For the right idea, venture capital might be there. Amount of venture capital in Michigan has doubled since 2002
You have just come up with the best idea since American capitalism began – or at least you think it is. It may be the proverbial better mousetrap or the widget to end all widgets. You may have spent years in the machine shop or on the computer developing it. You figure you've poured a couple PhDs worth of knowledge into it.
Or, tired of working for someone else, you simply want to start your own company. You know just what the market needs. You have done the research and polished your business plan to perfection. You have the right managerial skills. All your friends say they wish they had thought of it first.
And now you figure you need some money to get rolling. Well, hold on tight. Your real work is just beginning.
After you empty your savings account and hit up your friends and relatives for loans, you may need still more money to propel your idea into the stratosphere. You can pretty much rule out banks at this stage, although their loans may prove invaluable several years down the road.
After the first $100,000 or so, you may be interested in connecting with an angel and a venture capital investor, probably in that order. And they just might be interested in connecting with you – but only if they think you and your business are going to be a real winner.
They want something new, fresh and innovative that could bring in many times their original investment over a few short years. Humdrum, mainstream companies and products aren't even on their radar.
It might be good to think in terms of a company like Ann Arbor-based HandyLab, with its "lab on a computer chip." The brainchild of two U-M engineering students, its product offers lightning-fast DNA analysis, just the thing to quickly identify diseases or biological warfare agents.
Based in Marquette, Pioneer Surgical Technology is an example of a northern Michigan company that has found private investors. They recently poured more than $37 million into the company. It makes innovative spinal implants for therapies considered far less invasive than total disc replacements.
But your company doesn't need to be a biotech or information technology company to find investment. Even service businesses can qualify, provided they offer revolutionary products or processes, says LeAnn Auer, executive director of the Michigan Venture Capital Association, an Ann Arbor-based trade group.
If the entrepreneur has that better mousetrap – and gets a bite from an investor – he or she will usually want a share in the company. That may not be a comforting thought if the entrepreneur has grown to think of the company or product as his or her special creation. "You need to think about your appetite for venture capital," Auer said.
The investor's share can be anything from a tiny percentage to a majority of the company. That usually doesn't deter people intent on seeing their ideas realized, however.
On the plus side, it's not a bad time for the right Michigan entrepreneur to find the capital he or she needs. The state's venture capital has doubled to $600 million over the last five years, although much of that money has already been placed in specific ventures. In addition, there are 14 venture capital firms in the state now, up from eight in 2002.
There are also more "angel" groups active in Michigan. The Grand Traverse region even has one now with the start-up of the Traverse Angels. These groups consist of wealthy individuals – usually entrepreneurs themselves – who are ready to invest their money in the right company or idea.
This all represents a big improvement for Michigan, traditionally a laggard on the venture capital scene. "Out of the 50 states, we are probably somewhere around 25th," Auer said. "And it is going to get better."
Ann Arbor and Oakland County have long been the state's hotbeds of venture capital, but the rest of the state is now seeing activity, as well. For example, Kalamazoo now has two venture funds. And along with Traverse City, Holland and Lansing each have their own angel groups.
Fortunately, most organizations regard all of Michigan as their playground. About 50 percent of the capital that the state's venture firms invest goes to Michigan-based companies, Auer said. That bodes well for Grand Traverse companies looking for investment capital.
But investors are still as choosy as ever about their investments. They want to look at dozens of solid ideas before making their selection – and they just might reject them all. There is no doubt that some great ideas never get funded.
And even when they invest, venture firms know that only a small percentage of deals will actually score big. So they try to spread their risk by investing in a number of firms, hoping that at least some will make it. For similar reasons, an angel may team up with like-minded investors to reduce the odds of losing their shirts.
The key element, of course, is the company's product or service. It simply can't be like everyone else's. It must represent a quantum leap forward, offering an advantage in cost, quality or use that no competitor can match. It may involve a scientific or engineering breakthrough or a revolutionary change in a process. Needless to say, such innovations don't come along everyday.
"It can be anything that is innovative and that there is a clear market need for," Auer said. "That said, many of the VCs here in Michigan invest in life sciences."
Robert Ochtel, the founder of Traverse Angels, agrees.
"Investors want big markets and industry-changing technology. If you have those things, you have the potential for being discovered."
"What the entrepreneurs generally don't understand is that all ideas are not home runs," he said. "And most of them aren't fundable by ventures or by angels."
It's the entrepreneur's job to make his or her case. Auer recommends getting help with business plans from organizations and the Service Corps of Retired Executives (SCORE) throughout the state and your region's Small Business Technology and Development Center (the host institution in our area is the Northwest Michigan Council of Governments). Ochtel believes a business-savvy entrepreneur can get the similar results with a couple months of research.
"If you have only 10 minutes in front of a venture capitalist or a banking official or an angel investor, you want that 10 minutes to be worth their while," Auer said. "I would suggest it for any funds that you are seeking, including loans and grants."
Pennies from heaven
But angel networks shouldn't be neglected, either. According to Ochtel, this variety of investor funds 30 to 40 times as many businesses as venture capital firms do. Their window is known as "early stage funding."
They typically invest between $25,000 and $250,000 per transaction, and they are looking for returns of about 22.50 to 50 percent, Ochtel said. Groups hold out the best opportunity for funding in the important $2 million to $5 million investment range – which traditional venture capital funds increasingly avoid as they pursue bigger, less risky deals. But a venture firm might kick with a larger investment after the angels finish their work.
One good way to find an investor is through the numerous angel groups and VC firms that have sprouted around the state. (See Michigan Venture Capital Association's web site at www.michiganvca.org/ for lists of service providers, angel groups, venture capital firms and related organizations.)
Auer believes it is worth the entrepreneur's while to knock on the doors of each Michigan venture capital firm, perhaps making presentations at their regular investor meetings.
There is another difference between the two forms of funding: Venture capitalists invest other people's money, while angels invest their own,
Venture firms often get money from pension funds, corporate investor and insurance companies.
"So they have a fiduciary responsibility to take that money and invest in companies that are the best fit for their fund," Auer said.
Angels are not under the same legal constraints. But since the angels' own money is at stake, they aren't likely to stand by and watch it drain away either. What they often do is give the fledgling venture a hand.
"A lot of angels are entrepreneurs themselves," Ochtel said. "Money is money, but if you have more industry contacts or experience and you can knock down walls for the company, that's much more valuable than just money."
He also believes angels are less risk averse than venture fund managers.
Whatever contribution investors make, they probably aren't interested in sticking around forever. The entrepreneur has to consider when and how investors will cash out and move along to the next deal.
In five or 10 years, venture capitalists will want to recoup their investment and their earnings and move on, Auer said. They typically do this through the sale of their stake in the company. Ochtel puts the term of angels' investments at about five to seven years.
Contact Robert Ochtel at Robert@traverseangels.com or (760) 438 8750 if you are interested in learning more about and perhaps joining the Traverse Angels. An introductory membership meeting is being held Feb. 27 for invitees and members only. BN