Five years later, St. Louis' capital investment infrastructure is a different world
This article first appeared in the St. Louis Beacon: This fall, the nation will mark five years since the onset of the biggest global economic collapse in more than a generation.
The unhappy milestone of those turbulent autumn weeks, which ushered in a stormy era of bank bailouts and credit crises before giving way to a frigid drizzle of financial uncertainty, will be celebrated by few.
Yet locally the picture for startups seeking capital has brightened in ways that couldn’t have been foreseen in the days when the troubles of AIG and Lehman Brothers dominated the headlines.
“The national surveys are showing that angel investing had taken a pretty severe hit and is now picking up,” said Jerome Katz of the Billiken Angels Network, a local group of about 30 angels. “Here in St. Louis, I think we looked better than the national average.”
Most people in the local capital community feel optimistic about the city’s position as the economy continues its slow, stuttering recovery. Still the yardstick is somewhat distorted since the crisis took place just as efforts to augment a startup culture in the city were getting underway. It’s a fact that muddies the picture of how much of the area’s seed capital growth has been economic improvement and how much have been fruits borne of a still-expanding entrepreneurial infrastructure that largely didn’t exist before the collapse.
Katz’s organization is one example. As with a number of people in the local angel universe, it’s hard for him to comment on whether the environment for seed capital is better now than before the crisis.
After all, the Billiken Angels were only founded in 2008.
“It was sort of an inauspicious time to start,” he said.
Inauspicious perhaps, but not unprofitable. Katz’s group has made four investments in the last six months and they are not alone. The St. Louis Arch Angels, a local web of 67 investors, fuelled 16 new or existing startups last year with $5.6 million, the largest number of companies to which the organization has doled out funds since its 2005 inception.
“Innovation and entrepreneurship are really on fire. That’s the good news,” said Gil Bickel, chair of the group who said it has done six new deals just this year.
There is, of course, the bad news.
“I think more traditional businesses either seem to be doing just OK, or they are somewhat struggling,” he added.
While the startup scene in St. Louis hasn’t been insulated from the economic headwinds, it has been getting a strong boost from behind. Bickel said the Gateway City has been less volatile than boom areas like California, which took a heavy hit from the real estate collapse. The local area presents other advantages as well.
“The cost of living is so much greater on the coasts that I think companies and particularly entrepreneurs are starting to understand that St. Louis is a pretty darn good place to live and an excellent place to start a business,” he said.
Bickel said that’s been proven by the response to initiatives like Arch Grants, a business plan competition that gave away three-quarters of a million dollars in its initial round of funding nearly a year ago and has begun to generate serious interest outside Missouri. The most recent call for applications pulled in individuals from 40 states and 15 foreign countries from Israel to Bolivia.
Yet the picture isn’t without difficulties. Arch Grants gives away $50,000 stipends while institutions like the Arch Angels usually infuse six figures. But bigger amounts of funding can be elusive without mega-sized venture capital pools.
“Now, the problem is that they need to raise a million or $3 million or $5 million,” said Bickel of growing companies. “That’s where the rubber meets the road and where we are lacking.”
While heavy deal flow keeps angel capital pinned down, burgeoning enterprises may find themselves outgrowing St. Louis’ money reserves.
“That is the consequence,” he said. “We will be a great incubation ground for the East and West Coast funds unless we develop our own capital to keep the companies and grow them here.”
‘Stronger than it was’
Tom Melzer, managing director and co-founder of RiverVest Partners, an area venture capital fund focused on the life sciences industry, said he believes the economy is improving.
“There is evidence that things are thawing a bit in terms of a general reluctance to do illiquid investments,” he said. “That said, private and institutional investors who would invest in venture capital funds are still very selective in terms of what investments they would make. My general impression is that it’s not an easy fundraising market out there. I think there are opportunities to garner investment so there’s been a bit of a thaw, but it is certainly not where it was back in the mid-2000s.”
But even before 2008, Melzer felt the markets were changing and venture capital was becoming increasingly attracted to investments in which a result could be achieved in a tighter timeframe. Companies whose returns take a decade or so haven’t been as popular as in the past.
“We developed a very strong focus on things that we felt could exist in five years or less, and were very disciplined about that,” he said. “That’s really paid off in our experiences of late in 2011 and 2012. We exited a number of companies where our initial investment had been made sometime in the prior five years. I would say that’s quite a change and it’s had something to do with the sorts of opportunities you can select.”
