DESERT LAW BLOG

CHANDLER BIOSCIENCE AND TECH INCUBATOR IN THE WORKS

I attended the US-Asia Expo this week and one of the main themes of the business leaders speaking there was that Arizona needs more public support to both attract new companies and to organically grow new companies here in Arizona - particularly in the technology, biosciences and renewable energy fields.  Most there seemed to agree on the need for economic incentives from the state and municipalities in some form or another.

ASU has been leading this effort through their establishment of Skysong last year in south Scottsdale.  Skysong is envisioned as a live-work tech incubator where start-up companies can interact with academics and area business leaders to organically grow Arizona-based tech businesses.  It has unfortunately struggled to get out of the gate due to the economic downturn and big spending cuts by the Arizona legislature in their efforts to balance Arizona's budget (particularly the cuts to the Arizona Science Foundation budget).  Nevertheless, the business leaders at the Expo seemed optimistic Skysong will prove to be an important resource in the coming years in growing the local tech community and creating new knowledge-based companies and jobs here.

Yesterday, Chandler also took a pretty big step forward in adding to the local resources meant to organically grow new tech, bioscience and renewable energy companies here in Arizona with the announcement that they are finalizing funding for a new multi-million dollar tech incubation center.  The center is meant to provide the necessary facilities for start-up companies here in the Valley at a much lower cost than market rates.  It will be located in a building originally build by Intel that will be leased and remodeled by the City of Chandler and then leased at low rates to start-up companies.  In particular, it will have advanced wet-lab facilities that are necessary for (but often unavailable to) bioscience start-up companies.

Chandler is home to Intel, which attracts many highly skilled professionals in engineering, math and science.  Having resources like this new incubator available may help retain some of that talent in the Valley when they decide to branch off on their own as entrepreneurs - instead of moving away to other cities more known as tech and bioscience centers. 

This new incubator and Skysong combined with the many knowledge-based workers brought to the Valley by the chip industry will hopefully kick-start the growth of new tech, bioscience and renewable energy start-up companies to the point where a critical mass exists and the Valley becomes better known as a destination for these types of companies.

FALLING START-UP COMPANY VALUATIONS

Silicon Valley law firm Fenwick & West publishes a quarterly survey of venture financing, and not surprisingly the first half of 2009 was not pretty.  They report that for the last two quarters "down rounds" have outnumbered "up rounds" in venture financing of start-up companies - meaning the valuation of the start-up companies they are funding is falling.  In a down round, new stock is issued to investors at a lower valuation than previously issued stock.  This hurts previous investors as the value of their earlier investment falls.  Down rounds in the second quarter outnumbered up rounds by 46% to 32%.

From the NYTimes article about the study...

For context: in the salad days of 2007’s third quarter, there were some 79 percent up rounds and only 14 percent down rounds.

“These two previous quarters were by far the worst quarters for valuations in a good number of years, going back to the dot-com bubble bursting,” said Barry Kramer, a partner at Fenwick & West. “For the venture capital environment to work, you are supposed to have nontrivially more up-rounds than down-rounds. This is depressing to venture capitalists.”

The law firm, which surveyed 89 deals, or around half of the financings in the Valley last quarter, also found that the average valuation for companies receiving venture capital during the quarter decreased by 6 percent from the companies’ prior financing round. That’s slightly more of a drop than the 3 percent decrease the survey reported in the first quarter. These are the only two negative quarters since the law firm began reporting these statistics in 2004.

ARTICLE ON I/O DATA CENTERS

Earlier this year, I wrote about Sterling Partners' investment in I/O Data Centers, with which they leased the former Le Nature's headquarters by I-17.  The Business Journal has a nice write-up today of their progress in retrofitting the building for their data storage and "colocation" technology center.  Particularly interesting to me is their effort to reduce their power consumption through use of alternative energies, such as 4 megawatts of solar generation that will be installed on the roof of the building and a chilled water cooling system.

FUNDING FOR START-UPS STILL A STRUGGLE IN ARIZONA

The Business Journal has a good article today documenting some of the issues facing start-up companies in Arizona due to the weak economic environment... 

