New online intermediaries are closing the capital gap for companies that have outgrown friends-and-family financing but can't get a backward glance from venture capitalists.
The Internet will change everything about the way you live--why not how you raise capital?
Ask Dr. Drew Pinsky a question about adolescent hot buttons, from sex and drugs to diets and zits, and he could talk for hours--and does, as the cohost of MTV's Loveline. But ask him about financing for an adolescent company, and Dr. Drew, as he's known, is pretty much speechless. "It's like being in a parallel universe, and my learning curve is straight up," says Pinsky, an M.D. and the personality behind a new Web venture called Drdrew.com.
However, in the past two years--ever since a boyhood buddy approached him about transporting his TV and radio franchise to the Web--Pinsky has received a crash course in seed capital. "Leave it all to me," said his friend and business partner, Curtis Giesen. But finding funding wasn't that simple--even for Giesen, a Harvard M.B.A. The business plan Giesen wrote for Drdrew.com was roundly rejected by investors. "I must have pitched it 100 times in a year," says Giesen. To no avail. Then last year he heard about Guy Kawasaki and his band of angel investors--comprising high-net-worth individuals, angel groups, and even a few of the venture-capital "gods" of Menlo Park's famed Sand Hill Road--convening under the banner of Garage.com. (See " A Match Made in...Cyberspace?")
Giesen threw himself at Kawasaki's doorstep. "I contacted Garage.com before the doors even opened." Drdrew.com was one of the first companies taken under Kawasaki's wing--that is, after an employee clued Kawasaki in on the opportunity. "The venture capitalists didn't know who Dr. Drew was, and frankly, neither did I. Thank God a young staff member here knew who he was and said, 'Hey, this is a hot deal." Apparently, Kawasaki's seed financiers thought so too.
It wasn't long before the angels got together and decided to create a dream come true. "Overnight, your business plan is listed in Heaven," explains Giesen, referring to the password-protected section of Garage.com where investors can find start-up companies that match what they're looking for. Word got around, and soon even top-tier accounting and law firms were courting the young start-up. "These people were calling me," says an incredulous Giesen. "It was a beautiful thing."
All the networking--on-line and off--culminated last January in a private-equity deal. In exchange for 20% of the company, Pinsky and Giesen raised $1 million. Five investors, including a media corporation, kicked in the seed funds, and two agreed to be board members. And now the partners can't say enough about the advantages of the Garage.com model. "We found angels we never would have otherwise," says Giesen, CEO of the company, based in Pasadena, Calif. Pinsky, president, concludes that Drdrew.com, scheduled to go live with daily "Webcasts" this month, "would not have happened without this."
Clearly, Drdrew.com benefited from Kawasaki's own brand of angel evangelism. He's one part mentor and one part the merry matchmaker. The former "chief evangelist" of Apple Computer, Kawasaki has started two software companies and has been an angel in five other companies. He has years of personal connections to draw on, but he's also using on-line connections to help entrepreneurs close the capital gap. Playing to the Internet's natural advantages, Garage.com screens business plans very efficiently, "narrowcasting" the best prospects to a select group of investors and enabling one-to-one E-mail exchanges between the investors and company founders. The capital gap
In other words, Kawasaki is closing the information gap at the heart of the large capital gap that exists for companies who've outgrown friends-and-family financing and can't get so much as a backward glance from VCs. The most gaping hole exists in deals ranging from $100,000 to $1 million, and, more recently, from $1 million to $3 million, as traditional VCs continue to invest ever larger amounts in just a few thousand companies each year.
Garage.com hopes to help to bridge the capital chasm by focusing on companies seeking from $1 million to $4 million. Some say it's fulfilling the promise of the Small Business Administration's ACE-Net, which for a few years now has struggled to facilitate through its listing service public and private offerings in about the same dollar range. (See " We're from the Government. We're Here to Help.")
Kawasaki, though media savvy, is far from alone in spotting an on-line niche. In fact, a slew of E-capitalists are taking aim at inefficiencies across the whole spectrum of capital formation. From seed capital to later-stage private placements, from direct public offerings (DPOs) to the initial-public-offering market, all along the line there's a renegade or two or three attempting to rewrite the rules and open up the game to more company builders and investors on-line.
While some on-line ventures--such as Wit Capital and WR Hambrecht's OpenIPO to name two--have been lauded for helping to "democratize" the world of investing, the benefits to entrepreneurs have been less clear. To date, few of the new entries appear to be closing the most pressing capital gap.
That's why the sudden proliferation of on-line matchmakers aimed squarely at entrepreneurs looks so promising. Also known as money finders, placement agents, and "venture gapitalists"--to use Kawasaki's term--they all claim they can help founders slash the cost and time of finding start-up and growth capital. They can do this, they say, by tapping an expanding universe of angels over the Internet and using simple technology to match up the most suitable investors to a given company. To wit, a growing number of Web sites serve as portals to local angel groups. A prime example in the Southwest is Seedstage.com, based in Austin. Offroadcapital.com (see " The IPO Classifieds") takes the model to another level: it hopes to "aggregate" local angel groups into a national syndicate.
But can these matchmakers really close the capital gap? The answer's not clear. Seedstage.com, for one, focuses on helping high-tech-company founders locate from $500,000 to $1.5 million. That's a good start. But other sites are a letdown. In Chicago, an on-line "clearinghouse" called Vcapital.com, started by venture-capitalist Len Batterson, looks enticing, at least at first blush. But Vcapital.com is actually gunning for early-stage deals in the $2-million-to-$5-million range. That's progressive in some venture-capital circles, but it hardly rocks the world of entrepreneurs looking for their first $200,000. (On-line or off, of course, only growth companies can hope to get the attention of most investors.)
