News Column

High-tech Entrepreneurs Learn To Tap Angels, Venture Firms

Nov. 28, 2011

Jim Gallagher

Angel with money

So you've got an idea for a better mousetrap, but you need money to get it to market. What do you do?

According to entrepreneurs and investors in startup companies, here's the plan: Pray for angels.

Financing from "angel investors" -- mainly rich folks with money to invest -- is a crucial source for capital for high-tech entrepreneurs.

But to get this financing, you need to develop a working prototype and put it in the hands of potential customers, according to people who invest in startups.

Investors are happiest when they see customers itching to buy. A little revenue also does a lot to boost your chances.

If you're the nuts-and-bolts type (or the software or science type), you'll have to get a businessman involved. Investors want business and marketing skills in the ventures they back.

Next, pray to the "angels" that they will shower you with investment money -- in trade for a stake in your business, of course.

That's pretty much what Nathan Pettyjohn of St. Louis did in 2008. Pettyjohn, 30 at the time, was in the retailing business. He'd watched customers wander clueless through stores, unable to find what they wanted.

Why isn't there a smartphone application for that? he thought. So he started Aisle411, a service for mobile phones that can guide shoppers directly to the item they're looking for in the store.

He interested a couple of partners with software backgrounds, and they went to work. Their problem: "very little money," says Pettyjohn. They tapped their own savings, and raised money from family and friends. It was enough to pay for a marketing study to determine what customers wanted.

Then Pettyjohn did two things that investors like to see: He got other businesses interested in his product. The Ace Hardware chain and a supermarket chain in Springfield, Mo., signed on and provided inventory data for their stores.

Next, he partnered with an experienced entrepreneur, Matthew Kulig, co-founder of the Clayton computer security firm Global Velocity.

That got Pettyjohn ready to meet the angels.

Angels are mainly wealthy people, although investment companies, state development agencies and universities sometimes pitch in. St. Louis University, for instance, is devoting $1 million from its endowment to the "Billiken Angels" group that invests in entrepreneurs with a SLU connection.

Angels invest in startups. Their bigger cousins, venture capital firms, come in later after a firm is better established and needs money to grow. Both hope to cash out big when entrepreneurial firms issue stock to the public or sell out to larger companies.

Angels know that half their investments will fail, and they hope to make it up by big profits from the other half. The long-term return for angel capital is 10 percent, which is only slightly better than the stock market.

The good news is that St. Louis is growing more angels.

"The real growth is in the angel funding area," says Jerome Katz, professor of entrepreneurship at St. Louis University and director of the Billiken Angel Network.

Angels work alone or form groups to screen investments for members. Besides the Billiken group, St. Louis has the Arch Angels. The FinServe Tech Angels invest in financial services technology.

Capital Innovators just launched a program to "accelerate" five fledgling entrepreneurs at a time, handing them $50,000 each, office space and mentoring over a 12-week period in St. Louis. They were chosen from 165 applications.

"We're looking for businesses that can scale up quickly and on a smaller dime," says Judy Sindecuse, CEO of Capital Innovators.

The Biogenerator Seed Fund and i6 project provide seed funding to biotechnology startups. Centennial Investments of Columbia, Mo., seeks startup investments in St. Louis, as does Electio Investments of Chicago, says Katz.

Most of those groups were formed in the past five years.

For their money, angels want a piece of the action, either an equity stake or loans convertible to equity. Entrepreneurs wince at the bite to their ownership, but it is usually well below 50 percent, says Katz.

"That makes a major difference in motivation," he says, and the angels want the entrepreneur to stick with the enterprise.

Angels also like to keep entrepreneurs close at hand. They want to act as advisers and keep close track of progress.

"The vast majority of angel investments are within a two-hour drive," says Katz. So, local entrepreneurs are more likely to find angel funding in St. Louis than elsewhere.

If the invention is really a mousetrap, it will have a tougher time getting funded. Biotech and software are the hot ventures both among St. Louis angels and the local venture capital firms.

That gave Pettyjohn an advantage as he made his pitch to the Arch Angels.

"It wasn't easy, especially at the time we did it," he says. As the Great Recession took hold, some of the investors who pledged funding backed out.

But he had a technology product, the engineers to produce it and an experienced business manager. Pettyjohn himself knew retailing. "People have to believe in the leaders of the company," he said.

He ended up with enough money to go on, although he's coy about the amount.


Aisle411 signed up more stores, including Shop 'n Save and Schnucks. Then Pettyjohn did something economic development officials in St. Louis hate to see. He opened a second office in Silicon Valley and moved himself there.

The draw of the coasts is strong on technology companies. Aisle411 has to collaborate with other software firms, and they were generally in California. Pettyjohn found himself flying there so often that he decided it was easier to move.

Silicon Valley is also the world capital for venture financing, the next level of funding his company will need. The Valley alone had $8.4 billion in venture capital investments this year, compared with $1.1 billion for the Midwest. The national total was $21.2 billion, according to PricewaterhouseCoopers and the National Venture Capital Association.

Still, St. Louis offers good talent cheaper than in California, he says, so he plans to keep an office here.

St. Louis has its own crop of venture capitalists, but they tend to concentrate on biotechnology. Especially for technology businesses, it's still easier to land venture capital in California.

Venture capital firms are funded by pension funds, endowments, other institutional investors and wealthy individuals. Those investors saw their own holdings shrink after the 2008 stock market crash, and so they've shrunk the amount they allocate to venture capital.

It's a national phenomenon with venture investment falling from $30.7 billion in 2007 to this year's $21.2 billion.

In turn, venture capital firms have shrunk the amount of time they are willing to hold an investment before cashing out.

That's bad news for drug or medical device developers, who spend long periods in development and human trials.

"I've never seen the so-called valley of death between technology coming out of the universities and getting commercialized as wide as it is now," said Thomas Melzer, managing director at RiverVest Venture Partners, a St. Louis venture firm which has invested $164 million. "The venture industry has shifted further out on the food chain and is looking at later-stage operations."

That means that medical products usually must be into the human or animal testing stage before venture capital will commit. "It's a very tough sale," says Melzer, whose firm invests in medical ventures.

Investment has become so hard to get that he worries that it may choke off the pipeline of medical innovation as early-stage ventures are denied funding.

The national cutback is not as hard on technology entrepreneurs, who often have a shorter path to profitability. But new tech firms in St. Louis face another problem: Most venture firms here won't touch them.

RiverVest, Prologue Ventures and Oakwood Medical Investors, all in St. Louis, specialize in medical ventures. Advantage Capital takes a broader view, and uses state tax credits to favor entrepreneurs in lower-income neighborhoods.

St. Louis lacks venture capital focused on information technology, such as computers and software.

"I don't think there's a single venture capital fund in Missouri that specializes in (information) technology," says Sinecuse of Capital Innovators.

And that may mean more entrepreneurs like Pettyjohn moving to Silicon Valley.

Source: (c) 2011 the St. Louis Post-Dispatch

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