Entrepreneurs should have their credit cards ready

Tony Shipley thinks that entrepreneurs who can’t live without private investors should keep their day jobs.

“A lot of people find other ways to get early-stage funding,” said Shipley, chairman of Queen City Angels, an angel investor group that focuses on the regions around Cincinnati. “They turn to strategic partners, friends and family, use their credit cards or take out second mortgages.

“Frankly speaking, this is how companies where funded years ago when there was limited angel capital and VCs were focused on later stage companies,” he said. “This causes entrepreneurs to be more disciplined and focused on achieving meaningful goals with the money they have available.  People casually thinking about entrepreneurship must be really committed to operating effectively and efficiently or else they’re better off keeping their day job.”

The old-school approach is new again because of the dearth of private equity — both in money and in the shrinking number of firms. And Shipley says in an interview below that investors have become much more discerning — even among the companies they’ve invested in.

One-third of Queen City’s investments are life-science companies, including AssureRx, Orthodata Technologies and Minimally Invasive Devices. Below, Shipley discusses what anyone who’s planning to raise capital should expect from investors.

Q. What’s the state of private investment in the life sciences?
A. Venture capital firms with investment money have reserved it first and foremost for their existing portfolio companies, creating a more competitive funding environment for companies seeking their first venture round. Deals are still being done, but the terms might not be as friendly to the entrepreneur as they were a couple of years ago. If entrepreneurs miss their milestones, it’s costly to get additional money to complete their targeted milestones (in other words, the entrepreneur suffers more dilution).

Q. Given the economy, how are investors adjusting the way they do business?
A. We’re being more discriminating in assessing new companies and performing more due diligence. Pre-money valuations are lower than what they would have been a year ago. That’s probably where entrepreneurs see the biggest difference.

Q. What else is hard about getting money now?
A. The cycle time to make a decision to invest is longer due to more due diligence. Investors may be looking at later stage companies where the risk may be lower. More emphasis is placed on experienced management teams. More specific milestones may be defined and less money may be available to reach the milestones. This situation could cause entrepreneurs to have to tighten their salary budgets.

A couple of our companies have recently given up on VC funding due to the tougher terms.  There are lots of reasons for the steeper terms offered by VCs, including less VC capital available to fund new ventures, more money needed to ensure portfolio companies are properly capitalized, and some opportunistic pricing due to current market conditions.

Q. But it’s  not impossible?
A. There are a lot of new ideas that deserve funding, and investors are finding creative ways to put the capital in place, including funding in smaller tranches and syndicating deals on a broader basis.

Q: Are more companies approaching you for cash?
A. Historically, one to two companies seeking funding would present at our regularly scheduled meetings (held every three weeks). Recently, we have had as many as two to three companies presenting per meeting. It’s not surprising, however, as in a down economy; more people are willing to try their hand at entrepreneurship.

Q. It’s expected that companies will go under from a lack of funding. What do you foresee?
A. In a down economy, more companies go under due to lack of adequate capital, and this time is no exception.  Of course, in the best of times, the success rate for start ups in less than 50 percent.

[Front page photo courtesy of Flickr user The Consumerist]