Roanoke Times
Copyright (c) 1995, Landmark Communications, Inc.
DATE: SUNDAY, March 5, 1995 TAG: 9503040021
SECTION: HORIZON PAGE: G1 EDITION: METRO
SOURCE: JEFF DeBELL STAFF WRITER
DATELINE: LENGTH: Long
They have a tough time raising money.
The first time Harold Smelser of Salem asked a banker for money to open a machine shop, the banker said, "You must be kidding."
Dan Mosse wanted investors to help get his new company up and running. He wasn't looking for a loan. But he ended up having to borrow what he needed from a financial institution in Richmond.
"I've got a whole drawerful of potential sources of money and I couldn't get a thing," Mosse said.
His company, Wolf Creek Industries Inc., reclaims usable material from foundry slag for resale to industry.
"What the problem is I don't know, except there's no venture capital here," he said. "It's nonexistent."
Virginia Tech professor Tracy Wilkins founded a company that is internationally known for using plant and animal hosts to culture disease-fighting human proteins.
When the company needed venture capital to grow, it had to go to Maryland to get it.
"Virginia is a very cautious state," said Wilkins, who long has maintained that Virginia's economic development has been hurt by a shortage of venture capital. "You many times have to go where the money is."
Perhaps these and other regional entrepreneurs can take comfort from this: It's not just a local problem. Money is hard to get everywhere in Virginia, especially money for chancy early-stage investments.
"Start-up is as risky as it gets," said John Jennings, head of the Blue Ridge Small Business Development Center in Roanoke. The center has provided counseling and practical assistance to hundreds of small enterprises.
"The vast majority [of start-up money] has to come from personal resources," Jennings said. "Families, friends, credit cards, things like that."
Banks don't like risk. Venture capital funds also tend to avoid seed financings or start-ups unless that is their specialty.
Entrepreneurs say there are few such funds in Virginia. Even companies that have survived the earliest stages and are ready to grow can find it hard to come by venture capital in the state.
In all of 1993, venture capital funds invested only $17.6 million in Virginia companies, according to the annual report of the National Venture Capital Association.That placed Virginia 24th among the 40 states reporting .
Nationally, the total 1993 disbursement was $3.07 billion. By far, most of venture capital disbursements were on the West Coast (41 percent) and in the Northeast (27 percent).
The mid-Atlantic region received only 3 percent.
"There is no venture capital situation in Virginia," Barbara Plantholt Melera said.
Melera is president and chief executive officer of Baltimore-based Triad Investors. She says wealthy individuals show little interest in forming new Virginia funds, and it puzzles her.
"There are things to invest in all over Virginia," she said. "In Blacksburg, Richmond, Charlottesville."
The reluctance of other capitalists has not kept Triad from looking for Virginia companies to back. Encouraged by an investment in Triad by the Virginia Tech Foundation, the fund has a stake in a couple of Blacksburg high-technology enterprises.
"We have a godfather in Virginia and it happens to be Virginia Tech," Melera said.
There are 15 venture capital funds in Maryland, according to John Heesen of the Venture Capital Association of America. There are 11 in North Carolina and more than 30 in Pennsylvania.
But only eight are in Virginia. Experts say that's one reason Virginia companies have a hard time finding capital.
Among the Virginia funds is VEDCORP, L.C.; it was established in 1991 with financial assistance from the state government, and its aim was to promote economic development in Virginia. The $12 million fund has invested in at least two Roanoke Valley companies.
"It's clear that Virginia is out of the loop," said Beverly Fitzpatrick, director of the New Century Council.
The council is trying to formulate economic development guidelines for the Roanoke and New River valleys and the Alleghany Highlands.
"It's like there is this doughnut and Virginia is the hole in the middle of it," said Raymond Smoot, Virginia Tech treasurer and vice president for finance.
Venture capital is a subject of great interest to Tech. The school's Corporate Research Center is home to some 30 companies, most of them formed to commercialize the technological results of research at the university. Tech has a royalty interest in the companies' fortunes, which at some point are likely to depend on hard-to-find investment capital.
To help solve the problem, Tech has put $5 million into three venture capital funds. In return, it expects the funds to seriously consider investing in Tech-related companies and to take an ongoing interest in other commercially promising research at the university.
