The MIT Enterprise Forum held another of its continuing satellite broadcasts on technology and venture funding. Moderated by Bob Crowley, president of the Massachusetts Technology Development Council, the panel included: Ned Hazen, managing director of Lighthouse Capital Partners, Martin Hensel, chief executive officer of Texterity, Inc., T.L. Stebbins, managing director and chairman of Investing Banking for Canaccord Adams, and Claire Wadlington, partner and chief financial officer of FA Technology Ventures.
The event opened with Crowley introducing Martin Hensel, who, with self-deprecating humor, described his qualifications as "done many things wrong,” including getting ahead of the market, failing to recognize success when it came because it came from an unexpected direction and failing to listen to customer feedback.
Hensel talked about different kinds of forecasts, saying, "You can get a forecast for anything.” He explained that industry forecasts make investors happy and that "you can fool yourself,” referring to his unfortunate involvement with ebooks. Hensel did not seem very enthusiastic about industry forecasts, describing them as merchandising tools for the companies that created them.
He described entrepreneurial forecasts as always early, going on to say that customers were really smart and could spot value when they saw it. Hensel observed that it takes a while for young companies to hear customer feedback and internalize it.
Hensel seemed to have a better opinion of investor forecasting. He described investors as "sponges” for information. He said they are excellent judges of trends and people. Talking about startups, Hensel said, "Once you take outside money a clock starts ticking.” He made the point that it is critical to keep your burn rate low.
He concluded by listing the necessary qualities for members of your board: grace and candor in communications, and assuring the entrepreneur that they would be there, if the business milestones were met.
Claire Wadlington gave an overview of the current venture capital investing climate. 2005 saw the first rise in overall activity in four years; however, that only brought it to the same level as 1998. Software remains the single largest category, with biotech, Internet specific, medical devices and wireless also receiving significant funding. There were 922 startups in 2005 (startups have in been in the low 900’s for years). Significant funds went to later stage companies. Wadlington indicated this was because Venture Funds did not have exit strategies for their existing startups. Venture Funds invest in new companies with the money they earn in IPOs and acquisitions. Without an exit strategy they cannot fund new ventures. While IPO’s remain flat, merger and acquisitions are growing.
Wadlington predicted that open source, Web 2.0, wireless/third screen, energy technology, robots for unstructured environments, and biology/engineering co-development would continue to be areas of growth and investment.
She concluded with advice for entrepreneurs looking for venture funding: try to get a solid referral or "warm intro.” Venture capitalists will see your ability to get a referral as an indication of your networking capability. It is critical to be credible; be knowledgeable about your field and don’t repeat what everyone else is likely to have said, such as "it is a huge market and we only need one percent.” Demonstrate that you understand your market and competition. Best of all, find a champion within the venture firm.
Ned Hazen was there to talk about venture lending, which he described as "little known and understood.” Certainly, this author had never heard of it before. Venture lending is made to companies who are, as Hazen phrased it, "cash flow negative or pre-revenue.” Typically, entrepreneurs get equity from venture firms and then borrow from venture lending firms. Venture lending has the same criteria as venture investing, a strong management team, a real solution, and a real market. Entrepreneurs use loans to hire engineers, build prototypes, buy office equipment and furnishings and the like. The benefits of venture loans are the reduced dilution of ownership and extending what Hazen described as the cash runway, or how long you can go without revenue.
Hazen advised entrepreneurs on what to look out for when evaluating venture loans. Aside from such obvious considerations as warrants and interest rates, be careful of covenants, material adverse change clauses (which can mean anything the lender wants them to mean), and right of offset.
He described venture lending as a nascent market and “here to stay.”
T.S. Stebbins opened by saying that Canaccord Adams was Canada’s largest independent broker/dealer. Looking back over 2005, he observed that small capital stocks had outperformed large capital, but that the market was very volatile. The US market had underperformed every other major market in the world, but the strength of the dollar reduced the gap.
Stebbins said that the IPO market continues to be huge, but mostly from private equity rather than venture capital. Last year saw 380 new listings on NASDAQ.
