The motive of venture capitalists is easy to understand.
“We put money in to get more money out,” says Daniel Kellogg, managing director of Crystal Internet Venture Funds LP.
How likely they are to get that return on investment is the risky part. That said, investors at all levels are taking the risk in record numbers, and there is more venture money flowing into businesses than ever before. In 1993, venture capitalists raised about $20 billion, says Shanti Mittra, a partner with Primus Venture Partners Inc. In 1999, that skyrocketed to $100 billion.
Kellogg and Mittra were part of the seed capital conference conducted by the Northeast Ohio Software Association held in May at Landerhaven Conference Center. The conference was attended by a collection of investors, entrepreneurs and service providers, all looking to gain a little insight into the science and art surrounding start-up financing.
So what defines a true seed stage company?
According to Warren Goldenberg, partner at Hahn Loeser & Parks LLP, an enterprise fits that description when it has no revenue, its technology is still under development and the management team may still be incomplete. The question then becomes: How can investors distinguish between those that can and those that won’t succeed?
“The first stage of the Internet was a land grab,” Kellogg says. “That land grab is over.”
A company making its way into the world today must have a viable business model, a workable strategy and it must make money. Entrepreneurs shouldn’t be so naive, though, to think that they are the first ones to present an idea to the venture capitalist.
If there was one idea, there have been 100 similar presentations, Mittra says. Primus looks at “who’s going to run the hardest and fastest, and why. I really like early stage companies. To me, that is the heart of venture funding.”
That leads to one important question: Why aren’t start-ups flocking to Cleveland?
“We would love to see a stronger angel network in Cleveland,” Mittra says.
It’s not a lack of money, she claims. The biggest reason Cleveland is not San Francisco is that not enough angels understand the process.
Jeff Hanson, president of ConnectSpace.com and vice president of the Ohio Innovation Fund, underscores that point with some statistics. In the first quarter of this year, there were 500 venture deals in California, which averaged $12.5 million each. During the same period in Ohio, there were 10 deals, which averaged $2.7 million.
And what do venture caps look for in a company? How do you decide what a start-up is worth? Valuations are ephemeral, says Kellogg. His company looks at the amount of its investment, how much the entrepreneur risked and how much is available for others. And at all times, the company keeps an eye on the exit strategy.
Angel investor and former CEO of Revco Drug Stores Boake Sells follows his own selection criteria:
1. Beware the elegant idea. “I used to fall in love with deals faster than a high school quarterback working his way through cheerleaders,” Sells says.
2. Success cannot happen without a committed entrepreneur. “Since failure looms daily,” Sells says, “I only invest if the entrepreneur has nowhere to run.”
3. How will the deal be financed? When it comes to crunch time, where is the new money going to come from?
4. Beware of a commitment to a single path to market. Sells prefers an entrepreneur who concentrates on achieving a goal, not one committed to the path leading there.
5. “I am never a passive investor,” Sells says. “I have to have some value other than my money.”
Money isn’t the only answer. Partnerships offer start-ups opportunities other than venture and angel investing.
“Northeast Ohio is an absolute gold mine because it’s the home of the old economy, mature business,” says Anita Campbell, CEO of MotorcycleWorld.com Inc. and former vice president of e-commerce for Bell & Howell. That makes it the perfect place for strategic partnerships between existing operations and new ventures.
A strategic partnership is advantageous for several reasons:
- An entrepreneur doesn’t have to sell the company to get money;
- It brings credibility, which can open doors;
- There is built-in management experience;
- It provides access to industry relationships; and
- It brings access to an installed customer base.
The mature business wins as well by:
- Transforming an old business model into an e-business model;
- Creating a strategic partnership more cheaply than through acquisition or starting your own venture; and
- It does this all with the important ingredient of speed.
How to reach: NEOSA, www.neosa.org; Crystal Internet Venture Funds LP, www.crystalventure.com; Primus Venture Partners, www.primusventure.com; Ohio Innovation Fund I LP, (216) 830-1172; Hahn Loeser & Parks LLP, www.hahnlaw.com
Daniel G. Jacobs ([email protected]) is senior editor of SBN.
