Funding a Tech Startup: Sing for Your Supper

This story was originally published on June 24, 2009, and is brought to you today as part of our Best of ECT News series.

Funny thing about economic disasters: They tend to spawn a bevy of new businesses. It’s not that a recession is the best time for pie-in-the-sky thinking; rather, it’s when pie-in-the-mouth issues become most pressing.

“The tantalizing successes of some startups, coupled perhaps with the rise in unemployment, have more people pondering new ideas and new careers,” Doug Chertok, an angel investor and venture capitalist at Vast Ventures, told the E-Commerce Times. “In my opinion, that’s a great thing — gets more people thinking and doing, and out of some of the bureaucracy of corporate America.”

We call this “entrepreneurship,” but mostly it’s a creative way to eat — and if you’re really good at it, it’ll feed you far more than a meal or two. While a startup operation may be your best shot at fine dining in these trying times, it’s a long and scary trek from famine to feast.

“‘New’ money is almost impossible to get, no matter what capital sources say,” James C. Roberts III, an attorney with Global Capital Law Group, told the E-Commerce Times.

Despite this bitter recession, startups will generate the next round of billionaires if history does indeed repeat itself. Still, a startup is a high-stakes gamble no matter how great the initial idea. So where do you find the cash to fund your bet?

Where’s the Dough?

This is tricky business, finding the money. Seems the green stuff has slipped from nearly everyone’s grasp.

“Risk capital is scarcer than it has been in a long time,” Mike Fitzgerald, founding partner of Commonwealth Capital Ventures, told the E-Commerce Times. “Venture funds will husband their cash for their existing portfolios making new deal funding tougher.”

“Investors in venture funds are less liquid than ever, and new money coming into the business will continue to shrink,” added Fitzgerald, “again, putting pressure on the number of new deals being done.”

Indeed, angel investors or venture capitalists may nix your idea not because your nose-picking widget is delusional but because they are hoarding pennies and scrambling for cash as much as you are.

“If a VC fund did not raise a new fund in the late 2006 to early 2008 timeframe, don’t waste your time,” Peter Alternative, a partner at Mirus Capital Advisors, told the E-Commerce Times. “All other VCs are reserving their dry powder, despite their insistence that they still have several bullets left.”

Unfortunately, the venture capital industry is shrinking in more ways than one.

“With the expected 10-year return on the VC asset class expected to be negative, many prognosticators expect the number of VCs to shrink by 25 percent over the next couple years,” explained Alternative. “This has already started to happen as VCs cut their own burn, given their reduced management fees, which shrink as the fund reaches maturity, and their inability to raise new funds.”

That doesn’t mean that there isn’t any money out there, however.

Silicon Valley Secret

“There are specific niches being favored by the venture capital industry, including healthcare IT, renewable energy and education, which are all directly following the proposed stimulus plan,” said Kevin Kemmerer, executive vice president and managing director of the technology group at Safeguard Scientifics.

“From the e-commerce perspective, healthcare IT is the most applicable, with its drive towards new, Web-based payment systems which provide great opportunities to change the way things are done today,” he told the E-Commerce Times.

Shine a light on where the money’s flowing now, and you’ll see the glimmer does indeed glow directly behind President Obama’s stimulus plan.

The most active investors, as usual, are concentrated in California’s Silicon Valley. Among the 28 venture firms involved in 10 or more deals, 18 are headquartered in Menlo Park, Palo Alto, San Francisco or Santa Clara, according to Joint Venture: Silicon Valley Network’s annual report, the 2009 Silicon Valley Index. One-third of all venture capital in the U.S. is invested in the San Jose area. In 2007, Silicon Valley alone accounted for 55 percent of California and 31 percent of U.S. investment.

In the largest venture capital deal of last year, San Jose, Calif.-based NanoSolar secured US$300 million in funding.

“Even though total VC investment is down 7.7 percent, investment in clean tech increased 94 percent in the region between ’07 and ’08, reaching almost $1.9 billion,” Nanci Klein, director of corporate outreach for the City of San Jose’s Office of Economic Development, told the E-Commerce Times. “Silicon Valley accounts for 31 percent of total U.S. clean tech venture capital investment.”

The biggest secret of all, though, is that the market counts more than the product: Skip the product bells and whistles and instead scope out the lay of the land.

“I can’t tell you how many times I’ve sat in a presentation hearing a new company pitch, and all they talk about is product, product, product,” Mark J. Landay, managing director of Dynamic Synergy, an executive recruitment and capital consultant, as well as angel investor.

“They are thinking about what the company is doing rather than what the market is doing and how their company will help it,” Landay told the E-Commerce Times.

That said, beware of picturing the market for your product or service only in light of what’s happening now; even a bad recession doesn’t last forever.

“Make sure your product matters in the current and anticipated economy,” Michael H. Gurau, president of CEI Community Ventures, told the E-Commerce Times.

The House Almost Always Wins

Understand that this is a buyer’s market and investors can afford to be choosy.

“If you’re not in a VC’s sweet spot/core knitting — you’re wasting your time,” said Alternative. “It’s a buyer’s market, so they have too many other good opportunities and thus don’t have the bandwidth to invest any real cycles in diligencing your deal.”

To identify investors in your industry and therefore better your odds, turn to your network.

“Get associated with professionals — primarily attorneys, but also accountants, financial advisors and bankers — who have contacts for capital in whatever industry the business is in,” said Edward B. Stevenson, cochair of the venture capital and emerging growth company practice group at Herrick, Feinstein.

“Lawyers, in particular, have contacts with angel investors and venture capital funds,” he told the E-Commerce Times.

“If your attorney or other contacts don’t have good contacts in the investment community, or if you exhaust them, consider joining the groups and associations that specialize in putting investors and entrepreneurs together,” advised Stevenson. “They might invite you to make presentations to angel investors and VC sources. Keiretsu Forum and the FundingPost are two that come immediately to mind, but there are many others as well.”

Before you pitch any investors, though, make sure you have everything in order. Generally, you’ll only get one shot that will last about 30 minutes. You’ll need a lot more than just a good idea.

“People are finally recognizing getting funding with an idea on the napkin is a myth, which is healthy for everyone involved,” Steve Tennant, managing director of Tennant Consulting, told the E-Commerce Times. “As a result, it’s even more important to get customers on board before seeking investors — even if the product is not complete.”

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