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.