April 1, 2011

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The VC Money Tree

The Truth about Venture Capital in Utah

Gaylen Webb

April 1, 2011

According to word on the street, Utah is not well connected to Wall Street. Further, landing second-round venture capital funding is more difficult for Utah-based entrepreneurs than those in other states. The Wall Street Myth “Saying Utah is not well connected to Wall Street is pure BS,” says Bradley B. Bertoch, president of the Wayne Brown Institute (WBI), a nonprofit organization that provides mentor-based training to help shape companies into fundable entities. He should know. Utah-based WBI alums have gone on to raise more than $3 billion in capital. “Some of the bigger venture-backed IPOs of the past three to four years have come out of Utah, such as Ancestry.com, Omniture and soon-to-be Skullcandy,” Bertoch adds. Park City-based Skullcandy, Inc.’s recent IPO announcement should also help dispel any myths about Utah’s connection to Wall Street. Top-tier underwriters at Morgan Stanley and Bank of America-Merrill Lynch issued that IPO. What’s more, Fusion-io also just announced its plans to go public. (Fusion-io is a Utah startup that is transforming the world’s data centers with its flash-based, solid state “ioMemory” technology.) Clearly, for a small state, Utah has “pretty good IPO activity,” says Bertoch. “We have been the venture capital center of the West for the last three years. When we do comparison statistics, Utah is doing pretty well. Everyone is in trouble, but Utah is not in as much trouble.” As for attracting second-round venture funding, Bertoch notes that attracting any venture capital (VC) funding is always difficult…but not impossible. For example, Fusion-io’s path to stardom included three rounds of venture funding that totaled approximately $115.5 million. “My sense is that it depends on what one’s assumptions are. If it was easy to obtain first-round funding but hard to get second-round funding—this may sound facetious—but the first-round funding was probably too easily obtained, and the entrepreneur was not as prepared as he or she needed to be.” To be sure, he says, raising VC money is rarely going to be easy, no matter what round of funding the entrepreneur is seeking. Unique Challenges Victor Pollak, an entrepreneur, as well as corporate and securities attorney and shareholder in the firm Fabian Law, agrees with Bertoch’s assessment, but adds that “Utah presents several unique challenges” uncommon to entrepreneurs in other areas: Geography Utah may be the Crossroads of the West, but not for VC deals. The state’s location far away from the VC communities located on the East and West Coasts can adversely affect an entrepreneur’s ability to raise money here. “Venture capital firms like to invest in businesses that are located near them physically, in the event an investment requires more attention,” Pollak says. “It takes a lot of work to make and manage a VC investment.” On the positive side, he says most Utah companies can overcome the state’s geographical limitations by first developing a relationship with a VC firm located in Salt Lake City. “The local VC firm acts as a fiduciary on the ground and leverages the resources of other VC firms around the country,” Pollak explains. “The Utah Fund of Funds has helped in institutionalizing that approach by linking Utah-based venture capital firms with VC firms on the coasts.” The Critical Mass Myth Pollak says VC firms around the country view Utah’s executive talent pool as lacking in critical mass. “Other than in the information technology sector, they think it is more difficult to recruit top-tier management talent in Utah than it is in entrepreneurial centers like Boston or the Bay Area,” he says. The life sciences area has overcome that stigma to some degree, he notes, but not to the degree that it’s been done in Utah’s IT industry. “My personal experience is that Utah is a very attractive place to recruit top management. Top-tier management talent is attracted to Utah for the same reasons so many other people come here: the environment, outdoor recreation, the small metro area and simply because it is a great place to raise families,” Pollak explains. In reality, he says Utah has an enormous pool of talented, experienced business executives who have made their way here and never want to leave. Wild West Town “In the ‘60s and ‘70s, Salt Lake City was associated with a penny stock market characterized by stock fraud. This is still a misperception which casts a shadow on the state,” says Pollak. “There is a lot of folklore out there—most of it unjustified—about the LDS culture. Outsiders don’t realize that Salt Lake City is a diversified, cosmopolitan city and that all religions are welcome here,” he says, noting that the folklore can inhibit Utah companies from getting a fair look from out-of-state VC firms. Other challenges faced by Utah entrepreneurs have more to do with the economy and the VC industry and less to do with the entrepreneurs themselves. Matthew Peterson, vice president of the Utah Fund of Funds, says VC firms have gone through a paradigm shift over the past decade. “Fifty percent of VC funds that are in existence today won’t be in existence within two years,” he says, “because they won’t be able to raise money for new funds. Overall, venture capital returns have been negative, with terrible fund performance over the past 10 years. Fund sizes are going down, so there is a shrinking pool of capital, and investors are more risk averse.” Further, Peterson explains that venture capital allocations from institutional investors are shrinking, and institutional investors are a primary source of money for VC funds. Entrepreneur Strategies What can Utah’s entrepreneurs do to overcome such inhibitors to deal-making? Pollak says to “start early, do your homework, and get into a channel of mentoring and constructive criticism.” He points to organizations like the Wayne Brown Institute as essential training centers for entrepreneurs to get educated about attracting investors. Further, he says entrepreneurs need to understand what makes a business VC-suitable. VC firms like to get into a business early and get out early, and they generally look for deals that require significant capital investment. “Venture capital firms tend to focus on those opportunities that are likely to be the most successful the soonest and that can grow. Companies that are going to take a long time to mature are not ideal VC investments,” Pollak says. Peterson says Utah entrepreneurs need to be better prepared for the rigors of raising money, since the average deal takes about a year to develop. “Most of the people that come into my office are pretty naïve. They aren’t prepared for the time commitment and they haven’t done enough research on how their product is different than other products out there. Our role is to help them get educated on the market and position themselves the best they can to raise money” he continues. Having a solid track record of organic growth is more important now than ever before, adds Bertoch. Strengthening the State What has been done to strengthen the state’s visibility with out-of-the-state venture firms and investors? Bertoch points to a group of efforts that have helped raise awareness and attract VC firms to lookat deals in the Beehive State. First and foremost would be the 2002 Olympics, he says. “[The Wayne Brown Institute] did a program with the Salt Lake Olympic Committee to bring venture capitalists to Utah for the Olympics, which had a huge impact on Silicon Valley’s perception of Utah,” he says. Other efforts include the creation of the Utah Fund of Funds, a dramatic increase in state-sponsored R&D, the creation of programs like USTAR and the Centers of Excellence program, and an explosion of university-based entrepreneurship programs. Further, angel groups abound in Utah, along with a “cadre of truly great service providers,” he says. Such efforts are paying off. Since 2000, venture capital under management in Utah has increased 17-fold, from $200 million to almost $3.5 billion, according to Bertoch. “Some big deals have put us on the map in the last 10–12 years. We can’t be compared to Silicon Valley in terms of deals, but compare us to any little community that has 2.5 million people and we don’t play second fiddle to anybody,” he says. Utah’s fiscally sound state government also resonates well among VC firms, Bertoch adds. “We are one of the top states in the country in terms of fiscal responsibility. Make all the fun you want about our ‘goofy legislature’ and all that crap, but everyone else is jealous,” he says. For its part, the Utah Fund of Funds has had a significant impact in raising awareness and increasing the deal flow in Utah as well. In fact, Peterson says since its inception, the Fund portfolio has invested approximately $250 million in Utah companies. “Over 50 percent of that money came from funds outside of the state of Utah,” he adds. To be sure, the Fund of Funds can link Utah entrepreneurs with VC firms in and out of the state. “We are able to open doors for Utah entrepreneurs, and our funds are able to see the best deal flow in the state. We are the gateway to Silicon Valley,” says Peterson.
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