New entrepreneurs, like the founders of SourceLabs, are finding it easier to raise money at very early stages of their businesses. But that may be because they've already got a foot in the door with a venture-capital firm.
A year ago, Byron Sebastian quit his job at software maker BEA Systems to garden and learn the guitar.
That “vacation” lasted only months, or until he read an article about how Napster revolutionized the music industry. He wondered why the same phenomenon hadn’t occurred in technology, given the advent of open-source software that is distributed free.
A few months later, Sebastian found himself as the chief executive of SourceLabs, a Seattle-based company.
In starting the venture, Sebastian raised $3.5 million in capital from Ignition Partners and Index Ventures, making him part of a new crop of entrepreneurs who are increasingly able to raise money for newborn ideas. The trend is a reversal from years past, when money was largely reserved for mature companies with products and customers.
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Last year, $200 million, or almost a quarter of all funds raised in Washington state, went to seed and early-stage companies. That was more than twice as much as the previous year, when $98.7 million went to such young companies, according to the quarterly MoneyTree Survey released today by PricewaterhouseCoopers, Thomson Venture Economics and National Venture Capital Association.
While investments in early-stage companies stood out, the funding environment overall has improved for companies in all stages.
Last year, investors poured in $868.2 million in Washington deals, or more than double the $400 million invested in the previous year, according to the MoneyTree. (The numbers differ from those released last week by VentureOne/Ernst & Young, which reported that venture companies invested $773.6 million in Washington deals in 2004, compared with the $461.7 million in 2003. The two surveys differ in how they account for deals.)
Barriers aren’t all gone
Still, as pocketbooks have loosened, the barriers to entry aren’t completely gone. A common theme among entrepreneurs raising money for a company’s first round is that they have a personal connection or foot in the door with a venture-capital firm.
For Sebastian, that connection came through a friend who put him in touch with Brad Silverberg, Igniton’s founding partner, who intimately understood enterprise software after having been a central figure in building the Microsoft Windows franchise.
“We had coffee and started talking about my ideas,” Sebastian said. “He was really interested.”
By February, Sebastian was working at Ignition’s office as an Entrepreneur in Residence, a program that allowed Sebastian to fiddle with his idea to see whether it could become a viable business.
By September, he took his business plan out to raise funds. Four weeks later, he got commitments from Ignition and Index Ventures for the company, which develops open-source software that provides quality and dependability found in traditional software systems.
Sebastian said incubating the idea at Ignition was helpful, but it wasn’t the only reason why the company got funded.
“Connections might help you in the first minute or two, and certainly it’s always helpful to have introductions to people, but if you have a strong idea and a strong plan, lack of connections isn’t going to stand in your way,” he said.
But a broader sample of companies that received first-time financings in 2004 suggests that knowing someone is a large component of getting the deal done. Likewise, investors say knowing the entrepreneur making a pitch can expedite the process.
Of the more than eight first-time investments Bellevue-based Ignition made in Washington last year, three were part of the company’s Entrepreneur in Residence program. Besides SourceLabs, the others were Seattle-based Melodeo, which raised $9.5 million to help develop its service of delivering music on cellphones; and Jobster, a Seattle company that received $8 million for an online recruiting service.
Ignition Partners’ Robert Headley said a quarter to a third of the firm’s deals are residents. “That was the case in 2004 and what we might expect on a go-forward basis, too,” he said. “I think having some history with an entrepreneur lowers the risk in getting something done.”
The experience is similar in other entrepreneurial stories. When Jeremy Jaech set out to start The Graw Group, he returned to some of the same investors who funded his first company, Seattle-based Visio, which was acquired by Microsoft in 2000 for stock valued at $1.6 billion. Although reluctant to say exactly what The Graw Group does before it launches its product, he said it is a consumer Web service.
In March, Jaech approached August Capital and Kleiner Perkins Caufield & Byers. By July, the two firms had invested $4.75 million.
Jaech said although there were friendly faces in the boardroom when he made his presentation, it was still a relentless process.
“They look at three elements: the people, the market opportunity and the ability to solve the customer problem,” he said. “We had a lot of credibility on people, but we still had to convince them the market opportunity was there and big enough to be VC-fundable.”
Michael Metzger, chief executive of Seattle-based Payscale, had a similar experience. The company, which is still small enough to not have a vacation policy, was founded in 2001 by Joe Giordano and provides salary comparisons online.
When it decided to raise money, Metzger returned to the venture capitalists that backed him when he was chief executive at Performant.
Payscale raised an undisclosed amount in October from Fluke Venture Partners, Madrona Venture Group and Buerk Dale Victor.
“Both Madrona and Buerk had invested in Performant. That was helpful,” he said.
Metzger contended that using connections is a sign Seattle’s business environment is maturing.
A few years ago, Metzger said, there might not have been the breadth of entrepreneurs who could raise venture capital from people they knew.
“The talent pool is pretty rich, and lots of deals are getting done by using relationships and networks that worked before,” he said.
Tricia Duryee: 206-464-3283 or firstname.lastname@example.org