I attended the Los Angeles Venture Association monthly meeting on Tuesday and heard a panel of investors and lenders provide their first hand insights on what it takes to get funding in the current environment. The panel included asset lender VenCore, 2 angel investors (Tech Coast Angels and Pasadena Angels) and a VC from Rustic Canyon Partners. After a brief introduction of the panel, the moderator opened the floor to questions. It was a nice break from the usual panel sessions and allowed the audience to get their questions addressed directly. This is one of the better ways of covering a topic where the audience knows a considerable amount about the subject area.
As might be expected from the members of LAVA, most of the questions were directed at the VC and the Angels. It not only reveals the bias of the audience, but is pretty representative of the way entrepreneurs think about sources of financing. Both the lender and the moderator, LAVA President Richard Koffler, noted that many successful start-ups employ a variety of funding sources at appropriate times and stages of development. From getting the project off the ground with contributions from “friends, families and fools” to government loans or grants up through seed financing by local Angels and follow-on funding for a more mature, focused start-up from VCs. One thing the VCs and Angels have in common is their insistence that the entrepreneur have an exit strategy – that is who is going to buy them out of their positions. It is a key element that entrepreneurs must provide in their business planning to have any chance of success. Lenders dont share that concern and is less of an issue for them.
Angel investors are probably not as well understood and certainly get less attention from the business press than the more traditional Venture Capital firms. Angels are accredited investors (high net worth) who pool their business knowledge and interest in helping fledgling technology companies. They invest very early in the process, usually at the proof of concept stage or before the product or service is mature enough for market introduction. They have less formal, though not necessarily less rigorous due diligence processes and they tend to focus a bit more on technology businesses – where many of the angels made their money and achieved success. Angel investors differ from VCs in a number of ways: they get into companies earlier, they provide smaller amounts of funding, they have actual operational experience (usually) and they provide mentoring and assistance to help entrepreneurs beyond what might be expected from traditional VCs. They recognize that the management teams they are investing in are usually technology focused, business novices and haven’t the track record or operational history.
Many entrepreneurs get fixated on looking to give up some equity to investors and don’t look at alternative means of financing. The panel reminded us that there are many approaches and many sources of financing entrepreneurs might consider. There are government programs – SBA loans and SBIR research grants for very early development of technology. There are lenders of all sorts – receivables lending (factoring) and depreciable asset lenders like panel representative VenCore. Lenders, of course, really don’t care about the technology, only that they get their money back + interest. Lenders are concerned with seeing good management teams, deep pockets, solid business plans and excellent prospects for future funding. Lenders don’t want operational roles and board seats.
Angels invest $250K up to about $2 million very early in companies that are working on novel technology or tech products. The types of companies where they invest are less mature, usually just working on proof of concept. The management teams are probably composed of technologists with more research experience than business acumen. The product or service is technology based, can be produced, is novel or has an observable market. Angel’s assessments of projects are largely driven by their business experience.
And the VCs are for larger more established start-ups with a great story, great management, large addressable markets, protected technology, distribution schemes, patents on processes or technology and recognizable competitive advantages. VCs are used to dealing with more sophisticated management teams and don’t have time for the mentoring or in-depth advise that less mature entrepreneurs might require. Deal flow is such that they have enough candidates for funding that they can eliminate the vast majority of projects that are brought to their consideration. Though the Rustic Canyon VC did acknowledge that the next 18 months will be pretty interesting as the funds that raised money during the peak of the bubble have to put that money to work or give it back to the LPs. We may see some anomalous investment (on the high side) that may spark the equivalent of a dead cat bounce in IPOs and financing rounds.
And perhaps the most overlooked way of financing a start-up is a blend of all three – grants, loans and investors. It is critically important for entrepreneurs to know when and where sources of funding are applicable to their particular point in a start-up’s life cycle. Still the quickest way to kill a potential investor’s ardor for a deal is focusing on valuation. Many deals are lost by management team’s insistence on mythical valuation. Valuation is established by the investors and you are worth exactly how much they will invest in your endeavor.
If you examine the DNA of the New Entrepreneur, you will see many traits that characterize the earlier versions: the desire to do something different, the boldness to follow a different path, and the persistence to follow through in spite of extraordinary obstacles. And you will also see some new traits: The New Entrepreneurs are more battle scarred, less innocent, more realistic, less delusional, more bootstrap-oriented, less dependent on traditional venture capital, more operational, and less IPO-focused. They are less naive and have more business discipline and savvy. This business savvy comes not from getting an M.B.A., but rather from living through the last 10 years and trying to launch new businesses during the dramatic rollercoaster we experienced. The entrepreneurs we see today are, frankly, more capable than they were in the 80s and 90s-and they have to be.
Bill Reichert of Garage Technology Ventures has written a good summary of the changes that have occurred post-bubble with entrepreneurs and how these changes are reflected in their approach to securing financing. The New Entrepreneur appeared in the current version of LARTA’s VOX newsletter. LARTA is the Los Angeles Regional Technology Association that sponsors conferences and events around southern California that highlights new technology and start-ups. He gets it just right and his viewpoint about the new entrepreneurs comports with the panel groups’ assessment of the current environment for venture investing.