• Financing Early Stage Companies-Dealing With the “New Normal”
  • April 28, 2011 | Author: Robert Campbell White
  • Law Firm: Gunster - Fort Lauderdale Office
  • We have recently experienced some of the worst financial and economic conditions that we (hopefully) will see in our lifetimes. Most of us have been touched personally by these conditions. It appears that economic and financial conditions will continue to get better, but these situations have created some ongoing challenges that will continue to face early stage companies and entrepreneurs even under better conditions.

    The apparent changes in the traditional roles of the venture capital, private equity and angel investing models are some of the changes that will impact early stage companies. This appears to be the “new normal” for the financing of early stage companies.  Financing from venture capital and angel investor sources has historically been a vital source of funding for early stage companies.  Most early stage companies are not able to qualify for bank financing and are too early for private equity financing. Venture capital and angel investor financing traditionally stepped into this gap and gave these companies the critical financing that they needed to survive and expand. Private equity firms tended to remain out of the early stage financing arena until a company had reached a certain level of revenues or profitability.

    This traditional financing model has changed.  Many private equity firms have shifted their investment focus to an even more mature class of companies. There has been a concurrent shift in focus by venture capital firms as many of them have also shifted their investment focus to more mature companies and are subjecting target companies to stricter investment criteria.

    These shifts in investment focus are understandable, but they have significantly reduced the availability of crucial funding sources for early stage companies. These shifts happened at a very tough time for most small companies as they tried to recover from bad economic conditions.  This reduction in financing opportunities coupled with the overall slow pace of the economic recovery has caused a dire situation for many early stage companies and entrepreneurs.  Fortunately several events have occurred that should help to fill this financing gap.

    The main contenders who may be able to fill this financing gap are business incubators, angel investors, “super angels” and seed capital funds. Incubators normally provide a range of helpful services for early stage ventures and entrepreneurs. They may or may not provide financing, but more of them are beginning to do this as part of their models. Angel investors are probably the most active of the financing sources in filling this gap. Many smart and sophisticated angel investors see good opportunities in potential deals that they would not have had access to a few years ago (as the venture capital firms would have gotten them). This has in some situations led to the emergence of “super angels”, which are either very wealthy individuals or groups of wealthy individuals who have available capital and are ready to finance early stage companies. Finally, organized seed capital funds are emerging as sources of capital for these companies. These funds are similar to venture capital funds but are willing to make smaller investments in earlier stage companies.

    There are some other interesting things that may help early stage companies obtain financing. Group or composite financing by a number of investors who make relatively small investments (generally called crowdfunding) has become a popular topic and could facilitate early stage capital raising. The possible increase in the upper limit on the size of Regulation A offerings has also been discussed, and this could help. Some substantial challenges need to be resolved with these items, but they may prove to be helpful to small companies.

    What does this mean for us here in Florida? Unfortunately, our situation has lagged behind the efforts in some other areas of entrepreneurial activity. This is not necessarily a long-term problem, however. We are lucky to have several good business incubators in Florida, although we need to have more incubators that provide financing to early stage ventures. I have also seen both significantly more interest and activity in the seed capital fund area.

    The biggest opportunity for substantial improvement in early stage financing lies in the angel and “super angel” area. We are fortunate to have a significant percentage of residents in Florida who are wealthy and who could become significant sources of investment capital for early stage companies.  The angel investment community in Florida remains somewhat unorganized, however, and is not always easy to access, but this is changing for the better. Making this angel financing more accessible to early stage companies and entrepreneurs will be a huge benefit to Florida’s economy, providing significant opportunities for increasing employment (with many high paying jobs) and wealth creation.

    Early stage companies and entrepreneurs should make extra efforts to make contacts with these new sources of financing. This is the best way to become noticed by these financing sources and to gain access to financing. This is not easy, but accessibility to these financing sources has improved dramatically and should continue to improve.