Introductions Key to Obtaining VC Financing

Takeaways from a lively and informative presentation on early stage investing at the annual conference of the Pittsburgh Chapter of the Association for Corporate Growth:

1. Patience is a virtue in life sciences investing.
2. Ouch -- those crammed down angels.
3. Deal structure matters.
4. What may matter more is what terms "survive" subsequent financings.
5. Introductions are key in obtaining VC funding.
6. Management can make or break a deal.

Ned Renzi of Birchmere Ventures moderated the session. The panelists included Ross Bersot of Bay City Capital, a west coast firm focused on life sciences investing, Koleman Karleski (Princeton '85) of Chrysalis Ventures, a Louisville-based firm investing in healthcare & technology in middle America, and Patrick Stewart of Idea Foundry, a Pittsburgh non-profit that provides "idea stage" funding to Pennsylvania entrepreneurs.

Mr. Bersot noted that due to long FDA approval processes and other factors in the life sciences early stage investment arena, "revenues are rare and profits - a miracle." Patience is indeed a virtue in this sector. Interestingly, he explained that Bay City, in addition to traditional VC investing, also hires managers to create companies based on internally generated ideas. Mr. Bersot cited as trends materially affecting life sciences investing: the move away from IPOs toward trade sales as exit strategies; and the move toward "platform" technologies and away from more specialized technologies as an area of Bay City Capital's investment focus.

In contrast, Mr. Karleski stated that Chrysalis Ventures focuses more on what middle american businesses are doing with technology rather than on the technologies themselves. Chrysalis invests in companies with revenues typically in the $1 million to $2 million range in a 20 state area, that includes Western Pennsylvania, Chrysalis believes is underserved. Deal structure is important to Chrysalis, Mr. Karleski noting that deal terms such as participating preferred stock, anti-dilution protection and the like can add 15%-20% to the implied ownership position in a portfolio company, raising the VC's ownership position, for example, from 20% (on paper) to 23% (in the event of a liquidation event).

Mr. Renzi made a great point in response to the discussion of deal terms. What may matter more that what terms are in a deal is what terms survive over the course of the investment. Experience has shown that many deal sweetening terms, like full ratchet anti-dilution, do not survive subsequent rounds of financing because follow-on investors often require such provisions be eliminated or waived as a condition to making the subsequent investment.

Mr. Stewart bolstered this contention by indicating that the recent past has been tough for angel investors who have seen their percentage ownership positions "crammed down" in subsequent financings.

In response to a question I posed about how the firms cull business plans to find potential investments to investigate in more detail, three factors stood out. First the potential investment must meet the basic investment criteria of the fund. Second, referrals from trusted sources, including self generated leads, can be crucial. And third, it's Management, Managment, Management.