Part of the issue is the nature of startup investing. Venture capital firms, often one of the first stops for late-stage startups, have hunkered down and are investing only in their own portfolios — if at all. According to the MoneyTree report compiled by PriceWaterhouseCoopers, the first quarter was anemic for deals in the Southwest, with only $40 million of the $3 billion invested nationwide going to Arizona, Utah and New Mexico companies.

Of that, about $12.2 million went to three Arizona businesses. Southwest Windpower in Flagstaff nabbed the bulk, about $10 million. FiREapps Inc. in the Valley received $1.2 million, and Salutaris Medical Devices Inc. got $2 million.

Those numbers, of course, are not pretty for Arizona. 

For earlier-stage Arizona companies there is still some hope for finding local money through angel investor networks.  I attended the TiE event last week and had the opportunity to listen to an excellent panel of angel investors.  Their general consensus is that angels are still looking for investment opportunities in Arizona start-up companies - only that the size of the investments will be smaller, the valuations will be lower and the scrutiny of the company's viability will be greater.

Not an easy time to be an entrepreneur, but I often remind people that during the last dry spell in funding, some great companies were founded and thrived.  I think a more difficult funding environment weeds out some of the companies that should not normally receive funding, and makes people who do have great ideas work even harder to polish those plans and to figure out the correct business model for bringing those ideas to the market - thus improving their chances for success.

VENTURE CAPITAL INVESTMENT LOWEST SINCE PRE-DOT COM BUBBLE

NVCA has released first quarter numbers for venture capital investment and it continues to look ugly.  Venture investment hit only $3 billion in the first quarter of 2009, the lowest level since 1997, according to the NYTimes.  Clean-tech companies = a lone bright spot in the 4th quarter of 2008 - had the steepest fall in investment, falling by 84%.  More from the article:

Software companies received $614 million, a drop of 42 percent from the fourth quarter of last year. Quadriserv, which makes market data software for securities lending, was the biggest deal recorded in the sector, raising $34 million.

Internet companies raised $556 million, down 31 percent. The biggest deals were Obopay, a mobile phone payment service, and Twitter, the microblogging site, which each raised $35 million.

Biotechnology and medical device companies raised $989 million, a decline of 40 percent. Five of the 10 biggest deals in the quarter were medical companies, the biggest of which was Anacor Pharmaceuticals, which makes drugs for inflammatory and infectious diseases and raised $50 million.

According to the article, money is sitting on the sidelines and venture firms are busy tending to current portfolio companies amidst the uncertainty of the current economy and the dim outlook for exits from their investments:

Venture firms have been bruised by the economic crisis, which has made initial public offerings of venture-backed companies almost impossible and acquisitions much harder to come by.

As a result, investors are funneling time and money into existing portfolio companies instead of a new generation of start-ups. Only 132 start-ups raised money for the first time, the lowest number in 15 years.

Though venture capital funds raised $4.3 billion in the first quarter to invest in new companies, most are doing so slowly, waiting to see if the markets improve.

The full press release from NVCA can be read here (pdf).

VENTURE CAPITAL INVESTMENT DEAL TERMS GETTING TOUGHER

Businessweek in an article this past week documents some of the changes that the pain in the venture capital and start-up company sector are bringing about - particularly in investment terms being imposed on start-ups.  As the economy gets worse and young companies struggle, more investments are down-rounds - or investments at lower company valuations than previous investments.  And the deal terms are getting tougher.  The article shows results from a survey done by Silicon Valley law firm Fenwick & West.  Among the findings:

As venture capital firms retreat and finance fewer deals, the financiers that do move forward are continuing to extract tough terms from the entrepreneurs they go into business with. Of the companies that received financing, 41% of the deals contained "liquidation preferences," or provisions obligating that the most recent investors get their money back first if the company is sold or acquired. That's about the same rate as the previous two quarters.

However, many more firms that do receive liquidation preference are getting "multiple liquidation" preferences, which state that a venture firm will get back as much as two or three times the amount of capital it invested. In the fourth quarter, 23% of the companies that secured preferences negotiated a multiple preference, up from 16% in the third quarter.

