JumpStart: IdeaExchange Blog

In 2008, according to PWC MoneyTree and VentureXpert, Ohio moved into the top quartile, among all states, for number of venture capital deals. In 2009, Ohio moved into the Top 10. The states ahead of Ohio are: California, Massachusetts, New York, Pennsylvania, Texas, Washington, New Jersey, Colorado, and Maryland. Ohio is the only Midwestern state to break into the Top 10.

As far as $$ invested, we are lower down on the list — 21st in 2009, where historically, over 10-15 years, Ohio has ranged from 9th to 28th, averaging about 21st. In order to move up to a Top 10 spot, investors would need to more than double the amount of capital going into Ohio’s early-stage companies. Has something like this been done before? Yup: Maryland, for example, moved from 22nd in 1992 and 25th in 1993 to 8th in 2006.   

So, risk-oriented investors might say, “That’s fine, Becca — love your passion for Ohio’s innovation environment — but, um, what about returns?” My answer is that they are pretty good: an analysis done by Chrysalis Ventures shows that returns in Midwestern deals were higher than returns in every other region except California and the Southeast (where the Southeast had fewer deals than the Midwest). I have not reviewed this analysis since 2006, but even if updating shows it to have fallen, the 2006 data do show that strong returns can be generated in the Midwest — Ohio included.

Those same risk-oriented investors might next say, “Yeah, but what about exits? As investors, we know, obviously, returns are a sign of exits, but still, how about stories: do you have great stories of exits, stories that capture the imagination and define a region? Where’s your Google? Your Amgen?”

OK, I have to admit: you got me there. We do not have many of those tales of Stanford PhDs or MIT wunderkinds opening up entirely new industries and IPO’ing five nanoseconds later, and let’s face it: those are fun, iconic tales that generated great returns and captured the imagination. But, here is the good news. An analysis I recently saw showed that Ohio entrepreneurs and investors are actually quite good at something that may be emerging as an enduring investment thesis in the venture industry: entrepreneurs raising money in a capital efficient manner from smaller funds and growing solidly and well to provide those funds with nice returns, IRRs that are above-equity-stock-indices-and-above-venture-IRRs-as-a-whole-but-(admittedly)-no-Google/Amgen.  

I cannot, alas, offer here the details of this analysis because the person who conducted it is a trusted Ohio investor who was able to get many of his peer investors to offer up information that they requested not be made public. But I can, for illustrative purposes, offer up names of some of the companies whose exits were public domain and that collectively make the point that we do have exits, good exits, sometimes great exits, but admittedly not iconic, blockbuster exits. In IT, over the past 5-10 years, Ohio entrepreneurs and investors have seen exits from angel or venture-backed companies like Hyland, Plansoft, Brulant, Flashline, TMW Systems, Everstream, MRI, Northcoast PCS, Entek, and many more. In Healthcare, over the past handful of years, there is WholeHealth, MemberHealth, RIS Logic, Edgepark Surgical, Cleveland BioLabs, Atricure, NDI Medical, and many more. In Cleantech, of late, there is Sorbent Technologies and Solar Fields, plus others, and in Business Services, there is Flight Options, Atomic Dog Publishing, and more.

So, here is the summary of all this. Ohio is Top 10 nationwide in investment activity and Ohio’s entrepreneurial strengths are in areas where the venture industry may well be moving: Ohio growth businesses and entrepreneurs are capital efficient and, among states, Ohio is among the leaders on consistently starting strong, high growth businesses that pragmatically solve a certain problem in the world, grow quickly, and generate solid returns. This entrepreneurial mindset, or strategy, if you want to call it that, offers an outsized return to investors as shown by the Chrysalis analysis. The entrepreneurs who led these businesses are adept at growing more of these types of businesses as CEOs, serial entrepreneurs, angel investors, and board members.

These are all reasonable strengths to build on. With a lot of effort, which is what anything worth doing takes, we could become a Top 5 state in venture activity (deals, not dollars, given the more capital efficient nature of Ohio growth stories). Wouldn’t that be great?  

That’s not a rhetorical question, because I guess what I want to know is this: is this compelling? Is the paucity of iconic IPOs that capture the imagination, even if IRRs for investments in Ohio early-stage companies are collectively as strong as or better than elsewhere in the U.S. and the venture industry as a whole, a deal-killer (literally)? It strikes me and many successful Ohio entrepreneurs I speak with that it should not be.   

