Outside Financing for Early Stage Companies — Dealing with the ‘New Normal’

Part One: Since the economic downturn, how have funding sources changed their strategy for early stage companies?

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. Thankfully, it appears that things are improving, and that economic and financial conditions will continue to get better.

These financial and economic situations have created some ongoing challenges, however, that will continue to face early stage companies and entrepreneurs even under better conditions. Some of the most significant of these challenges that directly affect early stage companies and entrepreneurs are the apparent changes in the traditional roles of the venture capital, private equity and angel investing models. This is what appears to be the “new normal” for the financing of early stage companies. While this “new normal” will present significant challenges, it should also provide some substantial new opportunities for entities and individuals who want to finance these transactions and for the companies that need this financing.

Financing from venture capital and angel investor sources has historically been a vital source of funding for early stage companies. This financing has long served as one of the only ways for innovative and high-growth companies to get the expansion financing they need at a critical stage in their life cycles. Once a company had successfully navigated the rounds of early stage financing provided by founders and “friends, family and fools”, there is usually a gap in available financing. Most of these companies, especially in technology and other innovative spaces, were not able to qualify for bank financing and were too early for private equity financing. Venture capital and angel financing stepped into this gap and gave these companies the critical financing that they needed to survive and expand. To clarify, angel financing was typically provided by a wealthy individual or group of individuals who are not professional investors, while venture capital financing is typically provided by organized entities which provide funding on a professional basis. Angel investors historically tended to do smaller transactions than venture capital firms. 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. These are all generalizations, of course, and there have been numerous notable exceptions to each of these situations over the years.

This traditional financing model seems to have recently changed, however. Many private equity firms appear to 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, especially in the financial area. Some recent venture capital investments would likely have been private equity investment targets only a few years ago.

These shifts in investment focus are understandable from a financial standpoint, but they have significantly reduced the availability of crucial funding sources for early stage companies. These shifts also happened at a very tough time for most small companies as they tried to recover from the bad economic conditions. Many of them needed funding both to recover from these economic challenges and to take advantage of the opportunities that came out of these bad economic times. This reduction in financing opportunities coupled with the overall slow pace of the economic recovery made this a dire situation for many early stage companies and entrepreneurs.

Fortunately it appears that several contenders are stepping up to help fill this financing gap. Most of these investment vehicles are not new, but like the venture capital and private equity firms they are revising their investment models and sometimes morphing into something else. The good news is that these financing sources are helping early stage companies to survive, innovate and grow.

What are these new funding sources doing to help early stage companies? How can Florida’s start up and early stage companies ensure financial support going forward? More discussion on these topics and some possible answers will come in Part Two of this blog post.

For more information contact Robert C. White, Jr.