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Searching for an angel Featured

9:41am EDT July 22, 2002
The NASDAQ is soaring, the economy is booming, dot-coms are cropping up like daffodils in the spring, and it seems that every week, yet another IT-related company announces a multimillion dollar public offering.

It’s no wonder, then, that entrepreneurs might think that securing venture capital is as easy as strolling to the nearest ATM. It turns out, though, that the biggest challenge Cleveland start-ups face is not finding millions in venture capital, but securing seed money, early-stage contributions that go toward such things as hiring staff, leasing equipment and beefing up business plans to ultimately make a new enterprise more appealing to big-money investors.

“In the early stages, you need to get other kinds of financing to get to the point where you can get venture capital,” says Warren Goldenberg, a partner at the Cleveland law firm Hahn, Loeser and Parks. “It’s much more difficult to get the angel funding into the deal. There just aren’t as many people ... willing to make those investments.”

And they are extremely risky investments. Jim Cookinham, executive director of the Northeast Ohio Software Association, says that while seed money is critical to, say, a fledgling dot-com, “we’re talking incredibly high risk. You put in $75,000 and chances are pretty good that you’re not going to see it again.”

The National Venture Capital Association (NVCA) and the Venture Economics group of Thomson Financial Securities Data reported in January that an astounding 50 percent of more than 540 initial public offerings in 1999 were venture-backed, a 30 percent increase over 1998. According to the NVCA, the median age of an IPO in 1999 was only 4 years old, many of them IT-related start-ups.

But the headquarters of such venture-backed IPOs, Goldenberg says, are more likely to be in California than Cleveland. Even when companies are born here, financing must often come from out of state. Witness Cleveland-based NetGenics, a biotechnology software firm that in March filed plans for an initial public offering. The company has never made a secret of the fact that its investors are based in other, larger cities, including New York and Chicago.

Are Cleveland start-ups doing something wrong or simply at a different point in the start-up funding curve? What can new ventures do to improve their chances of grabbing precious seed money and, ultimately, venture capital?

The answers are complicated. Northeast Ohio must clear a number of hurdles — among them, a dearth of qualified managers, low numbers of proven successes among start-ups, and a shortage of fully realized business plans with which to seek investments in the first place.

“If you look at California or Boston, they have well-developed networks of angel investors,” Goldenberg says. “These are people who became rich themselves by forming technology companies — they understand it and are willing to invest.”

They also, he adds, understand the importance of strong management to the success of their contribution. “Investors are looking for qualified management as a stronger [requirement] than technical ideas.”

Lack of solid management can be a real liability — indeed, a deal-breaker — when entrepreneurs search for seed money and venture capital. Locally, Northeast Ohio’s industrial legacy is something of a roadblock: Cleveland, Goldenberg says, is “still a big corporate town,” where working for someone else is the rule excepted by start-ups.

Finding management, as opposed to technical talent, is a Catch-22: The area needs successful start-ups in areas like biotechnology and software development to give managers the experience individual and corporate investors like to see.

Goldenberg says that by contrast, in Southern California, “all these people are walking around with business plans in their briefcases. There’s a whole pool of people who have formed companies and gotten rich and now [are managers] of new companies. That’s a different kind of talent from somebody who’s a manager at a Fortune 100 company. It’s a different skill set.”

Wayne Zeman, executive director of the Lewis Incubator for Technology (LIFT) for Enterprise Development Inc., agrees.

“I call it the genetics of this region,” he says. “[Northeast Ohio] has a lot of wealthy people, but most of them made their money in the heavier industries, like steel and automotive. To have them jump to information technology is hard. They don’t have the comfort level necessary ... to make an investment. It’s going to take some time.”

Another difficulty facing Cleveland-area tech entrepreneurs is follow-through — putting a strong plan behind that great idea.

“Some businesses haven’t developed their idea to a stage where it’s fundable,” Zeman says. “They haven’t looked at the competition, they haven’t looked at what’s already out there. They feel that they have a strong technical idea that will automatically be a great business. That’s not always the case.”

As to management-recruiting difficulties, Zeman says some companies have actively sought out-of-state staff with a local connection.

“There’s a surprising pool of people who either were educated or grew up in Northeast Ohio and really value this region. There are a lot of people across the country that would like to come back, but you can imagine the challenge in finding them.”

So what’s an entrepreneur to do, short of packing a briefcase and heading for Silicon Valley?

The outlook is hardly as bleak as it may appear. Most local experts agree that the landscape is improving. Zeman points to technological resources throughout the area — from universities and medical facilities, to NASA’s Glenn Research Center — as well as the state’s Edison business incubator and education programs, as forming a strong support system to help entrepreneurs and inspire confidence in potential investors.

The encouragement and support are apparently working: Almost 40 percent of last year’s Weatherhead 100 list of the fastest-growing area companies were in the IT category, from software development and telecommunications to e-commerce. In 1998, less than one-quarter of the Weatherhead 100 were IT-related firms.

Goldenberg notes that the very fact that people are recognizing the difficulties finding seed money and venture capital signifies progress.

“I think it will continue to get better,” he says. “Now, when I go out and am talking to people [about investing] in deals, they’re willing to listen.”

Zeman notes that more ancillary businesses, such as law firms, investment bankers and business incubators such as LIFT, are placing particular emphasis on helping to pair entrepreneurs with potential angel investors.

“Our job is to help people start and grow technology-based businesses,” Zeman says. “That covers a whole range of technologies — software, IT, and also biotech and biomedical.”

The organization offers, in addition to four incubators and various educational programs, two programs to help start-up companies find sources of capital. Innovest (www.innovest.org) is a statewide program that places about 30 entrepreneurs in front of 300 or so potential investors, “a full range of angel investors, venture capitalists and some investment bankers. It really covers the whole range of possible sources of funding.”

Innovest has resulted in some $180 million in investment capital in its three-year existence, much of it in the form of early-stage funding.

The other program, operated by Enterprise Development for the federal Small Business Administration, is an Internet-based matching service through which entrepreneurs can post an abbreviated business plan for access by qualified investors.

Could these things happen without help from Innovest or SBA programs? “It’s hard to say,” Zeman says. “But this is a venue that makes it much easier, particularly when trying to find angel investors. Because they’re all individuals, it’s hard to get these businesses hooked up with them.”

Goldenberg and some of his colleagues have stepped up to the plate, putting together deals for start-ups and often actively seeking investors.

“Somebody has to,” Goldenberg says. Attorneys might, in addition to completing corporate legal work, do anything from provide strategic business advice to help structure financing or hook businesses up with investment bankers. “In many cases the entrepreneurs are very young and ... have never done this before.”

This May, NEOSA will host the Seed Capital Initiative, a day-long event designed, in part, Cookinham says, to graduate entrepreneurs from what he calls “financial kindergarten” and inspire confidence in potential angel investors. The Seed Capital Initiative — scheduled just before the Cleveland World Trade Conference, which this year will focus on e-business — will include a presentation of early stage financing options and business plan reviews “to expose investors to these companies and [help them] evaluate ideas,” Cookinham says.

Goldenberg, whose firm is a co-sponsor of the event, hopes to attract not only potential investors, but the stockbrokers and financial planners who advise high net-worth individuals, “to get people comfortable with how these deals are done.”

How to reach: NEOSA, (216) 592-2257; EDI, (216) 229-9445; Hahn Loeser & Parks, (216) 621-0150

Shari Sweeney (Sweene@aol.com) is a Lakewood-based freelance writer.