While “should not be” is not a strategy that will make quantum leaps in capital formation and high growth entrepreneurship, IRR is.

Becca Braun is President of JumpStart Ventures. She founded and led a number of early-stage companies and organizations, as well as worked as a private equity investor and management consultant. She received her MBA from Harvard Business School and her BA in Linguistics from Harvard University. She is keenly interested in the intersection of wealth creation and broad-based regional economic growth.

In late 2004, Lynn-Ann and I sat with our computers one night at a cafe at Cedar-Lee and put together a five year projection of how much additional capital the companies JumpStart would invest in might be able to raise. The first year showed $3 million. The second showed $6 million. We had benchmarked against Innovation Works in Pittsburgh, a phenomenally successful venture development organization; we would try to use their success ratios for our projections; no sandbagging. The third year showed $15 million. Year four showed $20 million. And year five showed $30 million. These numbers (totaling $74 million*) seemed huge at the time, especially since we projected that 25-50% of the companies we invested in would likely fail; it’s inherent to Imagining, Incubating and, to a lesser extent, Demonstrating stage investing. As we sat at our computers that night, JumpStart had only invested ~$300 thousand in two companies, Stanton Advanced Ceramics and PreEmptive Solutions. 

Suffice it to say, $100 million seemed light years away.

About three weeks ago, the companies in JumpStart Ventures’ portfolio officially surpassed the $100 million in capital raised mark (almost $103 million to be precise, or nearly 7 times the $15.7 million we have invested in 45 companies). By the numbers, 32 of the portfolio companies have raised follow-on capital over 127 fundraising rounds, with the average total amount raised by those 32 companies being $3.2 million and ranging from $50 thousand to $20 million, and the median timeline from our investment to next investment being 15 months (and trending downwards). Twenty-three companies raised over $1 million dollars. Cleantech companies have slightly edged out Healthcare companies, with the former totaling $41 million in follow-on funding raised, and the latter at $39 million. Phycal and Echogen (fka rexorce) have led the charge in Cleantech, and in Healthcare, Juventas, CardioInsight, and Synapse Biomedical have also raised significant capital. By type of investor, venture capital investors have carried the day, with angel investors close behind; grant funders (especially from the federal government) rose as a percent in 2010, but we expect that to even back out in 2011. Also, $100 million represents about 10% of the total amount raised in the Northeast Ohio region over the past five years of $1.1 billion.**

That’s the numbers, but as we all know, this is not about “companies” raising “capital”: too cut and dry sounding in so many ways. It is human beings, namely Northeast Ohio entrepreneurs, telling a story about innovation and how that innovation will somehow make the world a better place. And these entrepreneurs being resourceful enough to find people with money who happen to love their particular story – whether these people are former entrepreneurs turned angel investors, associates at investment funds, or even sometimes government officials who provide grants. Sure, while it’s not really “companies” and “capital” and various takes on the numbers, it is also no love story. Anyone who’s raised money knows that it is due diligence, term sheets, a whole lotta elbow grease, and, eventually, return on investment. It’s about taking something that is a science project and turning it into a product that customers want, which, if the revenues at our portfolio companies are any indication, is happening consistently, with ever more customers buying what these portfolio companies are offering.

$100 million is more than a number. That’s the point. So, regardless of which number or ratio holds meaning to you, here’s to the entrepreneurs who lead the companies in the portfolio and to whom “capital efficiency” is way more than a buzz word: Andrew, Arnon, Bill, Bob (3 of them actually), Brad, Brian, Chad, Chris, Craig, Dan, Dana, Dave, David, Dean, Elliot, Ethan, Fred, Gabe, Jay, Jeff, Jeeva, Jim (2), Jodi, Jon, Karl-Heinz, Ken, Kevin, Krzysztof, Lance, Laura, Len, Mark, Mike, Nick, Phil, Rahul, Scott, Steve (2), Sue, Tony (3), and Wendell. And here’s to the hundreds of investors who have put their hard-earned money behind these growth stories, from Arboretum to Charter Life Sciences, from Draper Triangle to Early Stage Partners, from North Coast Angel Fund to Ohio TechAngels, and from the Ohio Department of Development to the U.S. Department of Defense.   

