Seed Money Blossoming Again For Entrepreneurs

Although investors are more cautious than they were in the go-go 1980s, sources of early-round backing flourish anew After a four-year slump, venture capital funds that provide early-round financial support, including seed money, to start-up biotechnology companies and other high-tech enterprises are reportedly starting to flourish again. "On the order of 100 venture capital funds are currently raising money," says Robert Mast, vice president of Venture Economics, Newark, N.J., a unit of Securities Data Co. that tracks activity at the approximately 700 or so venture capital funds throughout the United States. "That's the highest number since 1987." It's easier to attract a venture capital investment than it is to win your state lottery. But not by much. As a rule of thumb, venture capitalists fund roughly one out of every 100 business plans they read. Fortunately, you can do much to beat these odds. Here are some suggestions gleaned from a recent seminar on venture financing sponsored by the Technology Council of Greater Philadelphia. How do you find a venture capitalist? Ask for recommendations from successful entrepreneurs or use a referral network through a banker or other financial consultant. Also useful: Pratt's Guide to Venture Capital Sources, a directory of U.S. venture capital firms, published by Venture Economics of Newark, N.J., a unit of Securities Data Co. that tracks activity at venture capital funds throughout the United States. Most entrepreneurs contact a number of funds, which increases the probability that at least one will be interested. Generally, look for funds whose investment strategy and expertise match your company's focus. Consider both large funds, which tend to invest across a broad spectrum of companies, and smaller funds, which often focus on specific industries, geographic regions, or stages of company development. After you've made initial contact with a fund, by either letter or phone, the next step usually is to submit a business plan. This all-important document serves to inform the venture capitalist about your business opportunity and detail your plan of execution. For guidelines, consult Stanley Rich and David Gumpert's Business Plans That Win (New York, Harper Collins, 1987), suggest the partners at NEPA Venture Fund in Bethlehem, Pa. Preface your business plan with an executive summary, recommends Robert E. Keith, operating principal of venture firm Technology Leaders in Wayne, Pa. "We see an awful lot of business plans," he says. "Tell us in 10 seconds or less what your business is, who the people are, and the size of your market." While an enticing business plan is essential, it's not enough to close the deal. Potential investors also want to make sure you and your company have what it takes to carry out your plans. Here are some important qualities they look for: * Have you done your homework? Be sure the key assumptions that drive your business plan are correct and carefully documented. "Details mean everything to us," says Glen R. Bressner, a principal of the NEPA Venture Fund. "To the extent that we can anchor your assumptions with real-life data, we get comforted." * Do you have a winning strategy? "Tell us why you'll be better than others in your market," advises John H. Martinson of the Edison Venture Fund in Lawrenceville, N.J. "Do you have a game plan or formula that will sustain your company?" * Do you feel in control of your own destiny--and your business? "We ask people to talk about a failure in their lives," says Bressner. "If they make excuses, such as `My banker didn't loan me enough money,' or `My employees didn't work hard enough,' that's someone who can rationalize failure away fairly easily. And they could just as easily rationalize losing our money." * Are you prepared to work till you drop, then work some more? "We often go to companies at odd hours just to see how hard you're working," says Martinson. "I've never been involved in a successful company where the lights were off by 6:30 or 7 P.M." * Do you hire the best available people? "If an entrepreneur has several employees, we want to meet them to see what kind of people they are," says Bressner. "If they're a bunch of `yes' men or `yes' women, that tells us the entrepreneur is really on an ego trip and doesn't want to hire the finest people." * Are you willing to sell, sell, sell? "Nothing happens in a company without orders," says Martinson. "Even though the CEO may be a technically oriented person, he or she still has to gain the confidence of customers, find them, and close them." --J.W. While scientists who are looking to take the entrepreneurial plunge may take heart from Mast's words, they should also note that investors who saw many iffy investments go sour in the 1980s have become far more discriminating about the companies on which they place their bets. Therefore, says Harold Smith, principal partner of the Synertech Group, a venture fund in Research Triangle Park, N.C., "There is money out there, but it's selective." Venture capitalists "are not interested in investing in technology boutiques but in businesses with solid potential," he says. "There was a time when a scientist could say, `Gee, I think I want to start my own business.' Those days are past. What it takes now is a substantive business plan, solid scientists, and a strong management team led by skilled businessmen." Mast and Smith would