How Investing Works in the Heartland
By Eric L. Dobson
There are few VC’s left in early stage investment space. It has been surrendered to incubators, accelerators, and angels. The great state of Tennessee is a notable exception due to a state funded VC program, the TNInvestco program, that began in 2010, which appears will have a substantial impact on the economy of the state. Kudos to the line of TN Governors that have consistently supported entrepreneurship and angel investing!
The challenge is angels have been fragmented for decades, which has only been exacerbated by the move of VC’s out of the market since 2008. Version 1.0 of angel investing was the “lone wolf,” who simply followed the coat-tails of the pre-Sarbanes Oxley ("SarBox") era VC’s as an individual or a member of a stand-alone geographically-focused angel group or fund. Version 2.0 came when angels and angel groups and funds began to syndicate. The reason is simple. One angel group, outside of the traditional early stage innovation centers (Silicon Valley, Boston, New York, Miami, LA, etc.), will have trouble backing one great company from concept to exit. And, the goal is to do so a dozen times. So, strength in numbers became the going plan. But, these first syndicates had a fatal flaw, the were built on loose amalgamations of groups with polite agreements to collaborate. Without a more rigid structure, they had redundant diligence processes, lack of aligned values and processes, and closings that approached glacial pace. They were simply not aligned with a clarity of unified purpose and action. As the VC’s moved out of the market, beginning with SarBox, and rapidly accelerating after the 2008 Great Credit Contraction, a void was left that has been filled with a new breed of angel. That is why we call the strong syndicates of today, Version 3.0. Angels have become the “pros” in the market. They have to manage the dealflow, diligence, legal wrangling, etc. (once done by teams of analysts) as interested, educated members in angel groups. This is the future of angel investing.......with one caveat. The JOBS Act Reg A+ statutes are effectively restoring the small-cap IPO as we speak. Time will tell if this draws VC’s back into the early stage market or it simply gives angels a path to liquidity without the VC’s participation. I tend to believe the latter will be the case, because that is how I intend to use the new regulations with our portfolio where it makes sense.
With the rise of these syndicates, we see a massive shift of attention from the traditional investment centers to the Heartland. Steve Case published a book, The Rise of the Rest, which supports this hypothesis. But, I am not sure even he realizes the extent to which this is happening in the Heartland. It is not just the Nashvilles of the Heartland that are rising, it is the Ashlands and Florences that are organizing capital and creating high-growth companies under this new syndication model. We see this because, as angels have become more organized, they brought to the market a sense of love of community that VC’s simply don’t share. Third, and even fourth tier metros, are seeking to compete in a new economic reality as traditional industries have collapsed, coupled with a bubble in the traditional innovation centers…..Voila! The rest are rising. The Heartland is organizing and marching to a new drum. And, they can because, and we have said this often, tech and talent are ubiquitous. Capital is the bottleneck, and there is substantial residual wealth across the Heartland that is organizing now. It is clear that capital investing is being disaggregated away from the traditional centers. Angels in the Heartland are snatching up startups based on IP from universities and research laboratories right and left. Partially, because this is where these entities have tended to form, and mostly because of the shift of employment patterns from large metropolitan areas highlighted by Richard Florida’s book, The Rise of the Creative Class. We see this with every industry the Internet touches – the traditional gatekeepers are being bypassed, disagregation of assets, and democratization of activity. We have reached a post-Silicon Valley world. Earlier this summer, I attended the 36/86 Conference in Nashville, TN where I listened to Steve Case and a slew of Valley VC’s all talking about coming to the Heartland to find deals at rational valuations. As a reversal of several years of programs that tried to draw Nashville to be more like the Valley, this one extolled the virtues and amenities of Nashville. It was a welcome message of self-realization after so many years of watching the West Coast bubble inflate from a distance.
So, let’s talk about how funding gets done in a post-Silicon Valley world. If there is no local capital the company dies or is usually forced to move to be close to capital sources. Increasingly out of town (OOT) capital wants local capital to have invested first. And for good reason. First, local investors are well vested in these companies and in seeing them grow. Second, every investor wants local mentors to serve as advisors and as “canaries in the coal mine.” They want to know that someone has already done a lot of the heavy lifting and is minding the store!
But, you may ask, where does crowdfunding fit here? The problem with this model is simply, who curates the deals? Crowds may be good a creating capital, but they tend to be lousy at adding value to a company. Angels first, and foremost add value. And, there is still a great deal of skepticism of the SEC regulations regarding equity-based crowdfunding. This will change over time, but for now, crowdfunding does not lead to angel or venture capital. It seems to preclude it. As VC’s have moved out of the space expanding the Series A Crunch, angels have to take these companies further and further to reach either organic growth or VC funding. Capital must be organized and professional. “Dumb” money does not buy you much when it comes to a Series A financing. Pass-the-hat investors are not respected by OOT capital, especially professionals and institutional capital, who often force these investors out of the deal once they take hold. That is why we say local, professional, organized, committed angel capital is the catalyst for growing ventures in your community. OOT capital will almost certainly require a venture to have local backing. They want to know that someone geographically close and financially vested in the company has vetted them, fixed the problems that plague early stage companies, taken a financial risk, and will vouch for their execution and stewardship of resources. This is why a syndicate of angel groups and funds is so critical!
A syndicate can cultivate local companies by bringing together expertise, networks, and capital to move these companies past the traditional investment range of angels. To do otherwise, is simply throwing good money away. These syndicates exist in a highly distributed fashion, but aligned around the economic benefit of lifting all ships. And, the proven strategy for angels to capture returns is to buy a seat at the table in many early stage ventures and then double or triple down on the winners. Everyone wins – investors make money, entrepreneurs create great companies and life-changing wealth, the community gets enterprises and jobs. This is the face of the brave new world of angel investing. Get involved!
Copyright Eric L. Dobson 2017
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