Now before year’s end, the JumpStart Ventures team will sit and project out the path to $1 billion for JumpStart Ventures portfolio companies. It’ll feel like as much of a SWAG as $100 million did five years ago. But at least now that path has faces, names, relationships and the other things that make a spreadsheet more than a spreadsheet: they make it an ecosystem.***

Notes:

* These numbers then increased by about 25% because we increased our investing budget from $3 million per year to $3.75 million per year, hence giving us the $100 million number.

** This is a slight apples to oranges comparison since our follow-on funding numbers include some grant funding and the overall region’s numbers include angel and venture capital only.

*** Thanks to Kerri Breen who took the spreadsheet I referenced at the beginning of the post and who has not only successfully supported many entrepreneurs on their fundraising efforts but also runs the numbers like it’s nobody’s business.

Becca Braun is President of JumpStart Ventures. She founded and led a number of early-stage companies and organizations, as well as worked as a private equity investor and management consultant. She received her MBA from Harvard Business School and her BA in Linguistics from Harvard University. She is keenly interested in the intersection of wealth creation and broad-based regional economic growth.

Albert Einstein once said “If, at first, the idea is not absurd, then there is no hope for it.” Here is my list of the top ten most absurd and hopeless ideas I have heard about in my lifetime:

1. Coffee shops? The world hardly needs more coffee shops. Plus, coffee shops don’t scale.
2. A Maine-based line of natural products that are made with bees wax? Last time I checked, the “bee” supply chain wasn’t that scalable.
3. Overpriced, finely made historically accurate dolls that will teach children about history? Seriously? I don’t even know where to go with that.
4. An algorithm that will improve upon Yahoo’s web search technology? Fatal flaw: why couldn’t Yahoo just do that themselves?
5. Packages overnight? The infrastructure required to make that happen is prohibitively expensive. Nice idea, but too much capital risk.
6. Growing a technology business in Seattle? Cow town, and too far away at that: investors want to be able to drive no more than four hours from their home. Plus, there’s no entrepreneurial talent in Seattle.
7. You want to trade collectibles and knick-knacks on the web? That’s maybe, like, a $1,000 market on a good day.
8. Your children have an “orphan disease” for which you want to find a cure? OK, so what don’t you understand about the healthcare industry(?): orphan diseases are unfundable.
9. Sell books on the Internet? People want the experience of touching books, opening the covers, being in a bookstore. Sorry, but the need just is not there.
10. You don’t want to develop computers but you do want to (basically) assemble them? There’s nothing novel or even very protectable about that. If you had invented a new microprocessor or something, I might be interested. But just putting the boxes together isn’t going to generate sustainable gross margins.

These are unassailably awful ideas. Every one of them. Laughable almost. I wonder what the poorly thought-out, misguided, ill advised…OK, can we all just agree to call them patently absurd?…ideas of the next decade will be:

• Making cost competitive oil out of algae (been there, tried that; plus, the whole algae industry is too capital intensive, don’t you know)?
• Competing with Google (ok, can you say naïve)?
• Starting a great company in Cleveland (too cold; no talent — seriously: none, anywhere in the entire state in fact)?

I confess that I do not know. But, I have the time of my life working with entrepreneurs trying to figure it out.

(So, the terrible ideas listed above are examples so well known to most Americans — never mind you fair, brilliant readers steeped in innovation history and always seeking contrarian ideas — that they are almost trite. But, to my mind, they bear repeating because they remain stalwart, iconic reminders of how visions and dreams become great companies in spite of a slew of reasonable obstacles and well reasoned protests. In case you didn’t recognize one or two, here they are:

1. Starbucks, founded in 1971 and a market cap of $17.2 billion today
2. Burts Bees, acquired by Clorox for $913 million in 2007
3. American Girl, founded in 1986 and acquired by Mattel Inc. for $700 million 1998
4. Google, founded in 1998 and a market cap of $184 billion today
5. FedEx, founded in 1971 and a market cap of $27 billion today
6. Microsoft, founded in 1975 and worth $274 billion today
7. eBay, founded in 1995 and a market cap of $29 billion today
8. Novazyme, acquired by Genzyme for $225 million in 2001; see Extraordinary Measures, which came out last week
9. Amazon, founded in 1994 and a market cap of $55 billion today
10. Dell Computers, founded in 1984 and a market cap of $28 billion today

Also, it should be noted that angel and/or venture capital investors believed in and invested in almost all of these companies. Each entrepreneur in question was able to get someone, and in some cases numerous someones, to believe in and put money behind the entrepreneur’s harebrained, crackpot — and I mean that with all due respect — idea.)