Just sorting out the many matchmakers on-line can leave you feeling bewildered. Some charge high listing fees; others take an equity stake. Some offer opportunities to meet investors in person; others are mere databases, and secretive at that. Often, it's not easy to get information on companies or investors at those sites. And most are too young to have a credible track record.
Clearly, it's daybreak in this brave new world of on-line venture financing. And it feels as if the dawn of E-commerce was just a few short years ago. Every week, it seems, there's a new player entering the on-line financing fray. As with E-commerce, plenty of prognosticators believe it will all happen soon. "In the next five years, I think the majority of debt and equity financing will be done on the Internet," says Batterson. Others remain dubious that companies can raise a dime on-line.
"The jury is still out" on the angel matchmaking services, says Ray Smilor, vice-president of the Kauffman Center for Entrepreneurial Leadership Inc., in Kansas City, Mo. "A minuscule number of entrepreneurs will get money. So there's going to be a lot of frustration."
It's true. For now, those hitting pay dirt through a Garage.com or a Seedstage.com form a very exclusive club of mostly high-tech companies. That's unlikely to change for some time to come. But eventually, a much wider spectrum of start-ups and growing companies should be able to tap on-line investors.
One reason the on-line matchmakers are multiplying is simple: there are tens of thousands of companies that can't get financing today. In fact, not even 1% of the 300,000 or so companies growing 20%-plus a year are backed by VCs. VC groups and investment banks, habitually understaffed and overwhelmed by the number of business plans that come in, simply can't keep up with demand.
By stealing some of the good deals, matchmakers are forcing VCs to take notice. John Thornton, a general partner at Austin Ventures, a Texas venture firm specializing in seed capital and managing $800 million in traditional private equity, predicts that in the next few years VCs will "redouble their efforts in seed- and early-stage deals." To make sure Austin Ventures stays abreast of the next wave of Southwestern superstar start-ups, it has chosen to be a sponsor of Seedstage.com. If such sponsorships succeed, we'll see more on-line players jumping in to fill the capital gap below $3 million.
There's another good reason matchmakers should one day help many more companies gain access to capital. Legions of '90s self-made millionaires are joining the angel ranks. All it takes is somebody to organize them. The typical angel today, says Jeffrey Sohl, director of the Center for Venture Research at the University of New Hampshire, "is a cashed-out entrepreneur who's very familiar with the Internet."
What's more, angels' investment interests are more eclectic than those of classic VCs. In theory, the Internet should help companies find angels who know about their industry, wherever those investors may be. And there's at least some evidence that the Internet can bring together investors to aid nontraditional candidates for capital. Dan Mitchell, director of the ACE-Net office at Southern Connecticut State University, shares the details of a courtship begun on-line. A company marketing a diet program was looking for $2 million in equity financing. A group of five angels responded to the initial on-line pitch. A deal was struck in June: the angels will kick in $2 million in four installments of $500,000 each and bring some needed expertise to the diet company's management team.
For now, though, the Net is helping companies that probably would have found financing eventually. They're just getting at it sooner on-line. Wyatt Starnes, CEO of Tripwire Security Systems Inc., in Portland, Oreg., is another beneficiary of Garage.com. Starnes relates that he closed on $2.4 million in private equity in less than six months. "This is my third company, and it's the most money I've ever raised personally, the fastest and least painful," he says. "I've made the cold call to Sand Hill Road. It's tough."
Risks and Realities
The Internet, says Jim Peters, a partner with Ernst & Young LLP, in Los Angeles, "is clearly going to be a source of additional capital for entrepreneurs and developing companies--directly or indirectly." But, he adds, "it also wouldn't surprise me if we see hang-ups that could have a chilling effect on investors." Any of these hang-ups could be a deal killer: a weakened economy, Internet stocks in the Dumpster, the first well-publicized bad deal from the likes of Garage.com, or an increase in the number of fraudulent stock offerings.
"The Web offers a wonderful opportunity for companies to reach investors," notes John Stark, who heads the Securities and Exchange Commission's Office of Internet Enforcement. "But it's also a great opportunity for scam artists to reach investors. That's my concern with matchmaking services, small offerings, and everything else" on the Internet.
The bottom line: the system is full of promise, and there are plenty of kinks as well. At the moment the biggest advantage of the Internet matchmakers may be an unintended one. If the Kawasakis of the world can "give entrepreneurs a fast no, that's a great benefit," says the Kauffman Center's Smilor. "A lot of entrepreneurs don't understand what different investors want, and that's where the frustration comes in."
Ironically, at this stage of the game, when finding cash on-line is in its infancy, company builders may get more bang for their buck from all the off-line activities sponsored by the on-line money finders--the start-up boot camps and venture forums and finance workshops. "My hope is that all of this will raise the educational component to raising capital," says Smilor.
Other observers agree. "To think the actual deal can be consummated on-line is wrong," says UNH's Sohl. Ultimately, the process of marrying entrepreneurs with the right backers is just too precarious and personal a business.
Starnes, the CEO of Tripwire, shares the story of how he and Kawasaki finally hooked up: "I had this E-mail exchange with Guy for a few weeks, but nothing happened. Then Guy came to visit me in person, luggage in tow." As in many areas of E-commerce, sometimes there's nothing like meeting face-to-face in the real world.
Susan Greco is a senior writer at Inc.