Multiple liquidations preferences mean that, for example, a venture capital firm investment $1 million would get paid a multiple of their $1 million investment (up to $3 million according to the study) prior to anyone else getting paid following a sale of the company.  This is a mechanism that venture capital firms use to elevate their return on investment above what they can normally earn simply from dividends on their preferred stock.  It's also a safety mechanism to make sure they get paid whatever money is left if the company liquidates.

Another feature increasingly being used are "pay to play" terms:

When companies can't find new investors to bring into a company, they sometimes will try to corral a new round of financing from existing investors. Some may balk. To force all of the current investors to pony up the money, venture capitalists who are willing to play will create a provision stipulating that if others don't participate, their existing equity, which is usually in preferred stock, will convert into common stock.

So in a given venture investment, there are often several different venture groups that will fund a round of investment (say VC A, B and C).  A "pay to play" provision means that if the company needs funding down the road to continue, can't find new investors and only current investor A wants to fund another round, B and C will have their preferred stock from the initial round converted into common stock and A will end up being the only holder of preferred stock - with its rights, preferences and dividends.  B and C are relegated to the last-in-line status of common stockholder in the case of a sale or liquidation of the company - essentially a punishment for not participating in the latter financing round.

As 2009 drags on, we are no doubt going to see investment terms continue to tighten as venture capital firms use the downturn as an opportunity to extract additional terms and conditions that mitigate their risk and help to safeguard their investments.  Start-ups will have to decide whether to try to tough it out without taking additional funding and its concomitant loss of valuation and control.  In this down economy, however, they may have no choice but to accept the tougher terms in order to just survive.

ANGEL INVESTORS CUT BACK FUNDING

Angel investors, the early-stage investors in new start-up companies, are feeling the pinch of the economic downturn writes the NYTimes:

But like all investors, many angels suffered deep losses when the market plunged last fall.  That has left them skittish, investing in fewer technology start-ups and demanding more of those they do consider, leaving founders struggling to find money at the stage they need it most. The slowdown, entrepreneurs and investors say, could stunt the growth of new companies and have long-term effects on innovation.

The long-term effect is fewer good start-ups that are in the pipeline for venture capital firms in the next several years, limiting venture capital prospects when the economy does come back:

The real impact will hit Silicon Valley two or three years down the road, said Mark Heesen, president of the National Venture Capital Association. That is when start-ups that receive angel financing today would typically turn to venture capitalists for their first round of institutional investments, known as a Series A.

The reverse is also true as the current slowdown in venture funding is making angel investors skittish because they are worried the companies they invest in won't be able to get venture funding down the road:

During normal economic times, several years after a start-up raises angel financing, it seeks larger amounts of money from venture capitalists to grow. But as venture capitalists also cut back on investments, many angels are wary of investing in a start-up without the assurance that the company will be able to raise more money to keep growing.

The angels investors who are still in the game are asking for more at lower valuations:

The angel investors he met with this fall, though, were far more demanding. “I could not believe the complexity,” he told The Times. “For small investments compared to their net worth, they brought in financial advisers and a whole list of questions.”

Some made impossible requests, like proof of patents, which take several years to acquire. Others would not even meet with him. “I think we have a very compelling business, we’ve hit all our milestones. I set up lunches with friends and they just keep putting them off,” he told The Times.

But many angels are sitting on the sidelines looking at other, less risky opportunities - particularly potentially undervalued blue chip stocks:

Investing in the stock market “smells to me like a much better opportunity than investing in the friend of a friend who wants to open a green Chuck E. Cheese restaurant or software to let people choose their dental implants,” Mr. Martin told The Times. “Those could be great ideas. But that versus Pfizer stock is an easy choice for us right now.”

Yes, 2009 is going to be a difficult year for start-ups.  Hopefully the stimulus package will find ways to help small, innovative companies.

VENTURE CAPITALISTS HUNKER DOWN AMIDST NEGATIVE RETURNS

From an article in the Boston Globe today covering a panel speaking last week on venture capital:

"Given what's happening in the macro economy, most venture guys took the opportunity to hunker down, look at the companies in their portfolios, and prepare for what could be a difficult 2009," said Ajay Agarwal, managing director at Bain Capital Ventures in Boston.

And the reasons...

Several factors are causing hesitation, the panelists said. One is a frozen market for initial public offerings of venture-backed companies - there were only a half-dozen nationally last year, none of them in New England - leaving corporate buyers of start-ups in a stronger bargaining position.