agree, however, that for entrepreneurs who have the right stuff, now may be the best time in recent memory to go after venture capital financ®MDNM¯ing. This year, venture funds will attract about $2 billion in capital commitments, predicts Mast. Although that's down considerably from the $4.2 billion raised in 1987, an all-time high, it's a clear upturn from last year, when a meager $1.3 billion was raised--the lowest level in nearly a decade. Industry experts attribute the recent upswing in venture fund raising to the success of last year's initial public offerings (IPOs), especially for biotechnology. "In 1991, the IPO market in biotech exploded in a way that was beyond the expectations of even the wildest-eyed optimist," says industry analyst Ken Lee, national director for life sciences practices in the Palo Alto, Calif., office of Ernst & Young. Because the market for initial public offerings was booming last year, and again in the first quarter of 1992, many venture capitalists reaped a healthy profit when their companies were sold in public stock offerings. As a result, the rates of return for many funds got a lift, helping to attract big investors for the current round of fund raising. "A lot of venture capital portfolios got a shot in the arm by the recent IPO market," says Mast. "It's also created a lot of excitement among institutional investors to give venture capital another try." By Lee's count, 40 biotech companies raised $1.25 billion in IPOs in 1991, compared to virtually no activity the year before. To put that into perspective, he says, "this was almost equal to all the money ever raised by IPOs in the history of the biotech industry." "The biotech industry has seen significant returns over the last 18 months, largely because of the IPO activity," agrees John H. Martinson, founder and general partner of the Edison Venture Fund in Lawrenceville, N.J. "I would imagine that success is going to fuel investment in venture funds that focus on biotech." Although the coffers of many venture funds are brimming once again, competition for these dollars is more formidable than ever. At Edison Venture, for example, entrepreneurs send in between 1,500 and 1,800 business plans each year, says Martinson. Last year, the firm selected just nine companies for new investments; another five companies in its portfolio received additional rounds of financing. To become one of these chosen few, a business idea had better be a blockbuster. Because investing in fledgling ventures is so risky, venture capital firms look for high-growth companies that will generate sizable returns within a few years. Edison Venture, for instance, prefers to invest in expansion-stage companies with at least $3 million in revenue that they project will surpass $25 million within five years, Martinson says. Even for companies that do get venture capital backing, making it as a profitable concern is still a long shot. "Unfortunately, the 80/20 rule applies--20 percent of our companies generate 80 percent of our profits," says Martinson. These few big winners more than compensate for the remainder of the companies in a portfolio, which earn little or nothing, he says. Biotech startups, especially, face a long and harrowing road to profitable sales. The average biotech firm needs about 10 years to go from product conception to market, says Marc Goldberg, the immediate past president of the Massachusetts Biotechnology Council, an industry group. "This is not the software industry," he says. "You can't just go into your garage and come out a few months later with a new product." Besides time, biotech startups need money--lots of it. To take a new drug from test tube to bedside, for example, costs in excess of $320 million, says Richard D. Godown, president of the Industrial Biotechnology Association (IBA), a Washington, D.C.-based trade organization. For these reasons, many venture firms are not especially eager to commit a lot of money to biotech startups, say Goldberg and Godown. Likewise, biotech entrepreneurs also enter this arena at some risk. "The climate is good, but be very, very sure of what you're doing," cautions Robert McNeil, general partner at Sanderling Ventures in Menlo Park, Calif. The nation's oldest venture firm specializing in biomedicine, started in 1979, Sanderling is currently raising a $30 million fund. "Don't give up your day job yet--you might need it," adds Mc-Neil. "There's a big difference between making a new drug in a test tube and injecting it into a human arm." As daunting as all this sounds, many biotech ventures will strike it rich in the 1990s, if industry projections are on target. Domestic biotech revenues are expected to leap from $4 billion this year to between $50 billion and $60 billion by the year 2000, predicts IBA, whose member companies represent more than 80 percent of U.S. research and development in biotech. IVenture funding, considered vital for high-tech startups, has launched some of the United States' most prominent science- or technology-based companies, including Genentech Inc. of South San Francisco, Calif., Cupertino, Calif.