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January 18, 2017 | Tom Ballard

OUTLOOK SERIES PART 4: What about the availability of growth stage capital?

2016-outlook(EDITOR’S NOTE: This is the fourth article in our annual multi-part series sharing the insights of angel and venture investors who are either located in East Tennessee or have a specific interest in investment opportunities here. We will be rotating the order of responses on a daily basis.)

Today’s question posed to our angel and venture capital panel was as follows: “For several years, we have discussed the challenge of available growth stage capital for firms that got their start as a result of initiatives like TNInvestco. To what extent did you see that occur in 2016 and are you concerned about it for 2017?”

Kristina Montague, Managing Partner, The JumpFund – The challenge still exists but it seems that more and more our companies are able to find that capital outside our region, especially on the coasts. Some of that is through introductions via LaunchTN and other connected networks, and some has been from those investors scouting in the Southeast for better opportunity and valuations. It is always a concern for our companies as they raise next stage capital, but it is not unattainable, just hard work. Start building those relationships at the front end, and you’ll be better off when it comes to raising the VC dollars.

Geoff Robson, President, and John Morris, Executive Vice President, The Lighthouse Fund – Morris: While East Tennessee companies did not receive a significant share of TNInvestco funds, it was a program that provided benefits to seed and early stage companies.  I don’t see any programs on the horizon that are similar to TNInvestco planned for 2017, so the challenge for seed and early stage companies will continue. Robson: We did see a couple of companies looking for a Series A in 2016 that struggled. It is a “competitive sport,” and typically the best deals get funded but that does leave a gap for funding companies who may be pivoting due to a lack of traction in their original market. This is something that will continue in 2017, and management teams have to be very smart about how they handle this situation.

Jack Studer, Managing Director, and Courtney Watson, Partner, both with the Chattanooga Renaissance Fund – Studer: Good and viable companies will always find capital, regardless of stage. Capital will find opportunities, no matter if some investors are geographically lazy. Just because companies don’t attract funding doesn’t mean there’s a problem, it could just mean the companies aren’t good enough.

Grady Vanderhoofven, Fund Manager of Meritus Ventures and President and CEO of Three Roots Capital – I do increasingly see maturing companies, having outgrown the start-up realm or outlived the TNInvestco peak, seeking a “next round” of financing, whatever that might mean for any given company. I definitely believe that trend will continue, which is why we are collaborating with others in the region to establish a couple of growth stage, institutional investment pools. We believe some of the most promising and compelling companies will experience a need for growth capital, and we hope to be able to support those companies.

Ken Woody, Partner in Innova Memphis – TNInvestco investments spurred the creation of several new funds across the state and encouraged Angels to get on board with the new influx of Capital. As TNInvestcos go away, more Angels are finding ways to invest on their own or as part of Angel Clubs or Groups. VCs who came to the state attracted by the TNInvestco are finding good reasons to stay. We’re certainly not at a Silicon Valley level yet, but the four big cities in the state have all received investments from Funds outside the state, and I see no reason that won’t continue.

Eric Dobson, Chief Executive Officer (CEO) of Angel Capital Group – TNInvestco (TNI) had one weak point. It flooded the market with capital that had to be spent or revert. There simply were not enough great deals in the state to take-up that kind of capital.  Good companies were funded, but inevitably some weaker opportunities were funded because the funds were use-it-or-lose-it. So, we should expect to see a lot of short-term failures of ventures, especially given the money has only been in the market for four years.  The adage in the industry is the lemons ripen in two years, long before the plums which take five to seven 7 years. What this means is the winners of the process take time to mature to exit, and we have not reached the time that the “plums” should mature for harvest. So, we believe there are still a number of companies in the TNI-based portfolio that will mature and should validate the program. The important outcome, and one that is already tangible, is the number of high quality start-ups that have come since the TNI program. As for in-state capital, we don’t perceive a significantly different landscape than 2015. The same players are still in the game. We are not seeing significant new entrants in the market for angel investing. But, we are seeing new debt instruments and new VC capital enter the market. TNI initially drove out-of-state money out of the state for the reason above. That effect should be over now, and we should start to see out of state money come back into the system.

Andrew Goldner, Founding Partner, GrowthX – Goldner asked Brad Holliday, a colleague and Partner who has resided in the state for years, to respond, and he did as follows: I would agree that the entrepreneurial ecosystem of the state is more robust than it was five years ago, but it isn’t just the number of start-ups that have impacted the fundability of many of the new ventures. The presence of an ecosystem comprised of accelerators, research organizations, state-sponsored support initiatives, angel groups, venture capital firms, mentor networks, co-working spaces, founder meet-ups, and more have created an environment that produces better founders and more compelling early-stage companies. Even five years ago (and certainly 10 years ago), only a fraction of this type of support network existed in the state. The public-private partnership that has produced and/or attracted much of this activity should be viewed as a model for other regions seeking to stimulate entrepreneurism.  In order to move to the next stage of development as a region, we need to see this system produce some winning growth companies to which we can all point. Those success stories should move more of the sideline capital into play and set the stage for more and better things in the future.

Tony Lettich, Managing Director, The Angel Roundtable – We see this as a continuing issue and reason for concern. It not only exists for firms that got their start through TNInvestco, but across the board. This issue is a significant one for The Angel Roundtable in that, without a vision as to the potential for follow-on investing in the late early and growth stages of the companies in which we potentially invest, we find it less compelling to invest in their seed and early stages.

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