A second factor has stemmed from the first. Venture firms have had to spend more time and money tending to mature companies in their portfolios that can't go public or be sold profitably. Too often, that has come at the expense of funding for promising early-stage start-ups.

Finally, many would-be entrepreneurs have gotten cold feet about taking a gamble, and trying to raise money, in a time of uncertainty.

Bob Higgins, founding partner at Highland Capital in Lexington, warned of what he called a "divorce syndrome" that's discouraging executives from leaving secure corporate jobs - those few that are still secure - to start companies in the current environment.

"This is not the time to say, 'Honey, I'm making $300,000 a year but I'm going off to start a company,' " Higgins said.

Of course that is for the people still making $300,000 per year.  As the article points out, the upside to this terrible economy is that there is a lot of talent looking for work and the start-up companies that do manage to attract capital have gone through a rigorous enough vetting that they may be seen as a good place to be (therefore attracting that talent).

Also:  The NYTimes has some more statistics on venture capital returns in 2008.  They are down, but not as badly as the stock markets indices.  With fewer exit strategies, it is harder to realize gains, the article points out.  I, on the other hand, point out that investment exits in this market don't always mean gains.  It can also mean recognizing losses and simply trying to recoup some of your investment.

VENTURE INVESTMENT IN GREEN TECHNOLOGY START-UPS RISES IN 2008

The NYTimes parses the 2008 venture capital numbers from the NVCA and finds that while fundraising and investment were down significantly in 2008 (particularly in the 4th quarter), green technology start-ups continued to fair well in attracting venture capital investment - raising 52% more in 2008 than 2007.  According to their data, this amounted to $4.1 billion invested into 277 "clean tech" start-ups in 2008.  Solar/photovoltaic technology start-ups accounted for nearly half of that money - a good sign for Arizona solar companies looking to grow.

TPI COMPOSITES RECEIVES SECOND ROUND FUNDING

The Republic and Business Journal both reported today on Scottsdale-based TPI Composites successfully raising second round financing in the amount of $20 million from the private equity wing of GE Capital (one of TPI's strategic partners) and a couple of other equity firms.

TPI uses their composite technology to manufacture light rail and maglev rail cars and for military vehicles.  More recently they have moved heavily into the production of wind turbines for electrical generation, having just opened up manufacturing facilities in Mexico, China and Iowa.  Mexico and China make sense because of their cheap labor, but Iowa?  For those of you who haven't been back to the Midwest lately, it is becoming the hot thing to build those huge wind turbines in the middle of corn fields on the flat (and windy) midwestern plains.  So Iowa makes sense and I am sure they are happy for the manufacturing jobs in the Midwest.

I'm not quite sure the reason or history behind why the corporate headquarters are in Scottsdale, as all of the manufacturing facilities are in far away states or countries.  But it is good to see a company based in Arizona taking the lead in alternative energy production - even if it is a form of energy which we don't have much of in the state.  With TPI's most recent round of funding, they are certainly well positioned to be able to take advantage of the extended tax credits for renewable energy and the expected bump up in funding for renewable energy platforms from the Obama administration.

VENTURE FUNDRAISING DOWN IN 2008

The Boston Globe reports venture capital fundraising nationwide from limited partners was down 21.4% in 2008 according to numbers released from the National Venture Capital Association.

The fourth quarter saw the largest drop with $3.4 billion raised versus $8.4 billion raised in the third quarter of 2008 and down from $11.7 billion in the fourth quarter of 2007.  That third to fourth quarter drop-off was about the same percentage drop reported in private equity numbers earlier this month by Dow Jones Private Equity Analyst (which also includes venture firms in its analysis under the "private equity" umbrella).

Press release from the NVCA with some historical numbers can be read here (pdf).

SCOTTSDALE-BASED FIREAPPS SECURES VENTURE CAPITAL FUNDING

According to the Phoenix Business Journal, Scottsdale-based FiREapps secured $8.75 million in venture capital from new investor Trilogy Equity Partners and current investor Ignition Partners.  Trilogy is getting one board seat and is known as sort of a secretive fund - having no website or much other information out there.  The article notes that FiREapps also secured additional debt funding from Silicon Valley Bank for operations.

