. In this, and throughout the process, you need to consult the Securities and Exchange Commission, the agency in charge of monitoring the stock market. The stock can't be "watered" (sold at less than its face value), and there can be no insider trading.

After all the requirements are met, then you can have an IPO -- initial public offering. Now, you don't start out on the "Big Board" (the New York Stock Exchange). Quite often your new stock will be traded OTC -- over the counter, unlisted stock. As your company develops a good reputation, you will be listed on the boards of regional exchanges and NASDAQ -- the National Association of Security Dealers Automated Quotations. Many companies that start on NASDAQ choose to stay there out of loyalty, even when they are big enough to move to the NYSE.

However you get your funding, the more people who get involved, the less profits each one gets to take home. Conversely, without all that input, there may be no profits to share at all. Everything has a price, and a trade-off, associated with it. The trick is to make the best possible trade.

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Classroom activity

If you are not continuing with the project, research several recent and upcoming IPOs. Find out if the first day price went up or down from the offer price and why. "Invest" in one and see how it does. (Note: Players of the Stock Market Simulation cannot buy IPOs in the game.

* * *

-- Tom W. Glaser is a high school teacher at the School for Advanced Studies at the Wolfson campus in Miami. He has won numerous national teaching awards for economics and was named Florida Council on Economic Education Economic Educator of the Year in 1997.

About the Florida Council on Economic Education

Money Stuff: Get it! Spend it! Keep It!

Introduction and previous chapters

Money Stuff was developed by the Florida Council on Economic Education and project director Fonda Anderson. The council is a statewide non-profit organization founded in 1975 to educate K-12 teachers and students about the free enterprise system and to instill in them an appreciation for a market economy. For more information on the council's programs for teachers and students, please call (813) 289-8489.

About Newspaper in Education

The St. Petersburg Times devotes news space to NIE features throughout the year, including this classroom series. The Times' NIE department works with local businesses and individuals to enrich the classroom experience by providing newspapers, supplemental guides and educational services to schools in the Tampa Bay area. To find out how you can become involved in NIE, please call (727) 893-8969 or (800) 333-7505, ext. 8969. For past chapters, check out www.sptimes.com/nie and click on Money Stuff.

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