As angels and venturists struggle to weather this fiscal cataclysm, some are reconfiguring to the new needs. Others will surely fall — a recent survey by the Kaufman Foundation shows a 50 percent drop in the number of venture capital firms could still fulfill current entrepreneurial lending needs.
Has the venture industry grown too large? Are there too many investors chasing too few deals, even in this recession?
To sort out and identify the challenges facing angels and venturists, the New Jersey Technology Council offers the panel discussion “Circling the Wagons: How to Keep Portfolio Companies Alive” on Thursday, October 8, at 4 p.m. at Fox Rothchild offices in Lawrenceville. Cost: $ 50. Visit www.njtc.org.
Jeff Nicholas, partner in charge of Fox Rothchild’s venture activities serves as moderator. Panel members include Katherine O’Neil, executive director of Jumpstart NJ and board member of the Angel Capital Association; Barbara Dalton, vice-president of venture capital for Pfizer; Amir Goldman of Susquehanna Growth Equity; and Rich Rueben of Associated Partners.
This discussion is designed for angels, venturists, and investors with a portfolio of entrepreneurial companies.
Veteran of both the traditional and early-stage lending arenas, O’Neil has helped fund everything from sole-proprietor startups to major corporate mergers. Following a globe-trotting youth with a career-air force father, O’Neil took her bachelor’s at the University of Maryland and her master’s from the University of Pennsylvania, both in economics.
O’Neil joined a succession of large, east coast financial houses, helping clients with expansions and acquisitions. For the past five years she has served as executive director of the angel network Jump Start New Jersey.
Everybody has a rumor about where alternative financiers are hiding. But for O’Neil, many of the historic angel and V.C. roles have remained somewhat stable. “Despite a lot of contrary talk, venture firms are no deeper into early stage financing than they ever were,” she says. “This means that for them and for angels, much of the traditional niches apply.”
Yet O’Neil also admits to having felt the ground rumbling beneath the lenders’ feet.
Loaners and lenders evolve. As layoffs have increased, New Jersey startups are mushrooming in near-record numbers. Meanwhile, recently battered traditional lenders remain cautious. As Jim McSweeney, co-president of the New Jersey Bankers Association puts it, “the good news is that banks are now loaning at the same, pre-recession criteria. That’s also the bad news, since most companies can’t meet those standards.”
So while there are more entrepreneurs out there, many are pitching deals constructed out of desperation. Despite a plethora of government plans, banks are still turning away more applicants than ever, leaving them to the also-cautious venture and angel investors.
Blooming angels. “Angel investing is invariably risky,” says O’Neil. “Angels, who also want a venture-like return, often are putting down their money before there is any sales revenue, or even a proven product.” Such early, pre-liquid stage investors might be more adventurous, but they are not, on average, any less skilled in the ways of finance.
The main ranks of angels are being drawn from cashed-out entrepreneurs and C-level executives. The Securities and Exchange Commission mandates that established angels and angel group members have an annual income of $200,000 or a net worth of more than $1 million, excluding personal residence. These are people investing what they can “reasonably afford” to lose.
Generally, angel groups have invested $50,000 to $500,000 in seed/early stage capital with a slightly more patient eye towards return, perhaps eight years. But the angel’s place in funding is changing. Individual angels still want to remain anonymous to avoid a public sugar daddy image, but they are combining into larger groups to make their loans more effective.
“Everywhere angels are entering into consortiums and expanding, allowing them to cross state lines or work in coordination with the many new government funding sources,” says O’Neil.
And there are more of them. Over the past three years traditional investing platforms have scarcely proven themselves remunerative, secure, and even trustworthy. Be it stocks, bundled bonds, or commodities, the sense of a rigged game has turned many people away. “People are coming to trust their own judgment more,” says O’Neil. “They are still cautious, but they are turning toward more self-directed investment growth.”
Venturists adapt. Having previously experienced much of this same kind of expansion and consolidation, venture capital companies are now finding themselves the victims of their own size. “This growth over the last decade has been natural, but now is limiting venture capitalists to only the larger deals,” notes panel moderator Jeff Nicholas.
Part of this expansion has come with an increase of scale. The venture-backed software company that might have tempted a buyer with its $10 million sales stream a few years ago must now show $20 million to attract a buyer. Additionally, venture funds are ever seeking to employ their capital in larger and larger bites, for the sake of simplicity. This has left many mainstream venture companies unable to handle early stage deals.
The solutions to this funding shortfall are coming from two corners. First, several new venture firms are coming on small with the stated intention of limited investment size. A more creative answer is coming from the partnering of venturists with angels. Increasingly as a V.C. firms, limited by SBA regulations or their own cash lines, are turning to angels to bridge the gap between development and actual production. Typically the entrepreneur at this stage is desperate, as the actual hopes of product launch dangle before his eyes. Angels get better deals; the venture fund gets to invest at its own comfortable level; and the company does indeed start up.
There comes a dilemma, of course, with such multilayered funding. More investors mean more seats on the board and more fingers in the decision-making pie. Timetables differ wildly, with the most recent investors seeking their profits sooner. Offers of sale might be turned away based not on their legitimacy, but on board members squabbling over optimum sale-date strategies.
Evolution, after all, is never easy. As angels and venturists morph to survive in this new economic climate, many less-than-comfortable changes are being demanded. The entrepreneurs must also adapt to the new funding laws. Yet all three groups are realizing the need and shifting to compete. These economic players are living up to their historic reputation for resilience, in ways even Charles Darwin would have heartily approved.