From FiREapps' website:

FiREapps™ is the leading provider of corporate foreign exchange management technologies. Established in 2005 as a division of Rim-Tec (Risk Management Technologies), FiREapps developed the first solution to automate foreign exchange exposure management for multinational companies, delivering unparalleled expertise and driving measurable results.

FORMER LE NATURE'S PHOENIX BOTTLING PLANT LEASED BY I/O DATA CENTERS

The former Le Nature's water bottling plant in south Phoenix has been leased by i/o Data Centers, a growing Phoenix company I wrote about a couple of weeks ago.  The 500,000 square foot bottling plant was an award winning state-of-the-art facility when opened several years ago.  It was purchased by CB Richard Ellis Investors, an ownership group led by CBRE, in 2006 and leased to Le Nature's.  Le Nature's subsequently went bankrupt in 2006 amid charges of embezzlement and fraud by top executives, closed the Phoenix plant and CBRE had been been looking for a new tenant ever since.  I have driven by the plant often and it is quite an impressive facility.  I'm sure i/o will be a welcome addition for the City of Phoenix (and will help temper those rising vacancy rates I just wrote about).

i/o will use the additional space to expand its data storage and management operations.  The expansion is being made possible by a $56 million venture investment from Sterling Partners in Chicago.  The full article from the Arizona Republic can be read here.

EXIT STRATEGIES FOR VENTURE CAPITAL FUNDS AND THEIR INVESTORS LIMITED

The New York Times has had a couple of articles over the last few days highlighting the difficulties for venture capitalists in exiting their investments in start-up companies - whether it be through sale or IPO of the company or through selling their investments in the secondary market.

Typically, venture capital investments in start-up companies are expected to produce some sort of exit opportunity within three to seven years.  Ideally, the company in which a venture capital firm invests is sold at a higher valuation to a larger company or completes an initial public offering (IPO).  For example, according to the NYTimes article, Cisco acquires 10 to 15 technology companies a year.  And in 2007, over 75 venture capital backed IPOs were completed.

Unfortunately for venture capital funds, as this Reuters article notes, venture-backed IPOs were down precipitously in 2008 - by one estimate only six were completed in 2008.  And companies like Cisco are dropping their acquisitions - in 2008 it only purchased five companies.  As the stock market continues to be volatile and economic uncertainty abounds, few believe there will be much improvement in 2009 in this arena.

For investors in venture capital funds, this lack of exit opportunity for their portfolio companies leaves few options for freeing up their cash in the short term.  Investments in venture capital funds are illiquid and investors go in with a general idea of the minimum amount of time their capital will be tied up.  However, in this difficult economic environment, many of the limited partner investors in venture capital funds - including pension funds, insurance companies, college endowments, etc. - are looking for ways to free up cash.  Some institutional investors have portfolio ratios they are required to maintain - capping the percentage of funds to be invested in venture capital firms.  With their other portfolio holdings devaluing over the last six months, these firms suddenly see their venture capital holdings breaching those percentage caps and are required to liquidate some of their venture capital fund holdings.

This is creating a situation where limited partners in venture capital funds are forced to sell their ownership interests into the secondary market at severely depressed prices.  This NYTimes article today details the plight of limited partners in venture funds who are selling their interests to secondary firms for at least a 40% discount.  Forced selling of course creates an abundance of supply and further depresses prices.  The only other option for freeing up cash is for venture fund managers to try to force a distressed sale of their portfolio companies to get whatever cash they can for their investment - something they may or may not be able (or willing) to do in this market.

Here(pdf) is the NVCA report on 2008 venture-backed IPOs and acquisitions.

Update:  An article here from the NYTimes indicating that the IPO slump is expected by many analysts to continue well into 2010 - bad news for venture capitalists.

SCOTTSDALE-BASED I/O DATA CENTERS SECURES $56 MILLION EQUITY INVESTMENT

Earlier this month, Scottsdale-based i/o Data Centers secured a $56 million equity investment from Chicago-based Sterling Partners.  The Arizona Republic carried a story about the investment this past Friday.  The company provides secure data storage for business customers - anything from company customer data to back-up for disaster recovery.  Their business is driven by the priority many companies are now putting on digitizing their documentation and operations.

