Venture Capitalists in Maryland Are Cautiously Selective

November 6, 2012

Posted in: MEQ

Venture capital (VC) is financing provided by professional managers
of private partnerships, closely-held corporations or other financial
institutions for startup and early stage companies with significant
potential for growth and profitability. These VC firms are funded by
private and public pension funds, endowment funds, foundations,
corporations, wealthy individuals, foreign investors and venture
capitalists.

While venture capital has played a critical role as a source of
equity financing for startup and early stage businesses, fewer than 0.5%
of new businesses started each year in the United States receive VC
financing. Further, since the Internet bubble burst in 2000, VC firms
have taken a more conservative investment posture and returned to the
fundamental investment analysis utilized prior to the euphoric
investments in dot-com businesses. Consequently, VC funds are not as
widely available nationally and in Maryland as they were in the late
1990s.

VC Funding Is Lower

According to a report by PricewaterhouseCoopers (PwC), companies in
Maryland, Washington, D.C., and Northern Virginia received 14% less VC
funding in the third quarter of 2012 than they did during the same
period in 2011. Firms in the mid-Atlantic region raised VC funding of
$215.7 million in the third quarter, down from $245.7 million in the
third quarter of 2011.

Nationwide, firms raised $6.5 billion of VC financing in the third quarter, down 11% from 2011.

The PwC report noted that 20 Maryland companies received VC financing
in 2012. Nine of those companies were located in greater Baltimore, and
11 of the companies were based in Maryland’s Washington, D.C., suburbs.
The PwC report notes that $51 million of VC financing was invested in
biotechnology and medical devices, while $158 million was invested in
information technology firms.

Yet, these results fail to capture the entire VC story.

“We’re seeing fewer new venture funds being raised which means less
capital is available for new investments,” remarked Tracy T. Lefteroff,
global managing partner of the venture capital practice at PwC US. “And,
we’re seeing venture capitalists be very cautious with the capital that
is available due to the lack of a significant number of liquidity
events. Instead, venture capitalists are continuing to support the
companies already in their portfolio.”

Liquidity events are exit strategies that allow investors to realize a
cash return on their investment, and include a sale of the enterprise,
refinancing of the business or an initial public offering (IPO).

A Few Attractive Sectors

According to Mark Heesen, president of the National Venture Capital
Association (NVCA), while third-quarter VC investment performance is
consistent with trends in 2012, there are industries that appear to be
attractive to VC investors.

“Information technology [IT] investment continues to be very strong,
particularly in the Internet arena. We also continue to see clean tech
(alternative energy, pollution and recycling, power supplies and
conservation) investment shifting concentration to smaller, more
efficient deals.”

However, Bjorn Frogner, entrepreneur-in-residence at bwTech@UMBC
Research and Technology Park Maryland Clean Energy Technology Incubator
(CETI), has not experienced a robust VC investment climate for clean
tech businesses.

“Among the companies (mostly clean energy) I deal with, very few (if
any) have received funding from professional investors,” he said. “Most
of them find money at TEDCO [Maryland Technology Development
Corporation], MEA [Maryland Energy Administration], DOE [Department of
Energy], and then customers. This may partially be because our incubator
deals with the companies during their very early stage, and partially
because they cannot demonstrate the kind of rapid entry into the market
required by the VCs.

“There are a few companies at UMD [University of Maryland] that are
of high caliber, have strong technologies and have high market
potential, making them attractive to serious equity investors.”

Public Funding Assistance

The financing sources identified by Frogner are representative of
public sector efforts to supplement private sector funding of
technology-based startup and early stage businesses. For example, TEDCO
is a corporation created by the Maryland state legislature in 1998 with a
mission to facilitate the creation and growth of businesses through the
commercialization of technology. TEDCO provides financing for
technology transfer and development programs and entrepreneurial
business assistance.

A state-funded seed and early-stage equity fund, the Maryland Venture
Fund makes direct investments in technology and life science companies,
and indirect investments in venture capital funds. About 60% of the
fund is invested in technology companies in software, communications and
IT security, while 40% of the fund is invested in life science
companies in the areas of therapeutics, medical devices and diagnostics.

Yet, despite these efforts, VC financing continues to be limited in
Maryland. This is particularly true for businesses serving the federal
market.

“It is more difficult for businesses that have the federal government
as [their] primary customer to obtain VC financing because of the
government’s extensive testing procedures, the necessity of obtaining
appropriate certifications, the rigid nature of the federal budget cycle
and the extended timeframe to realize a return on investment,” said Vic
Hess, Venable entrepreneur-in-residence at bwtech@UMBC Research and
Technology Park Cyber Incubator.

“Business owners and managers should consider alternative financing
vehicles, including the Small Business Innovation Research (SBIR)
program and investments from commercial customers,” Hess said.

Despite the grim picture for the state of VC financing in Maryland,
there are still numerous VC firms selectively investing in high
potential businesses that demonstrate the discipline, competence and
attention to customers required for the success of the enterprise.

“The majority of business plans I have read are wish-based,” noted
Hess. “That is, the author of the plan wishes for the plan outcomes,
rather than developing and implementing coherent strategies and tactics
that facilitate the optimum opportunity for the realization of plan
objectives.”

Hess has a simple view of the state of VC financing in Maryland. “If
you have a good business and prove the concept, VC financing will be
available. If not, then VC investors will seek more lucrative
opportunities.”

Michael A. Mobley is managing partner of Obsidian Management LLC
in Ellicott City. He may be reached at 410-418-4453 or
obsidianmgmt@aol.com.