Entrepreneurship and Investing and Startup and Banking & Finance and Venture Capital and Technology and Small Business

Growth funding drying up in Indianapolis

March 26, 2011

A key financial stepping stone for Indianapolis-area startups is dwindling, with no significant replacement on the horizon.

Venture capitalists and investment bankers say growth capital, the money that comes in once early-stage companies have raised about $1 million and need anywhere from $1 million to $5 million to continue development, began drying up late in the past decade. Local funds including Blue Chip Venture Co., SpringMill Venture Partners, Gazelle TechVentures and CID Capital spent their stashes and turned their attention to maturing their portfolio companies.

Meanwhile, the recession and lingering economic uncertainty have discouraged the firms from raising new funds.

The upshot is a bleak landscape for companies that outgrow investments from friends and family but are still too young to attract late-stage capital in the tens of millions of dollars.

“It’s really hard for companies here to raise that kind of

[growth] money,” said Christopher Day, managing principal at Navidar, an investment banking firm with offices in New York and Carmel. “We don’t have the venture capital funds here that are large enough to write those checks and also follow on with investment.”

Those aren’t the only consequences. When a local company lands growth capital now, it usually originates out of state. That risks the company’s being whisked away and profits from the investments not being reinvested in other Indiana companies.

“If you want to continue the life cycle of technology companies, you want to keep the money here,” said Kristine Danz, a partner with Indianapolis law firm Ice Miller LLP who focuses on private equity. “That creates more angel investors who want to invest in local companies.”

The widening gap comes at a tumultuous time in equity investing.

Private-equity fundraising took a hit across all levels during the recession. But the impact was particularly dramatic in the growth-stage arena as fund investors flocked to safer bets at the later end of the financing spectrum.

Experts say that’s true nationwide. The absence in growth funding, though, is more dramatic in cities such as Indianapolis, where the private-equity landscape has never been thickly populated.

In a bad sort of way, the Indianapolis market is coming full circle. Many of the local funds created to take advantage of the demand for growth funding are now wrapping up their portfolios.

“While [growth-stage funding] was fairly active and healthy for a period of five years-plus, it’s actually returned to a gap,” said Don Aquilano, managing director at Allos Ventures, which was formed last year to tackle the gap.

Most also focused on tech, meaning the sector is hurt disproportionately.

Not everyone believes a shortage exists.

Chris Baggott, a co-founder of e-mail marketing firm ExactTarget who now is developing the blogging software firm Compendium, said promising companies are able to secure growth-stage funding, though it likely will come in incermental chunks.

venture capitalBaggott noted ExactTarget has attracted about 500 investors, first by aggressively targeting founders’ friends and family members before catching the attention of Bob Compton, a Memphis-based angel investor.

Compton’s support caused other angel investors to follow suit before the company attracted bigger money from out-of-state venture firms.

Baggott said the key to strengthening local fundraising lies in more very-early-stage investors giving in the tens or hundreds of thousands. That level of money allows companies to build strong prototypes.

“Good companies can get to the next level,” Baggott said, “If they can’t, there might be something wrong.”

While others agree a funding gap exists, they differ on how to address it.

Some argue the state needs to make the funding a priority.

Still others say Indianapolis needs more successful companies in order to attract funding.

While Indianapolis’ tech startup scene has become more robust in recent years, it’s still nowhere close to more established enclaves, such as Boston or Silicon Valley.

“It’s sort of a chicken-and-egg thing,” said Tom Hiatt, founding partner at Centerfield Capital Partners, which focuses on later-stage investments. “If Indianapolis had a more thriving entrepreneurial sector, there would be more capital drawn here.”

A nearly unanimous view is that the challenging economic environment is squelching interest in new funds.

Wealthy individuals and pension funds saw their portfolios take a beating in the recession, making them more hesitant to allocate money to riskier investments such as venture capital.

“As people are now forming new pots of money to invest, there’s been a fairly noticeable migration to the [later-stage] investment round,” said John Thornburgh, co-chairman of Ice Miller’s business practice group. “Investors want to make sure they’re putting work into something that has a higher likelihood of good results.”•

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