Seed capital sprouting statewide
It was just a year ago that the John Pappajohn Entrepreneurial Center at North Iowa Area Community College sponsored a “Seed Investing as a Team Sport” seminar.
The seminar generated enough interest among potential investors that they formed a community-based seed capital fund. By August, a total of 61 investors from 14 communities around Mason City generated $1.69 million to start the North Iowa Venture Capital Fund.
Its first deal, which just recently closed, was an investment with three other Iowa seed funds for the expansion of ANE Technology Services of Johnston, which recently merged with Prime Logic Technical Partners of Cedar Falls. The combined investment in the company was about $750,000. The North Iowa fund is among the latest of several community-based seed capital funds to be formed in Iowa within the past two years, in what many say is an improving landscape for start-up capital. In all, there are now at least 19 seed capital or venture capital funds throughout the state. And, as evidenced by deals such as the ANE investment, Iowa funds are also becoming better coordinated and are beginning to do more deals together as well.
“Overall, we are very pleased with the development of the regional angel investor funds,” said Katherine Cota-Uyar, the program manager of the University of Northern Iowa’s John Pappajohn Entrepreneurial Center, who has tracked the development of new funds across Iowa. “These funds will greatly benefit new and growing companies in Iowa. Additionally, these funds will likely help encourage greater investment into Iowa companies by angels since there is a more organized method for their investment.”
A PATH TO FOLLOW
Newer funds such as the North Iowa Venture Capital Fund have two advantages that earlier funds lacked: a model for forming a fund and a tax credit program to encourage investors to participate.
Using a model it purchased last year from the state of Minnesota, the Iowa Department of Economic Development is working to assist groups of investors in forming seed capital funds known as regional angel investor networks across the state.
“If we can set up these networks, they can provide a filtering process to present deals to angel investors,” said Ray Walton, a business development specialist with the IDED. “It’s more professional and more organized.”
The angel networks can provide a first level of funding after start-up companies have tapped family and friends, but probably before seeking venture capital.
“Or, [angel and venture funds] could end up working very closely together,” Walton said. “It’s like a lot of other entrepreneurial things; you do what you have to do is grow the business.” The North Iowa fund was among the first angel funds to use the model provided by the IDED.
“It was very valuable,” said Tim Putnam, associate director of the Pappajohn Center at NIACC. “It was extremely comprehensive, from the initial thought processes to bring this together, to what all the legal documents needed to be. … We’re looking to work with IDED to provide what we learned to other people looking at funds as well.”
At the same time, a state program that offers tax credits to encourage venture capital investment has begun to gain some momentum. So far, the Iowa Department of Revenue has certified three community-based seed capital funds — Emerging Growth Capital Fund LP of Des Moines, Ames Seed Capital LLC, and North Iowa Venture Capital Fund LLC of Mason City — and is considering applications from Eastern Iowa Angel Investors and Cedar Valley Venture Fund.
Under the law, investors can receive a 20 percent tax credit on losses from investments made through certified seed capital funds in qualified companies, with a total of $10 million in credits available. So far, 13 companies have been qualified to participate in the program. For larger venture capital funds with $3 million or more to invest, a smaller 6 percent tax credit is available. One Iowa fund, AVIN Equity Partners I LLP, has been certified under that program, which has a $5 million total cap on credits.
“The state putting in place the legislation, and the encouragement for the venture capital funds is a very important thing,” said Dick Schwab, vice president of Eastern Iowa Angel Investors. Because the tax credits can be claimed only if the venture fails, their real value lies primarily in the perception provided, he said. “But that’s not why you’re in the game.”
The Eastern Iowa fund, formed less than two years ago, has 21 investors that have put in about $1.1 million. Most of them had not been active angel investors prior to the fund’s inception. “They bought the pitch,” Schwab said. “[Angel investing] can be good for you, it can be good for the state and it’s best done as a team sport. And I don’t think that’s snake oil. I think that we make better decisions collectively. And if any of these are successful, it will be good for the state of Iowa.”
A more established fund, Iowa Capital Corp. in Des Moines, has invested in more than a dozen companies in the past several years, all but one of them Iowa-based or founded in Iowa, said Terry Sullivan, vice president of Capital Management Associates Inc., the fund’s manager.
Originally formed in 1991 as a partnership between Corn Belt Cooperative and Central Iowa Power Cooperative, the fund was bought by the latter organization, which has operated it as a subsidiary for the past four years. It invests in a wide variety of businesses, including Dynamic Broadband of Des Moines and MediNotes Corp., a West Des Moines electronic medical records software company.
