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Show me the money: While venture capitalists invest their attention and dollars in technology firms, promising nontech start-ups struggle to find their place in the world of nondebt financing

by Meredith Erlewine

August 2000

“Raising money is a pain in the neck,” says Bob Thomson, manager of entrepreneurial programs at Ben Franklin Technology Partners of Northeastern Pennsylvania in Bethlehem. “I don’t care whether it’s a technology company or not, you’re never going to get away from that.”

But the pain can seem more persistent for a nontechnology start-up. Venture capitalists have turned their pockets inside out in hopes of ultrahigh returns on investment (ROI) from companies in high-tech industries including software, the Internet and biotechnology. Entrepreneurs in nontech industries, meanwhile, have been left with nondebt financing options that look like chump change in comparison.

“There’s almost a frenzy that exists within the investment community as it relates to technology driven companies, and specifically to information technology (IT) companies,” says Mike LeHere, director of the Akron Edison Industrial Incubator in Akron, Ohio.

According to PricewaterhouseCoopers, a whopping 90 percent of 1999’s record high $35.6 billion in U.S. venture capital investments went to technology firms. So far, 2000 investment trends don’t appear to be changing much: The National Venture Capital Association (NVCA) reports that there has been little change from 1999 regarding the industries that attract the most venture capital dollars. NVCA also reports that investments continue at unprecedented levels – to the tune of $22.7 billion during the first quarter of 2000.

So what’s a promising nontechnology start-up in search of investment capital to do in a world of B2B, B2C, Internet infrastructure and software? The fact that venture capitalists are investing at all-time-high levels and that more investment capital is available than ever before actually translates into good news for all growth companies. Even though nontechnology start-ups – and especially early-stage ones – are not the darlings of the venture capital community’s biggest players, there are other players out there looking for deals. But nobody said they’d be easy to find.

Here’s what you’re up against

“Nontechnology companies will spend more time searching and finding the right deal or deals,” says Rick Ritter, director of the Idaho Innovation Center in Idaho Falls, Idaho. “[They] must work harder and smarter, and the result is less money.” This is, in part, because of the high-upside potential of many of these firms. A venture capitalist probably can invest $7 million in a high-tech firm and get a 50 percent return on investment (ROI) in three to five years.

Recent high-tech dealmaking certainly has been inflated by the attention the media has provided, but there’s a solid foundation behind the hype. According to Charlie Huebner of Web-based private capital exchange, two major gaps exist in today’s investment market: one between technology and nontechnology firms, and another between start-ups and mature companies. “If you’re a technology start-up, you’re a fit for venture capital. If you’re an established nontechnology firm, you’re a fit for buyout. If you’re a nontechnology start-up, you don’t easily fit [anywhere] now,” says Huebner, managing director at vcapital. Principals of nontechnology start-ups must begin searching for less obvious capital providers. “They’re out there, but they’re probably more difficult to reach,” he says.

The companies finding themselves in the capital chasm include promising firms that any community would be thrilled to produce. They may, for instance, be early-stage companies looking for an equity investment to help them grow to a $10 million or $20 million company. To put that in perspective, many major-league venture capitalists (referred to by one interviewee as “vulture capitalists”) seek deals in which they can help an $8 million or $10 million company grow to be a $100 million company.

“It’s a gap,” says Dan Loague, seminar program director for the National Association for Seed and Venture Funds (NASVF), “and it’s an extremely competitive market.” He notes that things might be different if the private capital market recognized that social goods were just as important as ROI. “But unfortunately, the money goes where the money is – and a lot of other areas get neglected. It’s a nationwide problem.” Loague says the average seed investment for institutional venture capital is $7.5 million. “That’s huge, and that’s an average investment. So what if you have companies in a very early stage that don’t need that much?”

Those are exactly the types of companies that many communities need, and incubation programs strive to assist. “Quite frankly, we’d rather have 10 companies that [grow] to $10 million a year than one company that gets to $100 million a year,” says Ritter. “It’s a better distribution of risk.”

The fact is that high-upside, high-technology companies aren’t the only game in town. And neither are the nation’s top venture capital firms. Some investors are satisfied with more moderate returns from more traditional – and in their minds safer – industries, or have social agendas to meet as well. “But that doesn’t mean they don’t take a hard look at deals and doesn’t mean that they don’t get burned,” Loague cautions.

