October 29, 2009
Sourcing deal flow from venture development organizations is a relatively new phenomenon, as most of these organizations have started within the last five years. Despite their young age, they have already made it dramatically easier for you to access high potential deals within your own or other regions.
What is a VDO?
Venture Development Organizations combine two unlikely elements: venture capital and economic development. They are different from physical incubators, entrepreneurial service organizations, and small business government offices because they creatively combine three elements to their business model:
- They directly invest risk capital.
- Their operating and investment capital comes from charitable sources.
- They work intensively with the companies in which they invest.
The most interesting element of this, to venture capital investors, is the charitable risk capital, which makes venture development different from many other sources. The charitable capital concept stems from the region's leaders wanting to grow the local economy through entrepreneurship and the creation of entrepreneurial companies with technology-based jobs.
Sources for the charitable risk capital can be private or public, but all grantors (read: not LPs) share the understanding that the funds provided to a VDO are invested with no direct financial return to them, with returns instead going to a so-called evergreen fund.
Not surprisingly, most VDOs are located in geographies that are not known as entrepreneurial hot spots, though some of those regions now are awakening and making up nicely for lost time--Pittsburgh, Cleveland, and Oklahoma City, for example. Perhaps this is due to their base economies having struggled and having been forced to reinvent themselves through entrepreneurship. The indicators are that it is beginning to work.
Why pay any attention?
Sourcing deals from VDOs yields many benefits to a venture investor, namely:
They reduce risks
The combination of seed funding bundled with intensive technical assistance progresses technology companies through their earliest stages while simultaneously preparing them for venture funding. By providing pre-seed or seed funding, usually while the company is in the incubating stage, VDO's help minimize technical product risks. Intensive assistance, sometimes as much as a full day a week for 18-24 months, focuses founder entrepreneurs on hitting critical growth milestones, such as knowing their market and strengthening management teams.
"My belief in these programs as an investor is reinforced by my own experience as a first time founder and all the mistakes I was forced to experience, rather than being coached to avoid," said Phineas Barnes, Principal of First Round Capital,
They make your investment easier.
VDOs simplify your investment decision by bringing deals that have cleaner balance sheets and more information at-the-ready, effectively serving as a source of due diligence. Pitch presentations are stronger because the entrepreneur has already competitively pitched to secure investment from a VDO and received intensive additional marketing support for refining and polishing the pitch to you.
When a company receives an investment from a VDO, it goes through due diligence similar to that of a for-profit investor; documents are in place, materials are organized and easy to access and external expert opinions have been collated.
"By the time our local VDO has evaluated a company with domain experts, invested seed capital, educated the entrepreneurs about how to organize a business for follow-on venture capital, and helped the company meet meaningful milestones, it's ready for us to take a look," comments Managing Director Jonathan Murray of Early Stage Partners in Cleveland.
The bottom line
VDOs are good partners in identifying the highest potential technologies and companies in a region and making it easy for you to access and invest in them. Consider Pittsburgh: often mentioned as one of the 10 best up-and-coming regions for entrepreneurship. Seventy percent of the Pittsburgh region's venture capital investment goes to companies that received seed investment and worked with one of the most well-developed and successful VDOs in the country, Innovation Works.
Koleman Karleski, Managing Partner of Chrysalis Ventures, is among the many venture capitalists who increasingly see VDOs as a reliable and high quality source of deal flow. "The combination of bringing the right human resources and sufficient capital to actually achieve milestones is a really critical combination," he says. "It enables companies to get to the point where VC firms will pick them; these companies are the diamonds in the rough."
Becca Braun, President of JumpStart Ventures, was co-founder and initial CEO of Supplier Insight, a company that offers supplier management services and software to corporations and government agencies and that was ultimately acquired by Ariba (Nasdaq: ARBA). Becca was formerly a Vice President at Kirtland Capital Partners (KCP), a $300 million private equity firm located in Willoughby Hills, Ohio. Prior to KCP, Becca was a principal at The Parthenon Group, a strategic advisory and principle investing firm in Boston, Massachusetts. Becca graduated from Harvard Business School in 1997 and has a Bachelors degree in Linguistics from Harvard University. She is a co-founder of the Boston-based Harbus Foundation, and maintains involvement in The Braun Group, an executive communications firm. She serves on the boards/advisory boards of Embrace Pet Insurance, Red Cross Blood Services and Cleveland Skating Club, and is an alumna trustee of Springboard Enterprises.
The views expressed in this guest article do not necessarily reflect the views of PrivateEquityCentral.net.
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