I’ve never wanted this blog to be out linking around or posting others content, but from time-to-time I find that the written words of others do a better job than I could, or provide strong validation of a point I have made in a previous post.

The article below details how angel investors are going later stage and how companies are looking at angels as an alternative to traditional venture/private equity for expansion stage funding amounts up to $10 million.  The article also points out that angel funding was actually up in 1H08, despite the turbulent economic backdrop.

Interesting times.



CHICAGO (Reuters.com) — Fiberstar Inc., a small company that converts orange juice pulp into a line of food ingredients and other products, is no longer a start-up. Founded a decade ago, it now has a customer base of loyal multinationals and annual revenue in excess of $5 million.

At this point, the company might seem an unlikely candidate for funding from angels, the private investors who back start-up ventures with typical commitments of less than $1 million.

But that’s exactly who Minneapolis-based Fiberstar, which in the past has relied exclusively on angel investors for private equity, is going after to help raise up to $10 million for working capital and new production facilities to keep up with increasing global demand.

“Our goal is to continue to raise funding from angel investors and angel groups,” says Dale Lindquist, Fiberstar’s president and chief executive. “We’ve respected the investment that they’ve made and as management we’re trying to protect it.”

“It’s very unusual for a company to go as far as we have working solely with angels,” he adds.

It’s becoming less unusual, says Jeffrey Sohl, director of the Center for Venture Research at the University of New Hampshire. Investing in more established companies is just one of several signs that angel investors are seeking a higher degree of comfort as they look for safer bets in a volatile economic climate, he says.

“The angels are doing post-seed – more later-stage work than they normally would,” says Sohl, noting that venture capital groups, which frequently fund private companies higher up in the development food chain, have also boosted their investment thresholds in recent months.

In a highly unpredictable economy, when credit markets are tight and traditional sources of capital such as bank debt have dried up or become increasingly difficult to obtain, angel investors are taking on more prominence as a source of alternative financing.

Total angel funding during the first half of 2008 has been surprisingly steady, rising 2.1 percent to $12.4 billion, compared to the same period in 2007, according to first half data released by the center earlier this month.

Sohl points out that the numbers also show that angels, who typically take preferred stock or other equity in exchange for their investment, are exhibiting increasingly cautious behavior.

The total number of deals funded in the first six months – some 23,100 according to data collected by the center – has fallen 3.8 percent. Meanwhile, the average size of each deal is up 8 percent, and along with it, the number of investors behind it. The center notes that the total number of angels participating in the first half grew 2.l percent to some 143,000, investing either individually or as part of angel groups. Fiberstar, the food and beverage company, has 152 angel investors.

“What this is telling us is that the angels are spreading out their risk a little more,” says Sohl.

Marianne Hudson, executive director for the Lenexa, Kansas-based Angel Capital Association, notes that she saw this trend begin to take hold last year. Her organization, comprised of more than 170 angel groups, saw average deal size in 2007 rise 10 percent to $266,000. At the same time, Hudson, whose members self-report their investing results annually, saw the average number of investors per deal rise to 55 from 44.

And while Hudson expects that trend to continue in the current economy, she sees another important signal of skittishness among her member groups: the increased use of loosely formed syndicates to jointly fund deals.

“We are seeing more and more angel investor groups co-invest with each other,” she says. “The angels are minimizing their risk.”

Angels will clearly remain an active source of capital as the economy worsens, say these and other experts on alternative sources of financing. Data show an increased appetite for sectors such as software, health care, manufacturing, green technology and other energy-related concerns.

But for start-ups and later-stage private companies alike, the latest numbers signal what will also likely be a very competitive field for a limited supply of investment capital.

“There’s more demand for us – we can pick and choose,” says Knox Massey, executive director of the Atlanta Technology Angels. “Somebody out there is not going to get funded.”

By Deborah L. Cohen
(Deborah Cohen covers small business for Reuters.com. She can be reached at smallbusinessbigissues@yahoo.com)

I’ve been witnessing a disturbing trend, all in context, over the past 4 months in the consumer capital raise arena. I call it the “steak sauce” round. A stake sauce round occurs when a company tries to raise an interim round between its Series A and Series B. It’s grown up brother is called the “bomber” round, when a company raises an interim round between its Series B and Series C. These are often marketed as A-1 rounds (“steak sauce”) or B-1 rounds (“bombers”). Collectively we refer to them as “tweener rounds”. That said, I have seen more steak sauce offerings than bombers.

So why are we seeing so many interim rounds. Generally speaking, a majority of these offerings come to bare as a result of a company under performing it’s cash flow projections. Often times, in the interest of preserving value for the existing shareholders, a business is marketed under an aggressive set of projections so as to maximize valuation. It’s hard to ask for more money than your projections require, because it essentially invalidates them to a degree. However, projections are often made in a vacuum and fail to take into account the fluctuation’s that invariably occur when you are subject to economic cycles. All consumer businesses will experience some level of performance degradation in a deteriorating consumer environment. Given today’s economic climate it is not surprising that we are seeing so many steak rounds.

The second underlying cause of a steak round is that first time entrepreneurs underestimate the cost associated with market penetration. Invariably, in a start-up capital deployment is not fully efficient. Additionally, many consumer categories are either highly competitive or require work to educate the market on the value proposition. This takes more dollars than anyone ever anticipates.

Steak rounds are no fun for anyone. No surprise there. Existing management has to market the progress of the company in order to recruit more capital and existing investors must show support (hopefully with deep pockets) in order to incent new money to come into the equation if possible. Often times management must put on a brave face in light of performance that has not met. Further, this is a distraction for management at a critical time as tweener rounds can be protracted exercises, and the company is likely operating in challenging environment, hence the need for the additional capital ahead of plan.

So if you are faced with seeking fries for your steak round, how do you come up perfectly cooked (note I did not say well done)? A few ideas:

1) My first suggestion is to take mitigating action well in advance of tacking institutional capital. That is to focus your strategy on either profitability or defined market penetration. It is more marketable to show traction in one market that it is to show limited traction, but a broad distribution foot print. This is counter intuitive to many, but an ounce of prevention is worth a pound of cure. Of course this might not always be a viable strategy.

2) If you take anything away from my blog, ever, it is that you should not re-open your prior round. Not only is this a weak market signal, but it complicates things later down the road. It’s like getting a tattoo when you are 18; there is a high likelihood that you might regret that very demarcation later in life. Instead go for a convert. Convertible debt at a discount to the next rounds valuation offers the best opportunity to bring in new money due to the protections that it provides.

3) Be realistic, your convert should be at a discount to the next round and offer warrant coverage. Go heavy on the warrant coverage as opposed to the discount. Warrants will dilute everyone when exercised, discounts only dilute those who have invested to date when realized. I often hear from people who take my advice on a convert but do not offer a discount. More often than not those people end up less than enthused with the results of their tweener. Discounts of 10% – 33% are appropriate and warrants of 10% – 20% of the investment are within the acceptable parameters.

Of course, the way out of this mess is to be realistic about your capital plan in the first place. Easier said that done. However, the price of imperfection later is much greater than the value created by creating the price of perfection now. I know there I go again, robbing you of value on behalf of investors.