The hunt for venture capital “is a percentage game, with a low percentage. You’ve got to keep at it, with a positive and can-do attitude.”
When Sanjay Sathe came up with a business idea two years ago, he met with venture capitalists in Dallas, hoping to secure $3 million in funding. His business concept: a comprehensive, online job-search “concierge” service for senior-level managers seeking six-figure positions.
During those meetings, the former Sabre Holdings vice president got a sobering dose of reality. “A lot of them told me, ‘This is a great idea; now go and prove it out for us. Raise some angel money and be successful at that. Build out the technology, set up operations, actually sell and commercialize,’ ” Sathe recalls.
In other words, the venture firms wouldn’t even consider opening their checkbooks until he had proven the business model.
Sathe and his fellow North Texas entrepreneurs are continuing to absorb a tough lesson: Venture capitalists, slowly regaining strength after the dot-com bubble bust, remain sober, frugal, and relatively risk-averse.
“When the tech bust happened around here in 2000-2001, a lot of venture capitalists retreated to safer ground. Since then they have not been as aggressive,” says Bill Sproull, president and CEO of the Metroplex Technology Business Council, a group that fosters local business networking, work-force development, and technical innovations.
As a result, Sproull says, Dallas-Fort Worth needs more money for the next generation of local entrepreneurs. Fortunately, a few outfits are answering the call.
The Giddy Days
Jerry F. White, chairman of the Southwest Venture Forum, a bimonthly breakfast meeting that supports the venture infrastructure in Dallas, recalls how angel investors and venture firms flocked to the area’s Telecom Corridor in the mid-1990s. “The market was very hot and [initial public offering] valuations were extraordinary,” White says. “There was so much money that if a company didn’t have a bad story after a round of financing, every round was an up round. You didn’t have to complicate the story with revenue if it was a good concept.”
Companies went public before they were profitable. Nationwide, venture investments soared to more than $100 billion. Then, in March 2000, air began hissing out of the bubble. The next year, Enron went bankrupt. The Dow dropped, and information-technology stocks lost as much as 90 percent of their value. To protect investors, Congress clamped down with the Sarbanes-Oxley Act of 2002.
The stringent new rules made it next to impossible for most startups and small companies to pursue initial public offerings. Flagging companies folded. Lacking the IPO exit door, venture firms remained stuck in deflated deals.
“Since the performance of your last fund is what you raise the next fund on, there was a lot of agony,” White remembers. “The angel investors were so beaten up and had lost so much money that many withdrew from the game altogether.”
A number of venture firms that had been successful in the ’90s did not replenish their funds, and those that held on shifted their focus to more mature technologies.
“For about the last five to six years, entrepreneurs have had to go ‘old school’—rely on their own funding, family, friends, and the angel community,” says Larry Calton, executive director of the North Texas Enterprise Center for Medical Technology, a Frisco business accelerator that opened its doors in 2002.
“Investors became much more risk averse post-bubble. We’ve not seen nearly as much venture capital as we would have liked,” Calton says. “The question that remains for entrepreneurs is, how do you get funding for deals before they get venture capital? Many startups fail due to an inability to raise the $250,000 to $1.5 million needed to develop their business to the point where the risk/reward relationship works for institutional investors.”
In 2005, the Texas Legislature provided some relief for the problem, in the form of the Texas Emerging Technology Fund, which has given amounts ranging from $150,000 to $3 million for innovative technologies with marketplace potential.
“In some senses, the Emerging Technology Fund is the most organized angel investor in the state of Texas,” says R. Mike Lockerd, executive director of the North Texas Regional Center for Innovation & Commercialization, which facilitates the Texas ETF application process locally. “We work hand in glove with higher education institutions, health science centers, and incubators that are focused on spinning out research results for the purpose of commercialization.”
Lockerd’s office receives between 30 and 35 projects for every quarterly round of funding, about 12 of which meet the ETF criteria. Typically, no more than five applications make the final cut and are sent to Austin for further consideration. Thus far, about nine technology companies from the center’s North Texas region have received commercialization awards.
Fluttering of Wings
Individual investors have come out of hibernation, but cautiously. North Texas banking veteran Carol Nichols joined the national Golden Seed Angel Investors group in 2007. Nichols believes that angel groups help reduce risk, and says the diverse experience of the group’s members improves due diligence on potential deals.
