It's the Catch-22 of entrepreneurship. Attracting investment money is most difficult during the earliest days, exactly when startups need it most.
BioCrossroads hopes to break that tricky cycle with its new $4 million seed-stage venture capital fund, Indiana Seed Fund I. But when fund raising was launched last year, the life sciences initiative aimed for $10 million.
At about $250,000 per deal, BioCrossroads can do up to 15 deals-or two dozen fewer than it had intended.
"We would certainly have liked it to be a little bit larger," said BioCrossroads President and CEO David Johnson. "But we think we have the resources to move ahead."
Last year, BioCrossroads raised the $73 million Indiana Future Fund. That money is earmarked for venture-stage investments in budding companies with management teams, business plans and potential products in the pipeline. More than three years after BioCrossroads' debut, it's hard to find startups in Indiana ripe enough for IFF investment.
More common are the would- be entrepreneurs whose dreams have just begun to germinate. No matter how great their ideas, they need money before their startups can take root. So they're thrilled to see BioCrossroads form a seed fund, even a $4 million one.
But only a fraction of seed-funded startups ever attract venture-stage investments like the kind the IFF was built to deliver. And a still smaller percentage of those actually make it to market with biotech products or services-let alone become runaway successes.
For Indiana's life sciences effort to succeed, it needs to cast more than a handful of seed. It must plant by the acre.
"Admittedly, we would like to see more than $4 million," said David Doyle, president of local business incubator Inception LLC. "But this is an excellent start."
Most of Indiana Seed Fund's money came from the state in the form of a loan. BioCrossroads brokered $3 million last year from the old Indiana Development Finance Authority. The loan, which carries an interest rate of 1 percent, matures Oct. 13, 2019. If Indiana Seed Fund I does well, the state gets 5 percent of the upside. As the only other investor, BioCrossroads gets the other 95 percent.
The seed fund is managed by BC Advisors, a for-profit subsidiary of the not-for-profit BioCrossroads. Johnson said BC Advisors will have a five- to seven-member investment committee made up of professional venture capitalists. It will also have a larger advisory committee.
Who will actually sit on those committees hasn't been decided. But as the only equity investor in Indiana Seed Fund I, BioCrossroads will have final authority on deals.
Figuring a fair value for new life sciences technology at the seed stage is nearly impossible. So BioCrossroads will avoid the question entirely. Indiana Seed Fund's investments in biotech startups will likely be made in the form of convertible notes, Johnson said. If and when the startups receive formal venture capital financing, the notes will be swapped for equity stakes.
Investments will range from $50,000 to $500,000, Johnson said, with most around $250,000.
Eager startups are likely to line up for the $4 million. At the beginning, every dollar is precious. Chad Barden is president and CEO of fast-growing Lafayette startup QuadraSpec Inc., which makes a medical diagnostic device. Without that first $250,000, he said, academics can't make the leap to entrepreneurship.
"If I'm a professor and I want to start a company, I may continue my work as a professor while I investigate the opportunity, devoting, say, 10 percent of my time to the feasibility of the deal," Barden said. "With $250,000, I can establish an external office. I can support my family and I can develop the opportunity into something investable."
Institutional investors like Eli Lilly and Co. and the Indiana Public Employees Retirement Fund kicked in the $73 million for the Indiana Future Fund. Johnson said he didn't approach them or their peers with formal term sheets for the Indiana Seed Fund.
"Candidly, many institutions don't see [seed] as an investment," Johnson said. "The IFF is about as early a category you're going to see an institution consider."
Indeed, some of Indiana's institutional investors clearly consider seed too risky for their portfolios. Bob Newland, interim director of the Indiana State Teachers Retirement Fund, said TRF doesn't put any money to work in seed funds.
"I don't want to say we'd ipso-facto cut it off," he said. "But we would have to look at it closely. It's at the riskiest end of the spectrum."
Nationally, seed capital has not always been that hard to come by. In the late 1990s, the market was awash with it. According to San Francisco-based industry research firm VentureOne, 1999 saw $559 million in seed deals.
Institutional investors provided the bulk of the money. They know seed, while the riskiest asset class, is also the one with the prospect for the most gains. It can be a vital part of a properly diversified portfolio, said John Taylor, vice president of research for the Arlington, Va.-based National Venture Capital Association.
"Most of the leading institutional investors-whether you're talking about big university systems, teacher unions or private sector plans-there has always been a realization that you need to diversify," he said.
After the technology bubble burst, seed investing declined 85 percent nationally by the time it reached its nadir in 2003 with deals worth just $80.6 million, according to VentureOne. Seed has grown since then.
But most institutional investors want proven venture capitalists to manage their money, especially in the seed stage. Despite its success raising the Indiana Future Fund, BioCrossroads doesn't have that kind of track record.
Ironically, as a fund-raiser, BioCrossroads is in much the same position as the neophyte companies that hope to attract its seed investments.
"The established funds have absolutely no trouble raising money," Taylor said.
Still, Indiana institutions may be warming to the idea of seed-stage ventures. Johnson said BioCrossroads hopes to raise an Indiana Seed Fund II. David Adams, executive director of the Public Employees Retirement Fund, said PERF would be more than willing to look at it.
"Candidly, more energy and effort needs to be spent in the private equity segment determining what segments PERF would be comfortable being in," Adams said. "Seed represents an asset class we would look at. It's a very high-risk environment. But there might be a place for it."