"We decided you have to pay to play," Smoot said. "One thing we have found out is that Blacksburg, Va., is not a regular stop on the itinerary of these largely out-of-state capital investment funds."
Tech has put money into Triad; SpaceVest Partners L.P., which is based in Reston; and Intersouth Partners III, a fund based in North Carolina's Research Triangle Park.
Triad and SpaceVest already have invested in Tech-related companies. Triad will open an office in Blacksburg to monitor its investments and keep an eye out for others.
"We say that we put the money back where we got it from and that's what we do," Triad's Melera said. "We don't just say it."
Intersouth Partners, which is newer to the relationship with Tech, has not yet invested there. But Dennis Dougherty, a general partner, said Tech "looks like a good place to find promising young companies."
The Virginia Tech Foundation, owner of the corporate research park, put up $4 million of Tech's investment. The other $1 million came from Virginia Tech Intellectual Properties, the nonprofit corporation that manages commercial technologies arising from research at the school.
Steve Banegas has high hopes for Tech's connection with the venture funds. He heads Dominion BioSciences Inc., located in the Corporate Research Center. The company develops and commercializes technology out of Tech, most notably in the areas of water testing and pest control.
It hasn't needed venture capital yet, but Banegas said it will require between $3 million and $4 million for product testing and development later this year. Thanks to Tech's action, there are at least three venture funds he can approach with a reasonable expectation of being listened to.
Greg Feldmann, a private financial consultant in Roanoke, approves of Tech's proactive approach.
"It makes a lot of sense," he said. "It gets the venture capital people into the marketplace."
What that does, he said, is foster the development of an entrepreneurial environment that not only attracts more capital but in time can even influence local management attitudes.
It happened in Nashville, according to Frank Sheffield, a former Roanoke banker who has lived in the Tennessee city for 15 years. He said Nashville has shaken off its agricultural orientation and economic doldrums to become a prospering center of finance, including venture finance.
Sheffield is president of the Massey Burch Investment Group. As a venture organization that specializes in health care enterprises, it has had a role in developing Nashville into a leading health care center - attracting other venture capital in the process.
"Success breeds success," he said. "It begins to feed on itself."
The same can happen in Roanoke, he said, noting that the city once had a thriving entrepreneurial atmosphere. It was personified by men like J.B. Fishburn, founder of the Roanoke Times & World-News; soft drink promoter Bill "Dr Pepper" Davis; and Roanoke Electric Steel founder John Hancock.
Economic setbacks such as the loss of Norfolk Southern headquarters and the sale of Dominion Bank caused a loss of confidence, Sheffield said, but he sees signs of a resurgence of the entrepreneurial spirit in Roanoke.
He cited as evidence the current effort to launch Valley Bank, a wholly local enterprise.
"We have to figure out a way to develop our own companies," said Feldmann, the Roanoke investment consultant, and venture investments are one way of doing it. They complement industrial recruitment, which cannot carry the entire load of economic development by itself.
Feldmann was with Dominion Bank until its takeover by First Union, then helped found the Ferguson Andrews & Associates investment brokerage in Roanoke. He left there last year.
A number of reasons are suggested for why venture capital funds have "kind of stepped over Virginia," to use the words of Secretary of Commerce and Trade Robert T. Skunda.
Noting that much investment is technology-oriented, Skunda said it may be because "Virginia just has never had a reputation as a research center."
Perhaps it's because the state's universities are relatively new to big-time commercialization of their research, suggested Tech's Smoot.
The state's tradition of fiscal conservatism also is cited.
Paul Maupin, head of a Richmond-based business consulting firm called Virginia Ventures, said the state's investors traditionally have been oriented toward banks, insurance companies and similar institutions rather than "the high-tech stuff."
It can be argued that investment funds don't need to come to Virginia. There are lots of investment opportunities where the funds tend to be concentrated, which is in centers of population and/or research; places such as Boston and California's Silicon Valley.
The 1990 edition of Pratt's Guide to Venture Capital Sources lists 221 funds in California and 94 in Massachusetts, mostly in the Boston area.
"Venture guys have no problem getting to look at a lot of deals," said Paul J. Head, president of Peakwood Capital Corp. in Roanoke. "They've got to choose among them."
