Lack of venture capital is reshaping Triangle startup scene

dranii@newsobserver.comNovember 10, 2012 

  • The state of venture capital The state of venture capital – both nationwide and in North Carolina – is the topic being tackled by Mark Heesen, president of the National Venture Capital Association, at an event later this month sponsored by CED. Heesen’s presentation is scheduled for 5:30 p.m. on Nov. 29 at the Research Triangle Park Foundation, 12 Davis Drive in Durham. The event is free, but attendees are being asked to register online at http://www.cednc.org/events/event_details.asp?id=273635.

— When technology commercialization firm 8 Rivers Capital was formed four years ago, its founders concluded it would be foolhardy to depend on venture capital funding to bring their concepts to market.

After all, they realized, there weren’t a lot of venture capital firms flush with cash located in the Southeast. Moreover, most of the venture capital firms that were plowing money into startups were mesmerized by the information technology industry and weren’t much interested in investing in other industries.

While 8 Rivers doesn’t rule out raising venture capital funding for its ventures, its primary focus is attracting funding from industry partners.

“We’re agnostic as to where the money comes from,” said co-founder Bill Brown.

“Apple alone has more cash than all the venture capital in America,” he noted. “I can say that about a lot of companies. And corporations are actually looking for ways to put that cash to work.”

Fast forward to today, and 8 Rivers’ fundraising strategy looks smarter than ever.

Venture capital funding raised by Triangle companies has fallen significantly since peaking in 2007, and the $82.8 million in venture capital that local companies attracted over the first three quarters of this year is by far the lowest total since The News & Observer began reporting the quarterly numbers in 1999. Yet 8 Rivers managed to raise $50.4 million from a single corporate investor for a Durham company it is nurturing: NET Power, which is developing a next-generation power plant.

Unfortunately for the region, the fund-raising success of 8 Rivers and NET Power isn’t easily duplicated.

Some members of the Triangle startup scene fret that the scarcity of funding from venture capitalists, who receive an ownership stake in the companies they finance, is destined to persist for at least the near-term. That could create hardships for promising young companies that rely on such money to develop new products or ramp up their sales and marketing efforts.

“I think what is going to happen is that a lot of these startups ... a higher percentage than historically, are just going to die on the vine,” said Merrette Moore, co-founder of Raleigh investment firm Lookout Capital.

Venture capitalist Clay Thorp of Hatteras Venture Partners also worries about the big picture. He wishes aloud that the Triangle had more firms like his that are willing and able to invest in early-stage life science companies.

“It’s not possible for us to fund every good company we see. I wish it were,” said Thorp, co-founder of Durham-based Hatteras. “We need more investors. It sounds perverse to say we need more competition, but we do.”

Lack of venture captial not hurting some

To be sure, some remain unperturbed by the dearth of venture capital funds flowing into Triangle companies.

For one thing, the venture capital totals don’t capture most of the money supplied by so-called angel investors – wealthy individuals who invest money out of their own pockets. In addition, information technology companies don’t need as much money as they once did to get out of the starting blocks thanks to innovations such as cloud computing, which enables avoiding large investments in computer hardware.

Many life science companies, meanwhile, are relying on government funding in their early days, said Joan Siefert Rose, president of CED, a Triangle-based support group for entrepreneurs.

“Every company, just about, has NIH or SBIR funding,” said Rose, referring to federal government grants from the National Institutes of Health and Small Business Innovation Research funds from the Small Business Administration.

Another factor to consider is that the Triangle’s startup community is small enough that one or two big deals – or the lack of such deals – can skew the data considerably.

Chris Heivly, managing director of Triangle Startup Factory, a Durham business accelerator that invests in and nurtures startups, suggest that there’s a supply-and-demand issue at work: There just aren’t an abundance of IT companies seeking big sums of money.

“It’s a question I get every single day: Is there enough money?” said Heivly. “There’s always enough money for great companies.”

Sub-par returns for investors

There are also some systemic issues that make it difficult for Triangle companies to raise venture capital. The Triangle has long been a hub for biotechnology companies, but as the road to winning Food and Drug Administration approval for new drugs has gotten longer, riskier and more expensive, funding for biotech companies has become problematic.

At the same time, the returns that venture capital funds generate for their investors – wealthy individuals and institutional investors – hit a 10-year low last year because of the struggling markets for initial public offerings and mergers and acquisitions, said Mark Heesen, president of the National Venture Capital Association. Those markets are crucial because venture capital funds don’t cash in on their investments in a company until it is sold or goes public.

The sub-par returns have made it tougher for venture capitalists to raise new funds, pushing some firms out of the business of making new investments. The amount of money raised by venture capital firms plunged 62 percent between 2007 and 2010, although the totals have been rising since then, including a 31 percent jump so far this year.

But the industry’s woes have raised questions about its future.

“It’s become a bit of a sport among venture capital insiders and observers to assert that the venture capital model is broken,” asserted a report issued in May by the Ewing Marion Kauffman Foundation, a nonprofit focused on entrepreneurship.

Not so, said Heesen.

“I’ve been with the association for 22 years, and for 22 years I have heard that the venture capital model is broken,” Heesen said. “I think that the venture process is evolving.”

Heesen, who stressed that venture capital returns have begun “trending up” after hitting a low last year, envisions the contraction in the number of active venture capital firms having a domino effect that results in fewer entrepreneurs attracting VC funding going forward.

Filling the gap

But those companies that make the cut will be better companies with a greater chance of success.

“Instead of investing in a lot of what I call ‘me-too’ companies, you are going to see a lot more long-term investments in companies that are unique,” he said.

Entrepreneurs also will look elsewhere to fill the funding gap.

Lookout Capital’s Moore projects that more entrepreneurs will rely on corporations for backing, including the venture capital fund that Rex Healthcare created this year. Moore is an advisor to that fund.

Raleigh startup Valencell turned to a corporate investor – Best Buy Capital, the venture capital arm of electronics retailer Best Buy – last year when it sought $5.5 million to expand its team and the capability of its technology. The company’s sensor modules, which it is licensing to manufacturers, enable wearers of wireless headsets or arm bands to monitor key health data such as heart rate and calories burned while on the go.

The 12-employee company has benefitted from more than just the funding that Best Buy provided.

“Best Buy has actually helped us get access to licensees we would not have had otherwise,” said co-founder and CEO Steven LeBoeuf.

Ranii: 919-829-4877

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