He said that institutional equity commissions for sell side research have dramatically declined since 2001 and will continue to decline. (In an email to me Stebbins explained that, "Sell side commissions for research are the institutional commissions that, say, a Fidelity pays the sell side, i.e. broker/dealers, for research.) Most small capital stocks have no analytic coverage.
Compliance with Sarbanes-Oxley will cost approximately 2.5 million dollars. Stebbins said that the SEC and regulators and, as he put it, "our good friend Mr. Spitzer” were constraining the flow of capital to small companies.
Stebbins said that NASDAQ was still viable for small companies, but more difficult than in the past. He said, and this surprised me, that 100% of the employment growth in the US last year was directly attributable to small capital companies.
All other major markets have attempted to recreate NASDAQ. Most failed, some spectacularly. The London Stock Exchange has succeeded with the Alternative Investment Market (AIM).
Stebbins said that the preferred public market for small capital companies could be migrating to the Caymans and Bermuda in order to excuse themselves from the SEC. I could only wonder why anyone would wish to invest in companies who felt a need to excuse themselves from SEC regulation.
He said Institutional investors are looking for opportunities to invest in non-dollar denominated emerging markets. London’s Alternative Investment Market is doing a good job of attracting these companies. Trading systems and regulations in US public markets make it more difficult for companies with capitalization of less than $350 million. If the US junior market is weakened, others will take its place to the long term detriment of the US economy.
Here, Stebbins made a series of pessimistic predictions: interest rates are going up; real estate is going down; the Iraq war will make for a volatile international situation; growth in China and India will create increasing pressure on natural resources; the US balance of trade will remain hugely negative; and the dollar will remain under pressure. He predicted great volatility for 2006.
Stebbins concluded by saying that, in such a period, large capital companies have a natural advantage. He predicted that the dollar would continue to be weak, accentuating commodity/energy prices. A weak dollar will discourage investment in the US. In sum, it will be a year of struggle for US capital markets with great volatility and risk.
This concluded the telecast. The Washington/Baltimore chapter of MIT Enterprise Forum turned off the broadcast and instead elected to have a presentation from Julia Spicer, Executive Director Mid-Atlantic Venture Association. This was an excellent notion, for instead of vague generalities about the national scene, we were treated to an analysis of our own market.
Spicer asked for a show of hands to indicate how many entrepreneurs were in the audience; not quite half the audience responded. The rest worked in professional or financial services.
She began her presentation by saying, "We think now is a very good time; people are hungry for new deals.” I could only think that there would be a huge response to her words.
The Mid-Atlantic Venture Association represents 115-120 investment funds that range from family groups to angel funds to venture funds. MAVA recently celebrated its 20th anniversary and represents a more mature financial market locally.
Spicer said that post-bubble, funds moved toward later stage companies. Now, there is more money for early stage companies.
She spoke about greater Washington’s unique knowledge base. There is unique intellectual capital centered around NIH, the FDA and other agencies that creates unique investing opportunities.
The wireless telecom, internet and software areas are all good prospects for continued investment.
Most of the recent successes for local venture backed companies have come in the form of acquisitions; IPOs have still not reached pre-bubble levels.
Here, the floor was opened to questions. I asked if any of the local funds made a point of looking at phase III SBIR companies. Spicer replied that venture funds specialized by sector. Thus, funds investing in defense technologies might be interested in SBIR companies who received funds from the Defense Dept., likewise with NIH and so on. She went on to say that most phase III companies were too small for most venture funds and were better suited to angel funds.
The next questioner asked if it were possible that there were too many venture funds for the available opportunities. Spicer said that for about two years entrepreneurs were advised to "bootstrap it,” and so they did. Entrepreneurs were scared away from the venture market.
Another questioner asked Spicer to say more about the NIH and FDA related opportunities. Spicer said that she "knew enough to get into trouble.” In the past, large pharmaceutical companies would invest in small life sciences startups and then move them to New Jersey when they got big enough. Now there is more emphasis on keeping them local so that there can be a community of companies that feed off of one another.
The last questioner asked for advice as to how to network with local venture firms. Spicer replied, "Show up.” She talked about MAVA’s events including the Mid-Atlantic Venture Capital & Entrepreneurs Networking Luncheon on March 7th.
View the presentations from the panel of experts.