There's something else, too. Venture capitalists work hard to protect their investments, and it's more practical to do that close to home than in a distant locality.
Capitalists typically put more than money into promising companies. They get involved in the companies' operations as a way of protecting their investment.
They like to put someone on the companies' boards and key committees. They make available the management expertise of their own partners and may even recruit executives for the company.
Sometimes they take over the companies they invest in - detractors use the term "vulture" capitalists - but that's a worst-case scenario.
""They do a lot to nurture a company along and develop it," Feldmann said. "They help those companies get over the bumps in the night that always happen with start-ups."
That means companies in what Steve Banegas calls "economically disadvantaged" places like Blacksburg must go to the capitalists' backyards for money.
"The deals go where the money is," said Richmond lawyer Mike Drzal.
Drzal's interest in venture capital stems from work on the subject with the Virginia Chamber of Commerce, and from the fact that many of his clients are high-tech companies that he'd like to see remain in Virginia.
When the companies have to go elsewhere for money, it can be hard to keep them in Virginia. That's because the out-of-town investors want the companies nearby.
"They just about have their arms broken off to get them to move to wherever the money comes from," Drzal said.
It's not like the investors are asking a whole factory to pull up stakes. Companies seeking early-stage investments may consist primarily of promising technology or just a good idea.
"Many companies exist on a 31/2-inch diskette," Drzal said. "They are completely mobile."
At that stage, their absence may be hardly felt. But if they later pay off big, generating lots of jobs and business (and a big return for the investors), the state and locality where they originated are big losers.
That's why entrepreneurs would like to see more venture capitalists in Virginia.
Last year, Gov. George Allen directed the preparation of a comprehensive economic development plan for Virginia. It was released in December, titled "Opportunity Virginia: A Strategic Plan for Jobs & Prosperity."
One of its primary conclusions was that Virginia needs to attract seed and venture capital as a means of stemming the loss of investment funds and technology to other states.
A study of how this might be accomplished was recommended, and the recent General Assembly created a joint committee to look into the subject of capital formation and report to the next legislature.
"Opportunity Virginia" points out that a number of states, including Maryland and Pennsylvania, have used funds from their public pension systems to encourage the creation of venture capital programs.
It adds that the usual consequence of such action has been to increase not only the number of funds but the level of venture investments within those states.
Although there is no shortage of entrepreneurs who believe the Virginia Retirement System should follow suit, it appears unlikely to happen. The VRS has concluded that using its money to encourage in-state venture funds and investments would be at variance with its fiduciary obligations.
"I only invest for one reason," said Larry Kicher, manager of alternative investments for the VRS. "That is for the benefit of the beneficiaries of this plan, i.e., to make money."
Kicher said about $1.1 billion of VRS assets are committed to private equity investments and about 25 percent of that money, or $275 million, can go into venture capital funds.
The money is invested for the VRS by Brinson Partners Inc. of Chicago. Besides taking advantage of Brinson Partners' expertise, the arrangement avoids any appearance of impropriety when a fund chosen by Brinson puts money into a Virginia company.
Kicher said Virginia-based companies have received more than $50 million from investors with which the VRS, through Brinson, is a limited partner. But he doesn't know how much of the money is from the VRS, or how much of the $50 million qualifies as venture capital.
The assumption among Virginia entrepreneurs is that little if any VRS money returns to the state in the form of venture capital.
"It's frustrating" to know that millions of Virginia dollars are invested in venture capital funds outside the state, Richmond business consultant Stan Maupin said.
"It's idiotic," Greg Feldmann said. "You're channeling your capital to somebody else's market."
Mike Drzal said the VRS will be invited to participate in the venture capital study, assuming it is approved by the General Assembly, but it will not be looked to for leadership.
He professes himself upbeat about the prospects for improvement in the statewide venture capital situation, if for no other reason than the fact that "Opportunity Virginia" made everyone aware of the shortage of investment capital.
Stan Maupin of Virginia Ventures also sees better times ahead. He's encouraged by the Virginia Tech initiative and by the response of Triad and the other funds.
As companies prove their commercial viability and begin to show a good return, he said, investors will be attracted and that will attract more investors.
"I think the money will follow the deals," he said.
by CNB