Jeff Amerine: What’s Missing From The Arkansas Venture Scene?

Editor’s note: Jeff Amerine, PMP, is Associate Vice Provost/Research & Economic Development, Director/Technology Ventures and Adjunct Faculty/Entrepreneurship at the University of Arkansas and is an advisor for Innovate Arkansas. His guest commentary appears in the latest magazine edition of Talk Business & Politics, which you can read here.

Over the past 10 years, Arkansas has developed numerous sources for seed-stage capital. These include public sources such as the Arkansas Science and Technology Authority (ASTA) Seed Capital Investment Program (SCIP) and the Arkansas Development Finance Authority (ADFA) Risk Capital Matching Fund (ARMCF) as well as private sources such as the Fund for Arkansas’ Future, Gravity Ventures, Tonic NWA Fund, New Road Ventures, Torch Fund, Tech Rock Fund, Natural State Angel Association, Arkansas Angel Network and Union County Angels just to name a few.

Even with that considerable growth in angel funding, startup ventures in the state are still largely reliant on out-of-state venture funds for investment rounds of greater than $500,000.

Moreover, while the ADFA Arkansas Institutional Fund has done an excellent job in investing in out-of-state venture funds such as Noro Moseley Partners, Fulcrum Equity Partners and others to encourage Arkansas investments, more needs to be done to ensure adequate Series A (and beyond) funding sources are available. Otherwise, growing ventures will either stall or move to regions where needed growth capital is available.

CURRENT INITIATIVES
For the past year or so, business leaders and angel investors in Northwest Arkansas have been working to define a structure for a sector-focused $50M-$100M venture fund. This effort is intended to aim at retail technology, supply chain technology, and supporting digital and data analytics company investments that are here in the state and nationwide.

The investment thesis would be to provide both the growth stage funding that is currently absent to promising in-state ventures, and to also act as a significant attractant for promising ventures in these sectors that are currently located elsewhere. In addition, formation of such a fund would finally create a good partner for syndication with out-of-state venture firms that have coverage for Arkansas.

CHALLENGE: LIMITED PARTNER FATIGUE
One of the significant challenges facing all newly forming and existing venture funds is the general fatigue of the traditional limited partner (LP) institutional investors. Post 2001, exits (which are the means by which investors get a return) have primarily been driven by acquisition rather than public offering and as a result LP investments in venture funds are tied up for longer periods of time.

As an asset class, venture capital faces this significant hurdle as LPs are concentrating their allocations in fewer and fewer venture capital firms. This LP fatigue with venture capital as an asset class will pose a significant challenge to the formation of a venture fund of consequential size. This will be especially true in the case of an unproven management team leading the fund.

POSSIBLE ALTERNATIVES OR ADDITIONS: VENTURE DEBT
Several discussions have occurred around focusing on an alternative to a typical equity focused venture fund. One such approach would be to emulate the Silicon Valley Bank (SVB) model with a venture debt structure. SVB typically provides the debt portion of a venture round in conjunction with a well-established venture fund.

Arkansas could do something similar. Such an approach for Series A and later investments would give the venture debt fund and investors in the fund, a lower risk and potentially more timely return. In addition, some equity upside would be possible with warrant (warrants are the right to purchase stock in the future, typically at the time of a liquidity event at a discount) coverage. Based on inputs from those knowledgeable in both banking and venture capital, the time might be right to explore such an alternative in more detail.

In addition, revenue-based finance (akin to the ASTA SCIP non-dilutive royalty structure) could be considered for cash-flowing businesses with solid margins that are not yet “bankable.” Overall, the time appears to be right to consider alternate financial structures as traditional equity focused exits are still rare and stretched out over longer periods of time.

NEXT STEPS
Flagship business leaders, startup leaders and policymakers around the state, including Accelerate Arkansas (the catalysts behind Innovate Arkansas and the Arkansas Research Alliance) and the Northwest Arkansas Council, are giving these issues serious consideration.

Out of necessity and frankly due to a growing pipeline of quality deal flow, my prediction is that Arkansas will have several new sources of savvy growth capital within the next three to five years. Sooner is better than later. Let’s get after it!