Interestingly, one of the sales pitches i/o uses is its location in Phoenix, far away from most, if not all, natural disasters.  On their home page, they have a map of "catastrophic risk" in the U.S., including earthquakes, hurricanes, tornadoes and hail.  And of course Phoenix is far away from any of the risk zones.

In any event, it is good to see an Arizona-based company attract such a significant amout of venture capital in these tough times for raising capital.  The press release from i/o can be read here (pdf).

THERESE POLETTI DOESN'T LIKE THE OUTLOOK FOR START-UPS IN 2009

Writing for Marketwatch, Therese Poletti sounds a down note for tech start-ups and declares Web 2.0 officially dead.  Getting funding for your start-up is the main issue and she heavily cites a survey by the National Venture Capital Association (NVCA) indicating that 2009 is going to be a rough year to get early-stage tech businesses off the ground.

Her take is that unless it is a revolutionary idea - not already in play - or is in clean tech, it is best not to quit your day job and to wait for better times to launch your start-up company.  A choice excerpt from her column:

"The cash-rich corporate shoppers and free-spending buyout shops of recent years -- which combined to push tech deal making last year to a nearly half trillion dollar business -- stepped out of the market in 2008," said Brenon Daly, an analyst with the 451 Group, in a summary.

According to the 451 Group, there were only two venture-backed tech IPOs in 2008, and both offerings are currently underwater.

So what is an entrepreneur to do? According to the VCs interviewed in the NVCA survey, almost all venture capitalists, 96%, believe it will be harder for new companies to get funded in 2009. And another 93% predict it will be harder to sustain their existing portfolio companies, as exit strategies via acquisitions and the public markets have nearly completely shut down.

"2009 will be the year in which the world's capital markets begin rewarding 'real engineering' instead of 'financial engineering' again," said Trevor Loy, a general partner at Flywheel Ventures with headquarters in Santa Fe, N.M. He believes entrepreneurs creating companies based on innovations in materials science, chemistry and other physical sciences, looking to solve key problems of energy, water, infrastructure and health will offer the most promising long-term returns.

Most VCs, 48% of them, expect an increase in investment in clean tech companies, while 79% predicted a fall off in investment in semiconductors.

And here (pdf) is the actual press release from the NVCA about its survey.

My take is that in 2001 and 2002 during the dotcom bust, there were a lot of great ideas that were developed and refined in basements and incubators that led to Web 2.0.  So while 2009 may be a bad time to go out and find funding, entrepreneurs should keep developing their ideas and collaborating with others to polish them in anticipation for a better funding environment.

BUSINESSWEEK'S HOTTEST START-UPS 2008 INCLUDES EVERSPIN TECHNOLOGIES

Businessweek writes that venture capitalists invested over $7 billion in 1,400+ start-ups over the past four quarters - the most in a year since 2001.  That number, of course, is expected to drop in the next four quarters.

As part of the feature, they include a slideshow of their top 25 most promising early-stage start-ups for 2008.  Coming in at #9 on their list, raising $32.5 million over the last four quarters, is Chandler, Arizona-based Everspin Technologies.  Everspin was spun out of Freescale Semiconductor in June 2008 as a stand-alone company and is backed by venture capital from New Venture Partners, Sigma Partners, Lux Capital, Draper Fisher Jurvetson, and Epic Ventures.  They develop MRAM.

Now I would still be more impressed if this start-up was a stand-alone operation from the get-go, as having a parent company to incubate your business is a  bit less challenging.  But it is still good to get at least one Arizona company on the list to give Arizona start-ups a little exposure.  Hopefully the executives of Everspin are working to help other local start-ups along.

WHAT DOES "RAISING THE GATES" MEAN?

A new phrase investors are learning these days is "raising the gates."  So what exactly does that mean?  Simply put, to "raise the gates" means investment managers deciding to keep investors from redeeming their investments in hedge funds or funds of funds.  Think of a bunch of sheep running for freedom and the farmer slamming the gate shut just before they escape. Here is an article from the NYTimes yesterday that uses the term.