-based Apple Computer Inc., and Digital Equipment Corp. of Marlboro, Mass. Venture funds invest in promising young companies with a view toward making a hefty profit several years later, when the companies are sold in public stock offerings or to larger corporations. Venture capitalists raise their funds mostly from institutional investors, such as pension funds, insurance companies, and other financial institutions. The funds, typically in the range of $30 million to $150 million, are invested in smaller chunks over several years into portfolios of young companies with high growth potential. In exchange for their investments, the venture capital firms take an ownership position in the companies. --J.W. Despite this sunny forecast, some storm clouds remain. The biggest problem, say some entrepreneurs and venture capitalists, is a shortage of venture money for seed-stage deals--startups so new they may be based only on a vision in some scientist's head or a prototype product. "Venture capital no longer has an interest in funding a bright entrepreneur simply because he has a good product idea," says Anthony Guiseppi-Elie, president of AAI-ABTECH, a young biotech company in Yardley, Pa. "Venture capital is now looking at established companies--at a minimum, you ought to be doing a million dollars in sales for them to even look at the company." Guiseppi-Elie speaks from experience. In the late 1980s, he went looking for venture capital to finance his company, which turns biologically active molecules into solid-state measuring devices. Although most of the venture companies he met with were excited about the company's prospects, they turned him down just the same. "They all said, `Your company is too small' or `You're too early-stage,' " he recalls. After 18 rejections, Guiseppi-Elie gave up on venture financing. Since then, he has found alternative financing to grow his company, including a distribution deal with a larger firm. Although Guiseppi-Elie's experience happened several years ago, the story today is much the same, says Goldberg. "Venture capital, by and large, is no longer there for the small deal. If you have a megadeal, or if you're in the later stage of development, then it's easier to get venture capital," says Goldberg, who now heads the Massachusetts Biotechnology Research Institute, a nonprofit concern that aids entrepreneurs in technology transfer from academe to marketplace. Not everyone shares this view. Venture Economics' Mast points out that virtually all the major pharmaceutical houses have set up venture capital funds to scout out nascent biomedical deals, as has Harvard Medical School. And a number of specialized funds devote themselves to startups in the life sciences, including Sanderling Ventures and Domain Associates in Princeton, N.J. "Startups are coming along at a very, very fast clip in biotechnology," says Jesse Treu, general partner at Domain Associates. "It's been a busier year for us in terms of new investments." Last year, Domain raised a new $75 million fund to invest in life science companies. New Rules But compared to the 1980s, venture capital in the 1990s is going by a different, more rigorous, set of rules. Ten years ago, says Goldberg, venture money was so easy to come by that "if you had a couple of scientists with an idea and a Nobel laureate on the board, you could just walk in [to a venture capital firm] and say, `Hi, here we are.' " Back then, venture capitalists like to say, too much money was chasing too few worthy deals. In the early 1980s, for example, about a dozen companies got venture backing to make interferon; nearly all have long since vanished or changed directions, says Mast. Venture capitalists "have learned their lessons from the early '80s," he says. "They're looking much harder at the technology before they put money into it." In other words, entrepreneurs with pipe dreams need not apply. Today's venture capital companies want to see a solid base of technology around which a substantial but flexible company can be built, says Chris Moller, a former molecular biologist and vice president of Technology Leaders and Radnor Venture Partners in Wayne, Pa. "The environment today is much more competitive. It's going to weed out a lot of dogs," says Moller. Keener competition also means that many entrepreneurs, especially those with early-stage ventures, will need to find alternative financing, says James W. Sharpe, president of the Pennsylvania Biotechnology Association. He advises entrepreneurs to look into public-sector sources of financing, such as the federal Small Business Research and Innovation (SBIR) program. The SBIR program, run by the United States Small Business Administration, last year awarded $450 million in contracts to young companies, mostly in technology. The contracts, which range in size from $50,000 to $500,000, are available for all stages of new business development, from feasibility studies to product commercialization. For some entrepreneurs, state-funded programs that encourage new enterprises are another option. In Pennsylvania, for example, the Ben Franklin Partnership Program provides financing and assistance to small businesses, many of them in technology fields. Since its inception in 1982, the not-for-profit program has invested about $214 million in 820 young companies statewide. Similar programs operate in Ohio, Maryland, and a few other states. Entrepreneur Guiseppi-Elie says a $150,000 investment from the Ben Franklin Partnership was a lifesaver. "It has been very important," he says. Without investment from the public sector, he adds, "we would have been behind the eight ball." Jean Wallace is a science writer based in Philadelphia.

Seed Money Blossoming Again For Entrepreneurs

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