“Certainly in the last year we’ve seen more IT business plans than any other business sector,” says Frank Winslow, president of the NCIC Capital Fund, an early-stage investment fund in Ohio. Winslow’s firm is not antitech by any means – he and his colleagues are simply looking for good deals. To wit, NCIC recently has made some markedly nontech investments, including a start-up airline and a start-up truck manufacturing plant.

The problem is finding more Winslows. “Somebody’s got to go out and mine the resources,” says John Sandefur, state director of the Alabama Small Business Development Center and operator of that state’s ACE-Net program.

That, according to Thomson, is the beauty of incubators. “Within a region they can build the credibility of start-ups and can have a network of contacts so that they can expose a company to several investors at once.”

Know your options and play the field

When you’re helping clients look for equity capital, a good place to start is your community’s nonprofit economic development agency. These organizations often wear many hats and provide many services, including several of the financing options listed below.

Keep in mind that things are not always as they seem. Some financing options that appear to be unavailable to nontech companies might actually have potential.

Visit NCIC Capital Fund’s Web site ( A bold headline greets you: “Debt and equity financing available for early stage, technology based companies.” That’s enough to stop a manufacturing firm cold, but it shouldn’t. “We use the word technology, not in the Wall Street sense of computers, software, Internet, et cetera, but to exclude restaurants, dry cleaners and other lifestyle, nongrowth businesses,” Winslow says. The bottom line is that NCIC invests in promising companies.

So do the following nondebt financing vehicles, which range from venture capital to federal research funds. A combination of some or all, paired with a fair amount of creativity and sleuthing, can result in a respectable chunk of cash.

Angel investors. Several incubator managers agree that angel investors – those low-profile, high-net-worth individuals who are present in every community – are the most promising sources today for nondebt financing for nontechnology firms. Angels are an excellent option because there are lots of them out there, with staggering amounts of money to invest. In addition, they generally have an agenda that goes beyond the ROI, and the money is more patient than venture capital (many angels hope for an exit in five to seven years). Angels want to bring more to a company than money – they want to apply their experience and offer guidance and insight. “A venture capitalist is very concerned about how fast a company will grow and how fast [the firm] can get out,” says Ed Harrell, president of Edgar C. Harrell Associates, an incubation consulting company in Chevy Chase, Md. “Angels have a broader interest.”

Angels come with their difficulties, too. They often stick to industries they know something about, so it may take a long time to find the right match. Also, few invest as part of a formal organizational network. “The problem for many companies is getting an audience with these folks,” Ritter says. “They are typically unknown, by choice, and operate through some type of intermediary, such as an attorney, accountant or financial planner.” Networking with those intermediaries is one of the best ways to find out about the angels in your own community.

Venture capital. It may not be easy to get, but venture capital is an option for any company that promises growth and success. Not every venture capital firm is exclusively involved in megadeals, according to Winslow. “That’s certainly true …with the large venture capital firms, but I think smaller firms are not only funding IT companies but other things as well,” he says. Venture capital firms are much easier to find than angels, since they’re a known entity. A good place to start looking is your local bank. Banks often have seed, venture capital, SBIC or CDFI funds (read on for more on the latter two resources). Visit NVCA’s Web site ( for a list of member firms.

State seed funds. According to Loague, one of the best sources for nondebt capital for nontech firms is state seed funds. “They’re the most accessible right now,” Loague says, “because they’re out in the open and part of the public environment.” State seed funds include public agencies, state-sponsored private investors and public/private partnerships that leverage risk capital resources to meet the needs of entrepreneurs. State seed funds are more concerned with the quality of a business than the type, and generally offer financing options that range from investment capital to loans. The Rural Policy Research Institute, a consortium of the Universities of Missouri and Nebraska and Iowa State University, recently published a Directory of State Assisted Venture Capital Programs. The directory is available at Click on “Most Recent“ publications or “Equity Capital“ in the index. Also, visit for a list of NASVF members.

Community Development Financial Institutions (CDFIs). “CDFIs are a variety of community based nonprofits who do anything from housing to small business lending to venture capital,” says Mark Barbash, director of trade and development for the city of Columbus, Ohio. CDFIs raise money from banks and local government, then apply for matching funds from the federal government. The U.S. Treasury Department created the CDFI fund to expand the availability of financial services in distressed urban and rural communities. CDFIs include community development banks, credit unions, loan funds, venture capital funds and microenterprise loan funds. For a listing of certified CDFIs, visit

Small Business Investment Companies (SBICs). The SBIC program is the U.S. Small Business Administration’s (SBA) venture capital arm. Many traditional venture capital organizations and commercial banks elect to become SBICs, which allows them to leverage private sector investment with SBA funds. Whereas CDFI funds remain with the institution that receives them, SBICs must pay back the SBA for cash infusions they receive. Securing SBIC designation allows banks to invest in higher-risk ventures than possible under federal banking regulations. Visit for complete information about the SBIC program.