“Angel investors can provide mentoring and coaching—human capital—in addition to money,” she says. “Since they’re investing their own individual money, they generally have a passion about the product, the management team, or the industry, so each investment has personal meaning for them.”
A number of local events serve to introduce prospective angels to entrepreneurs. InvestIN Forum, a national syndicate of angels, opened a North Texas branch in 2005. That group, which meets monthly at the Dallas Country Club to consider pre-screened, early-stage companies, has completed more than 30 deals so far. They run the gamut from companies involved with nutritional beverages and medical devices to oil and gas operations.
InvestIN Forum President Laurence D. Briggs, an investment banker, says the investment climate became very good about 18 months ago; then came the subprime credit debacle. “Angels are behaving intelligently by keeping dry powder for their existing deals,” Briggs says. Now, “they’ll need more equity than they expected, either because the banks are not going to lend … any money, or because other people are not coming in on deals.”
A new kid on the block is the Lone Star Angels investment group, formed late last year by the Enterprise Center’s Calton and three others. Currently the founders screen deals, select the top three prospects in various industry segments, then invite them to make a presentation at a dinner. “We let the chips fall where they fall,” Calton says. “It’s not a committed fund.” As of spring 2008, the group had completed a couple of dinner meetings and, as a result, had invested a total of about $250,000 into two companies.
Sevin Rosen’s Dave McLean
STARTech Early Ventures in Richardson, which was launched in 1997, is a survivor of the tech bust. Something of a hybrid, it now has early-stage investment funds, incubation capacity, and a mentoring program. “There’s no question there have been a lot of funds and incubators in and out of business,” says managing partner Matt Blanton, formerly chief executive of a company with Sevin Rosen Funds, a major venture capital player here.
STARTech cultivates close relationships with academic researchers pursuing leading-edge technology and dozens of C-level executives who, when they’re “between engagements,” assist with due diligence on prospective deals. It also houses a group called Lynntech, which helps universities secure federal Small Business Innovation Research “translational” research grants, and the new Texas-Israeli Chamber of Commerce, which is intended to attract potentially high-growth, high-tech companies to Texas.
Blanton says that, as of the end of 2007, STARTech had invested $30 million in 47 high-tech companies that have gone on to raise more than $800 million from more than 60 venture capital firms. “We’re adapting, and a lot of it is driven by globalization,” he says.
Blanton sees opportunity in redirecting the region’s technical and telecom talent to new uses. STARTech’s third fund, currently being raised for an undisclosed amount, will focus on deals in communications IT, health-care IT, and opportunities in energy, water resources, and the environment.
Seed money remains tight due to a variety of factors, Blanton agrees, including fallout from the underperformance of venture funds starting in 2000. “Sarbanes-Oxley has definitely had a dampening effect” as well, he says. “My opinion is that at present we do not have enough early-stage investment capital in North Texas.”
Cynthia Pharr Lee, co-founder of the Texas Women Ventures Fund, sees a different problem. “My observations are that there’s lots of money in established venture funds,” Pharr Lee says. “Some are even returning money; they have cash sitting on the sidelines that they can’t get invested quickly enough.”
She too sees a changed climate. “At both the angel and venture capital tiers, everybody talks about benchmarks and milestones now,” she says. “That ‘write a business plan on the back of a napkin and get a million’ just isn’t happening anymore.”
Unlike the traditional venture capital firm, Texas Women Ventures Fund does not take equity in a company. Instead it provides mezzanine debt—a kind of bridge financing subordinated to bank debt—to women-led companies that are at advanced stages. The fund has financed three manufacturing operations since 2006 and is looking for roughly two more.
Working the System
Spurred on by the advice he received two years ago from the Dallas VCs, Sanjay Sathe began showing his business plan to private investors. He eventually secured $1.35 million from angels in Dallas and elsewhere. This allowed Sathe to hire employees and contractors in the United States and India, and to take his web site, called RiseSmart.com, “live” last November.
Within six months, its customer list included more than 4,000 job-hunting executives. A complementary service for firms seeking those executives was added early this year and soon signed on five corporations. “Since then,” Sathe says, “we’re growing at a pretty steady pace.”
