Creative finance vs traditional venture capital
Crowdfunding, tech-oriented alternative lenders and resurgent venture capitalists are rewriting the financing rules for startups and upstarts seeking growth capital. Entrepreneurs still need to show investors they can generate sales, and alternative loan rates can be steep, but now those with a vision and the industriousness to make it happen have a better chance of finding financing that fits the stage and scope of their enterprise.
Here’s a look at how those funding options are playing out in Colorado:
Alternative lending 2.0
After three tours in Iraq with the U.S. Army, Will White started Caveman Cafeteria in Denver in 2012. His business encompassed a food truck and catering business focused on the popular Paleolithic, or “paleo,” diet.
By early 2013, White wanted to open a food stand on lower downtown Denver’s 16th Street Mall and raised $21,000 on Kickstarter. Mission accomplished — for the time being.
A few months later, he began applying for bank financing to launch a prepared-food delivery service. He needed money for a website reboot and marketing. No dice.
“They said until we were in business for two years to forget about bank loans,” White says.
He went online in his hunt for alternative lenders and discovered OnDeck, which opened an office roughly a year ago in Denver with nearly 50 employees. “Within 24 to 48 hours, we had the funds in the bank.”
Once White landed his loan, he hired a chef to continue to grow. He's since received a renewal loan through OnDeck and plans to utilize that service along with Kickstarter in hopes of expansion into California later this year.
New York-based OnDeck aims to make better small business loans through technology. Founded in 2007, the company has delivered more than $1 billion in loans to date, with $30 million going to Colorado companies, including $13 million in 2013.
“At OnDeck we have built a technology platform that revolutionizes how small businesses can access capital,” says OnDeck COO James Hobson, noting that the company tracks data on 700 industries. “They have traditionally been underserved by the banking industry.”
He says the company's algorithm-driven application process is “super-efficient,” providing working capital in the amount of $5,000 to $250,000 with terms of three to 24 months. Loans up to $30,000 can be closed online the same day. Rates are premium, ranging from 18 percent to 36 percent.
OnDeck requires clients to have been in business for at least one year with $100,000 in annual revenue. Customers are eligible to apply for additional financing when the previous loan is half paid off.
Hobson says banks are focused on million-dollar deals. “It takes a lot of time and effort for the small-business owner to apply for the loan, and they're not getting approved,” Hobson says. He calls OnDeck's application process “transparent, very easy and frictionless,” noting, “That's really the power of the technology.”
More than 90 percent of customers say they'd recommend OnDeck to others, and the company grew by 150 percent in 2013. “We don't see it slowing down,” Hobson says. “It just shows the demand and need for capital.”
OnDeck closed on $77 million in venture capital in March 2014 and has cumulatively raised nearly $500 million in equity and debt financing. Competitors include CAN Capital, Kabbage, and Square Capital.
Crowdfunding comes to small-business finance
Just as peer-to-peer financing has reinvented the personal loan with Lending Club, crowdfunding is poised to offer similar options to small businesses.
Founded in 2012 and an acronym for “people to business,” P2Binvestor [P2Bi] is a Colorado startup looking to harness the power of the crowd to finance small businesses.
“We've come a long way in the past year,” says Bruce Morgan, P2Binvestor CEO. After closing on a Series A round of $850,000 led by NexGen Storage founder John Spiers last fall, P2Bi moved from Broomfield to Denver, grew to 10 employees, and made its first loans this January.
“A lot of the companies we talk to don't want to give up equity at an early stage,” Morgan says. The catch? “People who don't have revenue don't have a choice besides the equity route. Typically any company that's in a position to get a bank line, they're going to take it.”
As an alternative, P2Binvestor crowdfunds from a pool of accredited investors to loan to established businesses with a history of cash flow, Morgan says. Now P2Binvestor has a collection of 370 accredited investors. “We're really looking at companies that are $100,000 to $2 million a month in revenue.”
“We have huge amounts of money wanting to invest on our site,” Morgan says. “The real pressure is finding people we want to lend to.”
He also sees P2Bi as a provider of bridge loans to post-revenue startups. “We can be the next-stage lender after a company has gotten an equity investor.”
While the long-term P2Bi plan includes expansion to other markets, the focus is currently local, he adds. “We'e really focused on doing business in Denver, Boulder, and Fort Collins -- that's the sweet spot for us.”
Morgan says P2Bi's loans typically have rates of 15 percent to 18 percent. P2Bi also offers a rate guarantee that allows clients to switch if they can find a lower rate elsewhere. “That's a function of crowdfunding. As long as the crowd is willing to invest, we can invest. The downside is that clients have to market themselves to the crowd,” Morgan says.
“There are studies that say at least 60 percent of companies are not bankable,” Morgan notes. “Banks have become very conservative because of Dodd-Frank. It's an unintended consequence. It's certainly had an impact on small-business lending. The bottom line is that it's more likely a small business will run into payment difficulty than a large one.”
Traditional VC update
Colorado's venture capital continues to come back after some lean years.
After commuting from Virginia, Joe Zell moved to Denver full-time about five years ago to further Grotech Ventures' mission of “venture investing in underserved markets,” according to Zell. After the Mid-Atlantic and the Southeast, the Rockies were next.
“My phone started ringing and people said there were a lot of opportunities here,” he said. “The money really had dried up.”
Of about 15 venture funds in 2001, only two remained active in 2007, said Zell: Foundry Group in Boulder and Westminster's Access Venture Partners.
Since Zell started deal-making in Colorado that year, Virginia-based Grotech has closed on 12 Series A and B investments in the state, with a 13th on track to close this spring. “We're one of the most active investors in Colorado,” he says
Describing an overall upswing, Zell also highlights a critical gap in the Colorado VC world. “At the seed level, there are a lot of good opportunities,” he notes. And companies seeking B and C rounds are usually looking at a broader VC market. “Once a company is at $3 million to $4 million in revenue, we'll have good support from national firms.”
But for startups looking for Series A financing, Colorado is definitely lacking. “Most investors want it to be local,” Zell says.
He adds confidently, though, that things could change quickly, noting roughly 30 opportunities with Colorado startups in 2013. “If there are 60 great companies, the money will come here.”
Not that VC is a match for every startup. “Of all businesses that get started, only about 20 percent fit the venture model,” Zell says. Venture capitalists are looking for companies in high-growth industries where the annual growth rate could hit 50 percent or even triple digits, he explains. Startups in flatter sectors need not apply. While 20 percent growth is nice, it's not enough to justify a VC investment.
Until recently, “Denver/Boulder wasn't a destination for coastal capital sources,” says Chris Onan, a managing director with Denver's Galvanize. “Colorado has always been an importer of venture capital and will continue to be.”
Regardless, Onan says he's seen good signs of growth in the last few years. “The real catalyst was David Cohen, Brad Feld and Jared Polis starting TechStars.”
Exit activity is critical, and lacking in Colorado, adds Onan. “Utah is a great tech market, with unbelievable exits. That's when you really start to see that flywheel. We need to put a couple of those on the board.”
He looks at Zayo Group, Rally Software, Ping Identity and LogRhythm as local companies that could fit the bill.
“I think it's coming,” says Onan. “We've got tons of energy on the early-stage side. We just need to put a couple of runs on the board.”