Individual hedge fund investors typically have the ability under their investment agreements to withdraw or "redeem" their funds quarterly or semi-annually.  With the stock market dropping, new bankruptcies every day, general panic throughout markets in which hedge funds play (including mortgage backed securities, derivatives, etc.) and straight-up fraud (Bernie Madoff-style), investors are attempting to liquidate their hedge fund investments as quickly as possible - pulling billions out every quarter.

This heavy redemption requires hedge fund managers to liquidate a lot of their fund's holdings into cash in order to satisfy redemptions - making it exceedingly difficult to recover any amount of the money they have lost over the past several months' slide.  Many hedge funds are shutting down because of it.  So hedge fund managers are exercising clauses in their investment agreements temporarily limiting redemptions to allow them to keep the remaining money working in the markets - not necessarily a bad idea as there are a lot of good down-market plays during a recession and what is lost is already lost.

Quarterly redemptions is one thing that differentiates hedge funds from most private equity and venture capital funds.  PE and VC funds often have much longer lock-up periods for investors' money as they typically invest in longer term, less liquid assets (start-up companies, distressed companies, real estate, etc.).  So in order to exit a PE or VC fund, investors have to sell their ownership stakes in the secondary market, leaving the fund intact with more leeway to make a comback as our economy eventually rebounds.  Investors wishing to sell their private equity or venture capital fund ownership stakes should consult an attorney to make sure they comply both with their fund's restrictions on secondary sales of ownership interests and relevant securities laws.

INVEST SOUTHWEST FOLLOW-UP - PARTE DOS

I had an opportunity last week to meet and briefly chat with Dave Bittner, Chairman of Invest Southwest.  He clarified that while the conference is meant to help raise investment funds for the presenting companies, it can often take up to 18 months for the companies that present there to close on funds from investors attending the conference (some do it much sooner though).  The conference is often the "first date" (blind date?) for these companies with potential investors and they eventually build a relationship over a number of months through discussions between the companies and investors - hopefully leading to funding.

Dave works for Beanstalk CFO Group here in Phoenix.

My previous posts on Invest Southwest are here and here.

INFUSIONSOFT IN GILBERT RAISES $7.9 MILLION IN SERIES B FINANCING

Per NYTimes Dealbook, Infusionsoft, based in Gilbert, Arizona, announced this past Friday that it had closed on $7.9 million of Series B financing from vSpring out of Salt Lake City and Mohr Davidow Ventures out of Silicon Valley.

From the Infusionsoft press release:

About Infusionsoft
Infusionsoft, the leader in marketing automation software for small businesses, is revolutionizing the way small businesses grow. There are twenty-five million small businesses in America that need an easy-to-use, affordable, and powerful software solution that increases sales while freeing up their time. The company’s follow-up marketing software addresses that need by helping small businesses automatically convert more prospects to customers, get repeat sales, and grow their business without growing staff. The privately-held, Inc. 500 company, based in Gilbert, Arizona is funded by Mohr Davidow Ventures and vSpring Capital. For more information, visit www.infusionsoft.com.

Update:  A few quotes from the executives involved in the fundraising are here.

VENTURE CAPITAL OUTLOOK NOT SO HOT

The Times carried a story today detailing the bleak outlook for Silicon Valley venture capital firms going forward - the theme being that pain is being felt on so many levels that the system is currently broken.  Large institutional investors (the backbone of venture capital investing) are losing cash at such an astonishing rate in private equity, hedge funds, real estate and other investments that they are starting to default on capital calls from their venture capital and private equity commitments.  Any further fundraising is expected to be extremely difficult going forward even though there are going to be plenty of distressed company and asset plays in the next several years.  And the exit strategy of venture capital investing - IPOs - are down sharply due to the current economic environment.

The article brings up an interesting scenario where lack of venture capital investing over the next couple of years could mean that the IPO pipeline would be virtually empty and venture firms might have to more or less start from scratch.  In the meantime, small businesses - particularly in the software/tech industry - are seeing their overhead costs come down far enough that they are learning to get by without venture financing.  The article notes:

To cap it all, entrepreneurs are finding that they might just succeed without cash from VCs at all. Paul Graham, a partner at Y Combinator, which specialises in seed funding for tech start-ups, said that it was much cheaper now for entrepreneurs to get going on their own.