Believing the company was ready for a round of institutional investment, Sathe then got back in touch with venture capitalists like Jeanne Bayless. Since 2002, Bayless has been managing partner at Star Ventures, a Munich-based venture capital fund that houses its U.S. operations on the 16th floor of Two Galleria Tower, just down the hall from Sevin Rosen Funds and a handful of other venture firms. In May of this year, Bayless’ fund was part of a group that provided a $6 million Series C round of funding to Dallas-based software company SensorLogic.
The 16th-floor neighbors leverage each other’s industry knowledge, executive connections, and due diligence. “This is not a typical set-up that you would see elsewhere,” Bayless says, “but we find it to be very advantageous.”
Bayless—the daughter of Sevin Rosen’s Jon Bayless—worked with two successful startups, including Answer–Soft, a North Texas-based company she launched, before switching to the venture side of the desk. Still, she reserves no special treatment for local entrepreneurs. “When I look at a deal, I calibrate its uniqueness, traction, and exit potential against other companies in the same space globally,” she says.
Jeanne Bayless was introduced to Sathe through Sejal Desai, principal of MHT Partners Ltd., a middle-market-oriented investment bank based in Dallas. “The vast majority of deals I end up doing come from trusted sources,” Bayless says. “Those might be other venture capitalists who I’ve served on boards with, entrepreneurs I’ve funded before, or recommended associates. It helps take some of the risk out of the deal from my viewpoint.”
North Texas observers have been encouraged that Sevin Rosen Funds—the 27-year-old Dallas venture firm known for giving a leg up to notable companies such as Compaq and Lotus—is now raising money for its 10th fund.
“We’re very much in business, and very actively looking at interesting technologies,” says general partner John Jaggers, speaking from a New York airport following a meeting with East Coast investors. Though Sevin Rosen recently parted ways with its West Coast affiliates, Jaggers insists the split was amicable.
“For Fund X, we’ll be looking at a lot of different areas: health care, software, some media applications,” he says. “We’re not just looking at deals in North Texas. When we invest in Dallas, we think the company has potential to be world-class.”
Sevin Rosen allocates capital in increments and, when a company is sold or goes public, it may have received a total of $5 million to $10 million from the firm.
|Jeanne Bayless of Star Ventures
photography by Chad Windham
A few weeks ago, three partners at Sevin Rosen pulled up a chair on the 16th Floor to share their perspective with D CEO. But first, they passed around a new wire–less device that had recently arrived from one of their Fund IX companies, based in California. The handheld gadget downloads a personalized radio playlist from Slacker.com—sort of like “iPod meets Sirius Music.”
“We seeded the company,” says general partner Dave McLean. “One of the things we do well is help build companies. A lot of firms have left the early stage of venture capital. But the reward of early stage is that you can build large, valuable companies with significant multiples. Our goal is 10 times—that’s a home-run deal.”
Jackie Kimzey, a general partner who served as CEO of a Fund I company, cautions, “Not all of our deals are home runs. About half lose all their money. The big wins help offset the losses.”
In the late 1990s, Sevin Rosen had a monster grand-slam: one startup returned the fund’s investment 10-fold. Today, that scenario is much less likely. “It’s less of a home-run business today,” talent partner Dan Meyer says. “Now we’re looking for more hits; we can’t afford to strike out.”
“In 1999, we got drunk on the telecom Kool-Aid,” Kimzey adds. “Now we’re more diversified. No more piling on a single bandwagon. We don’t make multiple deals in one precise space.”
Mergers and acquisitions have become the routine exit strategy, with IPOs reserved for a select few. Most of all, the focus has moved to capital efficiency—doing more with less—and pulling the plug quickly on failing ventures. “We don’t want to dig big craters,” Kimzey says.
The Bottom Line
Nationwide, venture capital investments had been edging up during the last three years, according to Dow Jones’ VentureSource. However, the first quarter of this year saw a 7 percent downturn from the year before, to $6.84 billion nationwide.
“Venture funding isn’t as easy to come by as in past years,” acknowledges Jeanne Bayless. “But tenacious, hard-working North Texas entrepreneurs can still turn over a few rocks and find financing.”
Sanjay Sathe, for one, is betting on it. Calling the hunt for capital a “very challenging exercise,” he says the effort it requires is akin to a full-time job. “You need to really work the circuit. You’ve got to make sure you present your wares to the venture capital industry on the East and West coasts, too,” he says. “It is a percentage game, with a low percentage. You’ve got to keep at it, with a positive and can-do attitude.”
In late May, Sathe reported being in “the final stages” of closing a VC deal.