Becca Braun is President of JumpStart Ventures. She founded and led a number of early-stage companies and organizations, as well as worked as a private equity investor and management consultant. She received her MBA from Harvard Business School and her BA in Linguistics from Harvard University. She is keenly interested in the intersection of wealth creation and broad-based regional economic growth.

When entrepreneurs are frustrated with the terms they are offered by investors, they should find other investors who will invest on better terms. Simple, right? Not so much. In many cases, entrepreneurs are already locked into an exclusivity clause, at which point it is indeed advisable (from a legal standpoint, if nothing else) that they do not go find other investors. The “Exclusivity” clause of a term sheet is a common clause, and though some investors abuse the clause, using it to lock in an eager, cash-low entrepreneur (too) early, the vast majority use it properly: they do as much due diligence as possible before issuing the term sheet, and then issue the term sheet only when they are prepared to go into a brief (4-6 weeks) period of legal documentation. At this point, the legal costs begin and the investor wants to make sure the entrepreneur is motivated to get the investment closed quickly. The time to court other investors is over.

Entrepreneurs should realize that investors issuing the term sheet not early but rather towards the middle or end of due diligence is a good thing; it is not intended to string out the entrepreneur. It allows the entrepreneur to continue seeking other investors until one firm is truly ready to commit, and therefore allows the entrepreneur to try to “create a market for their securities” (which theoretically increases the price of the deal). To play this dynamic right, though, entrepreneurs should try to get as many investors as possible interested in their company, get from the investors the likely terms (without formally getting a term sheet), and then get a term sheet only when the entrepreneur is very comfortable with what the terms are likely to be. By the way, I think investors who do not require exclusivity in a term sheet are wise and brave: my compliments. I like to think that if I were an early-stage, for-profit investor, this is what I would do, but I understand all the upsides and downsides of this non-standard path. (JumpStart Ventures’ term sheet is non-exclusive, btw).

In one instance I have done the opposite of this advice, and that was in a case where, as an existing investor, I very quickly needed the physical proof of a signed term sheet to show other existing investors that new investors did indeed want to invest in the company in question. Speed was required, and I advised an entrepreneur to sign an exclusive term sheet very early in the game with virtually no due diligence completed. Long story short: while not perfect, this tactic did do the job. (Playing soon in theatres near you…Coming to Terms: War Stories from Cleveland’s Economic Development Jungle, directed by Quentin Tarantino and starring Angelina Jolie and Ralph Fiennes).

So, in summary, try to avoid an exclusivity clause in your term sheet, but since these are not unusual, just try to optimize the timing of getting the term sheet issued (they usually expire if not signed within a week, so you don’t even want it issued, never mind signed, too early). Work it out so the term sheet is mutually signed as late as possible and when you really want to lock into one investor. Before signing, ask the investor what the average timeline is from term sheet to close. Ask them when they’ve seen it extend and why. If an investor is pushing you to sign way earlier, without giving any signs of likely terms and without having done much due diligence, I’d suggest moving on. Unless you have no cash, in which case the terms are the terms are the terms.

Finally, though it’s cold comfort in the heat of a deal, remember that you don’t have to take a term sheet at all. It’s a free country, and it is your decision to start a company that doesn’t get money the traditional way (i.e., through customers, bank loan, etc) and that must use a statistically rare type of capital — OPM* — to become successful.**

(Here is one good resource on the exclusivity clause in a term sheet – venture capital for the serious entrepreneur).

* “Other Peoples’ Money”

** Attention Scriptwriters: please punch up this killer last line so that it’s in the voice of Angelina. She wouldn’t say “statistically rare type of capital”. Or maybe she would; she’d just be wearing a cat suit and carrying an Uzi as she said it.