Melzer said he feels good about the number of business accelerators in town but believes there is still a gap between seed stage and venture money that hasn’t really been filled as startups mature. Many, like Bickel, have suggested a need for more cash to be stationed here in St. Louis, particularly since investors often like to be close to their investments. However, Melzer said that attracting dollars from elsewhere isn’t a bad thing either.
“St. Louis needs to think about their opportunities in terms of funding as being national,” he said. “Capital will find good things no matter where it’s based. It’s unlikely all the capital we’re going to need is resident here.”
Greg Johnson, managing director of Prolog Ventures, an early stage life sciences investment outfit, said 2008 blew a very large hole in the fundraising picture.
“My general sense is that there is a tremendous shortage of capital in the venture industry, especially the life sciences part,” he said. “There were probably too many funds for a while and some have closed down. So there is somewhat of a capital gap to fund all these companies.”
Still, St. Louis has weathered the storm reasonably well due to the founding of accelerators and initiatives like BioSTL.
“Locally, it’s actually stronger than it was before because these other factors weren’t fully operational if you go back four or five years,” Johnson said. “That’s a big difference.”
Where the interest is
Katz, of the Billiken Angels, said some of the issue is that many angels were forced to play defense during the economic crisis. New money was often diverted to companies investors had already pumped cash into. This protected preexisting investments but left less cash for new ventures.
Worse, pleas for follow-on investments grew increasingly desperate as entrepreneurs came to grips with the realities of an unfriendly credit market.
“That was true for the VC firms too,” said Katz. “In tight economic times, it is harder for all of these firms to get debt financing from banks and other firms, so the chances of them going back to investors and saying we need an infusion of capital to keep ourselves going is much more likely.”
Katz said that biotech and IT are the big superstars in the capital market, but alternative energy, particularly wind, has risen in prominence as sustainability has come into its own.
Opportunities can be found elsewhere as well.
“Interestingly, one of the hot sectors is education,” he said. “A lot of for-profit activities have figured out that the education market is ripe for innovation and modernization.”
Industries also want to bring themselves up-to-date and retool.
“Right now, a lot of corporations are cash rich and what they are trying to do is figure out what they can do with that cash,” said Katz. “One of those things is to modernize, streamline and upgrade their internal processes and make things more sustainable and more efficient.”
Biotech and IT may make the biggest waves, they don’t necessarily break onshore equally – at least not in Missouri, which has seen a huge amount of interest in the life sciences while infrastructure for web-based startups has lagged a bit.
St. Louis is interesting because "we’ve had excellent follow-on funding opportunities for biotech (but) we really haven’t had a similar set of VC firms focused on IT,” he said. “There’s a lot of movement in the background right now trying to create funding vehicles, the equivalent of VC firms, with an IT focus.”
The world of IT
Judy Sindecuse appreciates that movement. As managing partner of Capital Innovators, a local group that deals in seed stage IT investments, Sindecuse said she’s seen an upsurge in excitement about IT.
"I don’t know how much of that is tied to an economic recovery and how much is tied to other factors as far as the things that are happening in IT across the country and across the world,” she said.
That confusion may be even worse in IT than it is in the life sciences. Except for some longer running institutions like the St. Louis IT Entrepreneurial Network (ITEN), a lot of the IT financial infrastructure simply didn’t exist until about a year and a half ago. If biotech is a toddler, IT is still in the crib.
That’s where outfits like Capital Innovators have played a role. By providing seed money, they have grown companies big enough to attract angel interest, something Sindecuse said was nearly non-existent only a few years ago.
“It helped those early stage companies get to the point where people like the Arch Angels or the Billiken Angel Network are able to invest,” she said. “What you see now is that there is a much greater percentage of investing in IT. It’s not just in the biotech/life sciences area.”
Sindecuse said she believes there is room in town for both life sciences and IT. The problem is that sometimes investors don’t understand the difference between the two. Biotech has huge capital needs and may take a decade or more to pay off before a drug or device comes to market. By contrast, a successful IT product might provide a quick turnaround in a few years on a relatively small investment. That’s become all the more so as costs for server space and other technology have fallen.
However, when investors have long-term cash soaked into the life sciences sponge, they are often reluctant to dig down for more. In reality, both are good investments, she said, but they act very differently and investor expectations may not always bridge the gap.
“While they are waiting, they are saying, ‘Well, I just don’t know if I want to invest in St. Louis startups anymore because it’s just not paying off,’” Sindecuse said. “It’s frustrating for me because I try to educate them and say, these are two completely different investments. You have not lost your initial one. It was always going to be a long play.”
In the end, she hopes to see the venture field expand as the economy grows.
“St. Louis is a big town,” she said. “We shouldn’t have just one area where we specialize."