Sullivan said the emerging community-based funds will need the leadership of such anchors as Principal Financial Group Inc. and Wellmark Blue Cross and Blue Shield of Iowa, both of whom have formed funds, as well as the larger venture capital firms like AAVIN Equity Partners to put together deals.
“There has been some good deal flow, but I think with the state’s help we could incubate some better deals,” he said. “It’s got to go hand in hand; you’ve got to have both the money and the deals to fund.”
Gregg Barcus, president of Emerging Growth Group in Des Moines, said the emergence of new angel funds in the state is “exciting.”
“For the first time, there are vehicles by which ordinary angel investors can become participants in venture funding, and I think that’s exciting,” he said. “And the tax credits are a huge deal.”
Emerging Growth, a for-profit technology incubator, is the general partner of Emerging Growth Capital Fund, an early-stage seed capital fund. The fund has raised $1.1 million and typically provides from $100,000 to $200,000 to start-up companies. Deals such as the funding of ANE Technology, in which Emerging Growth was among the four funds sharing the risk, are becoming more common, he said.
“In Iowa, just breaking escrow, starting to do deals, that tends to encourage more participation,” Barcus said. “(Seed capital) is kind of a foreign concept in Iowa. We don’t have a lot of history or inclination to risk high-risk, high-reward investments.”
With the new climate, “we’re seeing some people that quite frankly we weren’t even aware were around,” he said. “And we’ve had some new investors seek us out, which is encouraging. We’re trying to figure out how to handle that, because we really weren’t prepared for that. It’s a good phenomenon.”
Recently, there have also been increased efforts among the funds to network and share information. In mid-November, principals of funds from across the state met in Des Moines in a meeting coordinated by the IDED.
“They want to learn from each other,” Walton said, because in many ways, “venture capital is a new business.” Besides pooling their expertise, the fund principals are also interested in seeing how they can work together to finance projects, he said. The venture capital firms have planned another meeting in January.
As regional angel and seed capital funds are forming, another state initiative has led to further private-sector creation of venture capital that businesses can use after receiving initial capital from angel investors or seed capital funds. In return for a reduction of the tax on insurance premiums, eight Iowa insurance companies last year committed to create $60 million in new venture capital over a five-year period.
The largest investor in the program is Wellmark, which has invested $15 million out of a $25 million commitment. Among other large commitments are $10 million from Principal, $9 million from Aegon USA and $8 million from Iowa Farm Bureau.
The investments serve a dual purpose, said David Southwell, Wellmark’s group vice president, financial officer and treasurer.
“Obviously, we believe the investment in new business, and eventually new employment and new jobs, is critical to a company like Wellmark, which wants to see the new population that will hopefully be enticed to these companies,” he said. “This is a very important part of our future: keeping costs down by spreading out the risk with a younger workforce.”
At the same time, “we’re definitely tracking it as we would any other investment,” Southwell said. It’s too early, however, to tell how well those investments are doing, he said.
The Pappajohn Center for Entrepreneurship at Iowa State University is one of four centers in Iowa that assist start-up companies in applying for funding through the Wellmark Community Ventures Fund.
“That’s been a very good tool, and one that will be increasingly important to young companies here,” said Steve Carter, director of the Iowa State University Research Park Corp. In the past 15 years the research park has referred many start-up companies to the Ames Seed Capital Fund. Carter welcomes the addition of Wellmark’s fund. “If we have a very risky project where we can spread the risk among two funds, that’s very useful to the company,” he said.
GETTING FUNDS, MAINTAINING CONTROL
Start-up companies seeking seed capital must be careful to avoid losing control of their businesses, said Donald Schoen, chief executive of MediNotes Corp., a fast-growing medical software company in West Des Moines.
MediNotes, which specializes in software physicians can use to record and store information on patients electronically, is Schoen’s second technology start-up. He sold his first company, Retail Management Systems, in 1992. He found seed capital for both ventures through the Des Moines-based Iowa Capital Corp, managed by Capital Management Associates Inc.
“I try to keep the investments such that I still have control of the company, which I think is very important,” he said. It’s not unusual for the larger venture capital firms to put their own profits over the best interests of the company, Schoen said. However, with Capital Management Corp., “I was fortunate in that they provided guidance, but they allowed me to make decisions that were in the best interest of the client, rather than for the short-term gain of the investors,” he said.
Another key to entrepreneurial success, according to Schoen, is finding enough money to finance the company’s operations until demand builds for its products.
Now, with MediNotes’ software being sold in all 50 states and Canada, MediNotes in the past year has doubled its workforce to 40 employees, and sales are up 100 percent, Schoen said.