ACE-Net (Access to Capital Electronic Network). ACE-Net is an Internet-based listing service for securities offerings for small companies. Password-protected access is available only to accredited investors (angels). The SBA’s Office of Advocacy, in cooperation with the U.S. Securities and Exchange Commission (SEC) and others, developed ACE-Net to help small companies raise equity capital in the range of $250,000 to $5 million. The network is a nonprofit service designed to facilitate the information flow between entrepreneurs and investors. Nearly every state has a sponsoring organization and a network operator who manages the day-to-day operations of the program there. According to Sandefur, entrepreneurs who use the service get a lot more than introductions to investors. “There is a lot of work that goes into prepping entrepreneurs to go into the system,” he says, explaining that entrepreneurs often need and receive technical assistance from ACE-Net staff in areas such as business planning and market research. The SBA is now in the process of privatizing ACE-Net, a move it planned since the program began. To learn more about the ACE-Net program, visit

SCOR (Small Corporate Offering Registration). A SCOR offering is the most common form of direct public offering (DPO). The state-level program operates under federal rules that provide an exemption from the normal SEC filing requirements for amounts under $1 million. More than 40 states allow SCOR offerings, in which corporations may raise up to $1 million per year by filing a Form U-7. “This is a good tool for nontechnology companies,” Ritter says. Whereas typical angel investments take place privately, a SCOR offering allows anyone to buy stock in a company at the price offered. For a list of states that recognize the Form U-7 visit Advertising the offering is up to the entrepreneur, so any help an incubator can provide with researching and targeting potential investors could greatly affect the success of the offering.

Federal research and development funding resources. This category includes programs such as Small Business Innovation Research (SBIR –, Small Business Technology Transfer (STTR –, Advanced Technology Program (ATP –, Inventions & Innovation (I&I – and National Industrial Competitiveness through Energy, Environment and Economics (NICE3 – According to Ritter, many people assume that these grant programs specifically are for technology companies (most of these programs specify technology companies as their target audiences). “But if you look through the solicitations, there are [many] things that federal agencies are looking for that are not technology related,” he says. One of the first SBIR awards that Ritter was involved with went to an elderly farmer in Idaho who had cobbled together several pieces of farm equipment, creating a tractor-like machine that chopped straw and dumped it into furrows in hopes of conserving water during irrigation. “He ultimately got an SBIR award,” Ritter says. The money funded machinery refinements and allowed the farmer to build custom prototype parts. For the right company with the right type of product, programs like these can provide a good bit of help during a company’s early stages.

The incubator as facilitator

At an incubator, a client company’s chance of getting funded is directly related to the back office work of the staff. The technical assistance offerings and networking give companies a head start and an edge in the crowded capital hunt. Incubator managers and staff who emphasize the following services at the right time during clients’ quests for capital will help them make smart choices.

Get to know your region’s investors. Thomson says it’s essential for incubator managers to build relationships with the region’s investors. “My role is to act as a one-stop shop in directing [clients] to the appropriate avenues for possible investment capital,” he says. Ben Franklin Technology Partners staff know representatives of all of the venture capital firms and banks in the region, and try to make as much contact as possible with local private investors. “We work through a network of contacts to find out what individual investors’ tastes and preferences are,” he says. “It’s a work in process right now.” Thomson is referring to his goal of building a pool of angel investors so that when an appropriate deal comes forward he can make an introduction. Other good ways to find out who might be investing money in your region include joining venture capital clubs, local investment clubs and associations of industries clients are likely to be involved with, hosting angel investor conferences and keeping in touch with representatives of your local SBDC and other business assistance organizations. Get to know your local lawyers and accountants – they often represent the angels in your community.

Make sure clients understand the valuation process. “You always have to worry about giving up too much equity, particularly with a venture capitalist,” Thomson says. When cash is short, an entrepreneur could leap at a deal that may not be prudent over the long haul. In Akron, LeHere helps clients with initial (precapital seeking) valuations based on growth potential and market. Then the client knows an estimated value of the business and what might be a reasonable portion to sell for a $500,000 investment. After a potential investor is involved, “the entrepreneur needs the services of a good CPA and a good attorney to help him appropriately value and structure the deal,” LeHere says. That’s another good reason to get to know the lawyers and accountants in your region – and get them interested in your program.

