Rooting for growth

Is Central Pennsylvania cultivating an environment for investment?

Photo illustration/Kathryn Morton

On a recent trip to Palo Alto, Lancaster software entrepreneur Charlie Crystle was hanging out at a café when he spied legendary “super angel” startup investor Ron Conway getting out of a car.

“I introduced myself, and now we’re talking,” Crystle said.

Such encounters are easy to come by in Silicon Valley, he said. Social and financial capital flow easily there, making it the vibrant, energized, innovative place it is, he said. The midstate needs to become more like that, he said.

Local investors have plenty of money, but “it flows like molasses,” said Crystle, who sold a startup, ChiliSoft, for tens of millions of dollars in 2000. Investors here are risk-averse, out of touch, slow and wedded to deal structures that shortchange company founders, he said.

Not surprisingly, the investment community takes issue with Crystle’s characterization.

Lancaster and the midstate enjoy a healthy crop of software and technology companies that testifies to investors’ willingness to fund new ventures, said Mike Shoemaker, leader of the Lancaster Angel Network investor group.

Though there’s always more to be done, Shoemaker said, he doesn’t see the huge, gaping need Crystle depicts.

“He’s looking for a Silicon Valley kind of atmosphere. You’re never going to get that here in Lancaster,” he said.

To see an example of what Crystle is talking about, consider the path taken by social media company CoTweet.

Founded in the Hershey area, CoTweet today is the San Francisco office of an Indianapolis-based online marketing company, Exact Target.

“Our search for capital led us out of the area,” said Jesse Engle, CoTweet co-founder and CEO.

CoTweet helps companies manage their presence on social media sites such as Facebook and Twitter.

CoTweet’s founders realized they needed investors with close ties to those juggernauts, Engle said.

“There’s a lot of value investors can bring to the table beyond the money,” he said. Bringing on investors with deep industry knowledge and a wealth of contacts “can really make the difference between success and failure,” he said.

Similarly, Crystle said he’s looking to places like New York and the Bay Area for funding for his own new venture, Jawaya, a project that brings social media to bear on the world of search engines. He wants to develop Jawaya in Lancaster, but may have to move, he said.

“If you think it’s bad here, it’s a lot worse in 45 other states,” said John Sider, managing director for statewide initiatives with Ben Franklin Technology Partners, a state-supported organization charged with nurturing small high-tech companies.
Pennsylvania has been in the top five states for venture capital deals for the past three years, he said.

Moreover, the state’s venture investment climate has improved over the past decade, he said. The Ben Franklin Technology Development Authority and the four regional Ben Franklin organizations have provided financial and consulting assistance to dozens of companies, helping them reach the stage where they become attractive to private investors.

Also, creation of the state-supported Pennsylvania Angel Network has improved early-stage investors’ communications, methodology and access to potential deals, Sider said.
The Lancaster Angel Network has been funding companies, both high-tech and low-tech, for a decade, Shoemaker said. The network meets monthly and hears presentations from two startups each time, Shoemaker said. It has about 45 active members, of whom 10 to 20 will show up at a given meeting.

Companies request anywhere from a few thousand dollars up to about half a million, he said. The network’s only job is to bring investors and companies together — it’s up to them to make any subsequent deals, he said.

Similar groups exist in Philadelphia, Altoona, Scranton and York, among other cities, according to the Pennsylvania Angel Network roster.

Yet, from a high-tech entrepreneur’s point of view, midstate investors are too inclined to stick with conventional businesses and conventional investments, said Anthony Warren, a professor of entrepreneurship at Penn State and co-founder of Halare Inc., a project to develop therapy for asthma and sleep apnea patients.

“There’s enough money, but there isn’t enough sophistication” in the local investor community, he said.

The lack of a local track record with emerging-market companies creates a reluctance to invest in them, creating a self-perpetuating cycle, he said.

Every segment of the startup world believes it could use more investment capital, said Michael Hund, a partner with Harrisburg-based law firm McNees, Wallace & Nurick who specializes in early-stage technology firms and investors.

“Everybody thinks there’s more focus needed on their space. And from their vantage point, it’s true,” he said.

Nevertheless, the bottleneck Hund sees isn’t capital, but managerial talent — the ability to turn small companies into big ones is “the biggest missing component,” he said.
Another problem, Sider said, is the global increase in venture investors’ aversion to risk in the wake of the 2008 recession.

Angel investing declined 26.2 percent in 2008 and 8.3 percent in 2009, according to the Center for Venture Research at the University of New Hampshire.

Investors today want companies with more “later-stage characteristics” than they used to, Sider said — more revenue, more market share, more products fully ready for prime time.

Central Pennsylvania has many strengths for startups, including experienced managers, a capable workforce and a strong manufacturing sector, said David Freschman, managing principal of venture capital firm Innovation Ventures, which has offices in Lancaster and Wilmington, Del.

“There’s always enough capital for good companies, no matter where they are,” he said.

Still, pioneer companies trying to break ground in new economic sectors will face challenges, he acknowledged.

“Venture has always been cautious,” he said.

And that’s just it, entrepreneurs said: Venture should be more adventurous.

Capital is cheap in Silicon Valley, Crystle said. Investors can lose a million dollars without blinking an eye because they’re confident one of their other million-dollar bets will pay off tenfold or better, he said.

The Lancaster Angel Network has made some good investments, but “it’s nowhere near what we’re talking about,” he said.

He singled out First Round Capital, which has an office in Conshohocken, as having the right approach, “but we need five of those firms investing with the same ethic and efficiency,” he said.

“The attitude for supporting entrepreneurs and catalyzing big things is the big difference,” he said.

Crystle said he believes he can change that.

“There’s optimism in my dissent,” he said.

Stages of a startup

It takes a lot of money to launch a company, especially when its core offering is an advanced drug or a complex software product.

Startup funding begins with the entrepreneur’s own stake. Most founders then turn to what venture capitalists refer to, somewhat acerbically, as FFF: friends, family and fools.
Money in hand, startups then try to cross the “valley of death” — the sometimes lengthy period before revenue comes online to be set against expenses. Few survive.

In Pennsylvania, the Ben Franklin Technology Partners organization was formed to help companies through that period, statewide director John Sider said.

The Ben Franklin Technology Development Authority offers early-stage financing, often through loans that later get converted into equity stakes once the value of the company is better understood.

Many companies seek to do one or more rounds of angel and venture financing, getting more money in exchange for equity stakes as specified in term sheets that founders and investors sign off on. Angels are wealthy individuals who invest their own money, while venture funds invest on others’ behalf.

Startup investors are seeking off-the-charts successes — ideally, culminating in an initial public offering. Nine in 10 startup investments will tank, so the one that succeeds has to more than make up for them, Sider said.

“If I’m an equity investor, I want a threefold to tenfold return within five to eight years,” he said.

Tim Stuhldreher

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