Local entrepreneurs starved for venture capital often go hungry

ANDREA MELENDEZ Out-of-towner Larry Simpson secured more than $5 million from venture capitalists from outside Rochester for his Internet start-up, WebPRN.com. Simpson says, Rochester "is not a hotbed for venture capital." Venture capital It begins with an idea and, if all goes well, ends with a sale of the business or an initial public offering. Here's how the venture capital process works: 1. An entrepreneur has an idea for a start-up company. 2. The entrepreneur seeks seed capital, the investment prior to the production of a working model or prototype. The money typically comes from the company founders, friends and family, or from "angels," people with high net-worth who are anxious to invest in start-ups. The typical angel investment is $500,000. 3. The next round of financing can come from a venture capital fund, a pool of managed capital from which investments are made. It resembles a mutual fund but is not publicly held and does not offer to redeem its shares frequently or at all. The money also could come from a small business investment company which uses funds from the federal government at low rates to finance small businesses. 4. Next comes the beta test. That's when a prototype of the product is placed in the hands of a customer for testing. While the product is being beta tested, capital is often raised to develop and implement a sales and marketing strategy. This round of financing typically totals about $3 million. 5. The start-up company must watch its burn rate. That's the monthly expense burden that indicates how long the company can exist until the next financing. 6. The next (and sometimes last) round of financing is the mezzanine round. That's the round calculated to bring the company enough cash to break even. It's often financed by investors willing to pay a relatively high price, assuming their investment will soon be followed by the sale of the company or an initial public offering. SOURCE: Fundamentals of Venture Capital, by Joseph W. Bartlett

By Christine VanDusen
Democrat and Chronicle

(01/30/2000) -- The idea is hot.

That's what big-money people on the West Coast told Larry Simpson when he asked them to help finance his Internet-based start-up.

But they also told him in July that if he wanted their cash, he should move his company, WebPRN.com, out of Rochester.

He was set on staying here, but Simpson couldn't dismiss the demands. He hadn't been able to find any local investors; there were so few doors to knock on. And the wealthy here held tight to their wallets.

So Simpson agreed to set up an office in the Bay Area and travel there for board meetings while keeping the company -- a business-to-business trading exchange for consumer electronics developers -- based in Rochester.

In return, outside investors infused WebPRN.com with more than $5 million. When that news got out, a small public and private investment group based in Rochester, the Monroe Fund, decided to chip in $500,000.

As Simpson now knows, the venture capital game is not easily played. It's even tougher in Rochester -- a place with ideas and money but few ways to connect the two. "This is not a hotbed for venture capital by any stretch of the imagination," he said.

Consider this: During the third quarter of 1999, Rochester-area companies received more than $37 million in venture capital, according to PricewaterhouseCoopers LLP. It was the largest quarter on record.

But it was less than 0.6 percent of all the venture capital invested in the United States. Other areas, comparable in size to Rochester, received six times more venture capital.

That is a problem not only for entrepreneurs, but for Rochester's entire economy.

Rochester was once a big-company town. But now its growth is driven by small businesses, founded by entrepreneurs. Those businesses need money, and venture capitalists have it.

If they don't invest it here, more than just an entrepreneur's ego stands to suffer. Innovative companies will go under or move away, and the region's economic strength could diminish.

There are very few venture capitalists in the Rochester area, and they say they are typically looking for a later-stage company and less risk. But most entrepreneurs here need the riskiest type of investment -- seed funding -- to start up.

Then there's the perception problem. Many outside investors don't want to bring their money to Rochester, a place they see as technologically unsophisticated and too expensive to visit. They would rather move the companies out.

It's certainly not impossible to get venture capital in Rochester. There has been some success, particularly in the telecommunications field. But that's just a start. Business and government leaders alike recognize that the creation of a vibrant venture capital community needs to be a priority. But few efforts, beyond the public-private partnership of the Monroe Fund, are currently under way.

The list of success stories is short.

"Our community has been on a slow bleed," said Cynthia A. Gary, chairwoman of the Rochester Venture Capital Group, a private organization of high-net-worth individual investors. "Other places are passing us. We're falling behind."

Courting cash

Terrence Sick likens a company's search for capital to a poor sap's search for a girlfriend.

"It's like being rejected when you want to go on a date," he said. "It's frustrating. But you survive and go on to the next."

Sick founded Logical Energy Solutions, a high-tech Henrietta company that provides energy services related to deregulation, in June. He has been looking for funding ever since. His business plans have gone out to about 40 investors; only six, five of which are outside of Rochester, have expressed interest.

Logical Energy Solutions received one state grant, for $200,000, but otherwise is completely funded by its founders. They want to raise $1 million to $3 million.

But there are few local funding opportunities for start-ups, Sick said. Investors here are looking for a proven product or service; they don't want to pay for something that hasn't been tested in the marketplace.

Even "angels" -- high-net-worth individuals who have typically invested in start-ups -- are "increasingly less interested in the seed round," according to Fundamentals of Venture Capital, by Joseph W. Bartlett.

Much of the money here is considered "old" and conservative, and most of it wasn't made on high-tech initial public offerings. So there are many local investors who don't completely understand -- and perhaps are leery of -- tech-based business, which more than any other sector has fueled the stock market's record gains.