Coach clients on presentation. Investment opportunities don’t always come when expected, so it’s important to make sure your clients are prepared in a heartbeat to pitch a quick sale. The Idaho Innovation Center has added assistance with public speaking to its menu of services, in response to investors’ comments that clients’ presentation skills didn’t always match the quality of their business plans. “We have really pushed our folks to be prepared, wherever they go, to answer the question, ‘What do you do?’” It must be working – one of Ritter’s clients landed a $300,000 investment after tangling lines with an (unbeknownst to him) angel while fishing on an Idaho river.

Cultivate graduates. Incubator graduates are a promising investment source to keep on your program’s radar – they could be angels in the making. Many are successful, rich and best of all, entrepreneurial. “One of the things we’ve changed significantly in the last three years is that after a company graduates, we continue to work with [it],” Ritter says. He’s hoping that one graduate, in particular, will return to town (the firm was acquired by John Deere) and consider putting together an investment fund. “They’re entrepreneurs by nature, and can take the big corporation for a period of time, but ultimately will leave and strike out on their own again,” Ritter says. He refers to his graduates as alumni, and likes to remind them on a friendly basis that they had their starts at the Innovation Center. “I anticipate that there’s not only financing for businesses but longer term financial support – I don’t know what form it will take, but those alumni are going to be absolutely critical to the long-term growth of the incubator,” Ritter says.

Make sure clients’ business plans shine. Client companies’ business plans simply must be irresistible. Potential investors want to see a rock-solid plan with a strong executive summary, credible market research and clear indications that the business is headed for success. Investors’ interest is particularly piqued if the idea or product is proprietary or has some type of competitive edge. Winslow says the business plan played a big part in the truck manufacturing start-up landing an investment from NCIC. “This business plan is written for building highly customized step vans for companies largely included in the IT sector that will have a big demand for step vans,” he says. The firm plans to cash in on the need for specialized delivery services that the Internet already is creating. “If they had just written a sort of mundane plan we probably would have said ‘good luck,’’’ Winslow says.

Help build a crackerjack management team. “With real estate, it’s location, location, location,” Harrell says. “With investing, it’s the people, the people, the people.” Investments often are appealing to investors because the entrepreneurs are appealing. The help an incubator provides a client with building the management team may seriously impact that company’s chances of getting investment capital. “I can’t tell you how many times we’ve had conversations with venture capital companies from Seattle, Portland, even the Silicon Valley, who have said ‘Great product, but this is a B or C team. The team isn’t capable of taking the company from where it’s at to where it needs to be,’” Ritter says. The challenge of helping entrepreneurs with this hurdle is that they don’t often recognize that they may not be the best people to run the company that they conceptualized and have begun to build. Managers can help by maintaining one-on-one contact with clients in order to assess their management teams’ strengths and weaknesses, providing honest critiques, and helping to identify the skills that could enhance the team.

When the pendulum swings…

…it often swings back. Many tech-related venture capital investments of late, particularly those involved with the Internet, haven’t turned out to pack quite the punch investors expected. “It got crazy in the dot com world, and venture capitalists are turning back now and I think there will be a downturn,” Thomson says. This is not to say that technology investment opportunities will fall out of favor – certainly those companies will continue to offer the opportunities with the highest upsides and likely will always command the lion’s share of investments.

But to some extent, people like to follow what’s hot. “Investments go in themes, and right now technology is a theme that people are keyed into,” Huebner says. “Whether it’s a perception or a reality, time will tell.”

On the horizon

President Clinton’s New Markets Initiatives, still in the proposal stage, have garnered both media attention and political backing and are worth keeping an eye on. Initiatives include:

  • New Markets Tax Credit, intended to spur $15 billion in new private equity investment for business growth in inner cities and rural communities. Eligible investment funds (including community development banks, CDFIs, venture funds and other investors) serving low- and moderate-income communities would receive a tax credit worth in present value terms more than 30 percent of the amount invested.
  • New Markets Venture Capital Firms (NMVCs). This proposal would create new venture capital funds that target a lower rate of return (10 percent, for example) and provide more hands-on management assistance to their small business portfolio investments. NMVCs would target smaller firms with growth potential that do not have sufficient equity.

Keywords: angel investors/network, company valuation, capital access, venture capital

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