In an online essay, Mr Graham, recently named one of Time Magazine’s top 25 most influential people on the web, said that start-ups were now becoming profitable on revenues of just $3,000 a month – basically the cost of the founders’ living expenses.

Computer hardware was coming down in price, open source had made software free, the web had made marketing and distribution free and more powerful programming languages meant development teams could be smaller, he said.

“Start-ups aren’t tied to VC the way they were ten years ago. It’s now possible for VCs and start-ups to diverge. And if they do, they may not reconverge once the economy gets better,” he said. “Once you’re profitable you don’t need investors’ money. And because internet start-ups have become so cheap to run, the threshold of profitability can be trivially low. ”

I think start-up companies will still look to venture capital firms in the future for financing - particularly ones that need extra capital to reach a size where they can achieve profitability (e.g., a biomedical company that needs funding for research and development).  But where possible, many companies will try to avoid venture capital financing for a whole host of reasons - starting with giving up a portion of control over the company.   It will be interesting to keep an eye on the venture capital world over the next several years to see if they are able to crank up fundraising again and to see if they maintain their importance in the ever-evolving world of start-up companies.  Perhaps the new rules of venture capital in the next several years will mean software/internet/tech companies will shun venture capital, while more capital-intensive companies still seek funding.

For Arizona start-up companies, such news is even bleaker as it is hard enough to get the attention of the larger Silicon Valley venture capital firms even in a good market.  As venture firms become even more picky in their investments and the pool of available money gets smaller, Arizona start-up companies are going to have to fight that much harder for a slice of the pie.

INVEST SOUTHWEST FOLLOW-UP

Andrew Johnson on his blog at AZCentral reports that Medipacs, LLC won the best presenter award at Invest Southwest yesterday and the $200,000 prize that comes along with it.   No immediate announcements of investments in the presenting companies are expected, but discussions apparently will take place between several of the presenters and conference attendeeds/investors.

Update:  Here is the Phoenix Business Journal's coverage of the event with some additional details about each presenter.

Update #2:  A longer Sunday story in the Arizona Republic about Invest Southwest is here.

INVEST SOUTHWEST IN PHOENIX THIS WEEK

Against the backdrop of a severe downturn in private equity and venture capital financing in the U.S., the Invest Southwest conference starts tomorrow here in Phoenix. Andrew Johnson from the Arizona Republic had a nice write-up Sunday about the conference and its attendees. The annual conference is billed as an opportunity for emerging Arizona companies to present their business plans to venture capital and private equity firms (i.e., to ask for money).

When reading the AZ Republic article, you can’t help but be struck by what a small share of private funding Arizona companies receive. The article indicates that Arizona companies managed to secure $71 million in venture financing last year, while in the third quarter alone of 2007, there was $7.1 billion in venture funding in the U.S. And for 2008, a paltry $14.5 million has been raised by Arizona companies.  It’s a theme I’m sure I will return to often – Arizona needs to push harder than it already has to attract and maintain entrepreneurs who will base their start-up companies here.  I know there is a lot of good engineering talent in the large chip companies here in Phoenix.  Those individuals shouldn't feel like they need to leave Arizona to get the support resources and funding they need to have a successful start-up company.  Invest Southwest is a good start to getting Arizona companies some exposure without the need to make the trek to Palo Alto.  There are other groups like ASU Technopolis and the Arizona Technology Council who are also doing their part to incubate start-ups.

Needless to say that 2009 is going to be a particularly difficult one not only for the firms seeking equity infusions at Invest Southwest, but also around the country. The NY Times had two articles earlier this week (here and here) about the difficulties facing private equity and venture capital firms as they struggle to raise new funds and to hold on to their current investors. Obviously, there are going to be some great distressed buyout and investment opportunities going forward for the firms that are able to raise the cash – assuming that banks will start lending on the deals again to allow them at least some leverage. Without debt financing, the numbers don’t work. 

Next year looks to be a rough year for our economy, but that is the perfect time to put together plans for forming an opportunity fund to take advantage of the economic downturn.  If you do so, contact me first to make sure you comply with securities laws.  And please call early before you start soliciting investors as there are plenty of regulations that apply in the early stages of the process that can trip up fund sponsors.