The State of Risk Capital in Wisconsin

PanVera, for example, was funded with $4M in angel money.

But the angel networks offered a new mechanism to entrepreneurs. Tech entrepreneurs could apply to the first networks (Wisconsin Investment Partners, founded by Dick Leazer and Terry Sivesind, and Early Stage Research, founded by Tom Terry and Larry Landweber) for investment consideration. At company presentations, a syndicate of investors who were actively looking for precisely these types of opportunities would make relatively quick decisions. The Nasdaq was above 4000, interest rates were low, and venture capital investments nationwide exceeded $100B.

The venture world is different now. Venture capital investments totaled $21.2B in 2003, the Nasdaq is at 1300, and early round valuations are rarely above $3M.

In truth, we’ve been here before – in 1998. Venture capital investments were $21.6B that year, and the Nasdaq had only recently broken 1500. My instinct is that valuations were also probably comparable (though I suspect deal terms in 2003 favor the investor more than in 1998).

I was there when ESR was formed, having been hired to do the research for the network. I’ve watched the formation of other networks: Silicon Pastures in Milwaukee, Origin Investment Group in LaCrosse, Valley Angels in Green Bay, and others. SWIB has made laudable efforts to support the risk capital industry in Wisconsin, and we’ve watched anxiously while the big players from the coasts (even as their own portfolios tanked) made preliminary investments in Wisconsin companies. It’s been a wild ride – possibly the most dramatic three years in the history of venture investing – and while it’s not over yet, it is time to provide some perspective. Where is here, anyway?

The University of New Hampshire’s Center for Venture Research suggests that angel investing dropped from about $45B in 2001 to $30B in 2002. The drop has been far less dramatic than the VC drought. Our experience suggests that private investors have “retrenched” as their Dow Jones and Nasdaq paper profits dwindled. But the money is still out there.

Most angels, however, aren’t in it just for the money – most have additional motives. They want to encourage local economic development; they want to support the development of a high-tech community with high-wage jobs. Perhaps they should allocate a specific amount of money each year to angel investing – but most don’t. They invest when they identify an engaging opportunity and they have the cash available.

How do we get past here, then?

My comments about being back in 1998 are serious. Last year, numerous entrepreneurs passed on the terms offered by our angel networks, explaining that they would “hold out until the market comes back.” Rather than give up 40% ownership, they’d stick it out for another year: low wages, hamstrung R&D budgets, nervous employees, evolving competition and all.

It’s my opinion that, for the most part, the market has come back – it’s come back to reality.

The problem is too many companies are seeking risk capital that isn’t appropriate for them. Risk capital has always been expensive (except in 2000), and it’s normal for entrepreneurs to give up big chunks of equity in the first few rounds of financing. And lots of start-up companies are supposed to fail – it’s a natural, even required outcome of the capital market system. Professor Bob Pricer used to say that 90% of restaurants fail in the first 18 months – that’s worse than the failure rates for tech companies. According to Jeffrey Sohl, the director of the Center for Venture Research, only 10% of companies that pitch to angels should expect to get funded, compared to one in four in 2000. As I’ve heard Dick Leazer say numerous times, the goal isn’t more start-up companies – the goal is more quality start-up companies.

At the same time, it’s not 1998. The UW and Medical College are national leaders in tech licensing. The angel networks are working together more and more often. The Wisconsin financing community has shown a willingness to take risks, both good and bad. TechStar has a half-dozen clients, with two funded. The State has stepped in with programs supporting networking and entrepreneurship. Assuming the SWIB money anchors additional VC funds, it’s not unreasonable to expect that total venture capital under management in the state will have grown from $50M in 1998 to over $350M in 2003. In Wisconsin, there is more money out there than ever before, in almost every form (not even including the expected infusion of SWIB money into the VC field). The president of a private bank in Wisconsin commented that their commercial business has more than doubled in the last 3 years.

We aren’t “there” yet (though some of us see Austin and Silicon Valley as both inspirational and cautionary tales). We can’t stop working to bring forward innovative and beneficial technologies. We have to support entrepreneurs, even knowing that some will be winnowed out. We must learn from mistakes. We should celebrate successes: the Origin Investment Group led an angel round for the first time just this month.

Given the opportunities, we shouldn’t mistake today’s financing reality as a soon-to-be-alleviated slump. Early stage finance isn’t easy. Thus angels band together, and VCs syndicate deals, and entrepreneurs network. Governor Doyle may not have been referring to us specifically in his inaugural speech, but his words are apt: “We have many risks to take… if you work together , you’re liable to get more done – and when you do, everyone comes out ahead.”



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Adam J. Bock is the research manager for Early Stage Research, an angel network, and a regular contributor to the Wisconsin Technology Network.

Editor's Note: Adam Bock will be will providing perspective and expertise across a number of areas, including the world of angel financing as well as his own experience with start-up companies. His columns will run every other week. We encourage our readers to read, ponder and provide feedback to Adam on his columns on what's useful, what's not and submit your questions and opinions to adam@wistechnology.com