One local venture fund, Manning Ventures, describes itself as a funding vehicle for start-ups. But the company has invested primarily in concepts generated outside the Rochester area, said Bill Manning, chief executive officer.

"We've tried to do things closer to home, where there is a dearth of capital for the early stage," he said. "But (organized ideas) are scarce. Money is in abundance."

Herein lies the confusion: Does Rochester lack ideas, or does it lack available funds? The local venture capital community is divided.

"There is plenty of venture capital," said Richard A. Glaser, managing partner for New York City-based Hudson Venture Partners LLP's operations in Rochester.

"There's just no sense of urgency. It's a strong economy, and if not for the rising tide that lifts all boats, we would be sinking."

One of the problems, he said, is that most people who are leaving Rochester's big companies are not starting their own entrepreneurial ventures. There is a culture of complacency in the community, Glaser said.

Simpson, the entrepreneur, agrees: "The large corporations here don't really have to scramble for position, so their people are not trained to constantly be in the mind-set of competing and thinking of new things."

When new ideas are conceived, they often are disorganized. So says Frank P. Strong Jr., principal with the local Trillium Group LLC, which manages the $5 million Monroe Fund.

"There are a lot of good ideas out there, but they end up not succeeding or surviving because the management of the companies hasn't got the experience and breadth and depth of knowledge to start up and manage the business," he said.

The number of deals in Rochester is fairly good, he said, but there need to be more ideas so investors can pick and choose.

Hometown hex

One morning every month, an assemblage of 15 or more "angels" -- known as the Rochester Venture Capital Group -- munch on fruit salad and muffins and listen to entrepreneurs pitch concepts as varied as biomedical services and professional putting greens.

Ronald Furman has stood up before that group twice, trying to raise money for MemberWare, his Pittsford company that has created a Web site that would connect to every association around the world.

He didn't get any money from the group.

"You have to be psychologically prepared for a lot of turndowns," he said. "I don't think I was able to close an investment in one out of five conversations."

Furman ended up raising about $1.5 million in his first two rounds of financing, mostly through business contacts he has made since breaking away from Xerox Corp. in the late 1960s.

For his third round, he looked to institutional investors for more than $3 million, primarily outside of Rochester.

"These investors see five business plans a minute," said Furman, who wants to take his company public in the fall. "It's intensely competitive. It's an enormous problem getting their attention."

Being from Rochester makes it even more difficult. Outside venture capitalists, if they have not invested in Rochester before, sometimes turn up their noses at businesses from this city.

That's often been the experience for John W. Germanow of Germanow & Co. He's a member of the Rochester Venture Capital Group and attends its meetings to scout for investments and opportunities to help entrepreneurs get connected to other people's money.

"One fellow I spoke to, his first line to me was, 'The company is from Rochester? That's a strike against you,' " Germanow said.

Simpson was often faced with that question when he made his presentations in the plush offices of West Coast investors. He learned that there are three main reasons venture capitalists often turn away from cities such as Rochester.

• The investors don't like to travel. They don't want to burn time and money by flying to Rochester for board meetings. The Internet helps address that problem somewhat, but investors want to be able to kick a company's tires.

• There are plenty of opportunities in the venture capitalist's own back yard. Silicon Valley, for example, is full of start-up companies. They got the lion's share of investment dollars -- more than $3 billion, or 37.1 percent -- in the third quarter of 1999.

• Investors often want to replace a company's chief executive officer or others on the management team. A city needs to have an ample supply of candidates for the jobs. Many investors think Rochester lacks that, Simpson said, despite the presence of former Eastman Kodak Co., Xerox and Bausch & Lomb Inc. executives.

Outside investors often make assumptions that prove to be untrue. David M. Coit -- president of North Atlantic Capital Corp., a venture capital firm based in Maine -- was turned on to investing opportunities in Rochester in 1997. Now he regularly pokes around here for later-stage companies that need money.

Coit had always thought Rochester was "a small, more industrial town," he said. "I was surprised and very impressed at the levels of skills that were available and the sophistication.

"We haven't found our next investment in Rochester yet. But we're trying hard."

Success stories

To be sure, Rochester has had some venture capital-backed successes. Just look at the local telecommunications industry, where players such as PaeTec Communications Inc. of Fairport have raised big money.

The naming rights for the proposed soccer stadium will go to PaeTec, which has raised more than $76 million in equity.

Choice One Communications Inc. raised $50 million in one weekend in New York City. The company, founded in 1998 by four former ACC Corp. executives, is now backed by a total of about $280 million in venture financing and has filed to go public.

On a smaller scale, a little biotechnology company nestled in Geneva, Ontario County, has quietly raised more than $6 million in venture capital.

Bioworks Inc., founded in 1993, has relied primarily on investors from New York state.

The company hasn't been hamstrung by its location, said Bill Foster, president and chief executive officer. The challenge lies more in competing against dot-coms for dollars.

"In every round, we've done better than we thought we would," he said. "No one has asked us to move away."

Though Simpson's experience in trying to fund WebPRN.com was decidedly more frustrating, he remains optimistic about future financing and the promise of going public.

"We just need more success stories to show that it can be done," he said.