Diamond State Dominates State?s Tiny VC Industry

When C. Sam Walls and Joe T. Hays looked around a few years ago, they saw a state chock full of natural resources — timber, soybeans, catfish and even oil and diamonds.

But the Arkansas Capital Corporation Group executives didn’t see much venture capital.

Walls and Hays launched an ambitious plan in 1999 to turn Arkansas into fertile VC soil with Diamond State Ventures — a funding firm made up of 41 banks, the Arkansas Development Finance Authority, a handful of individuals and Stephens Group Inc. of Little Rock

“We were looking for some way to develop the venture capital industry in Arkansas … Activity stimulates activity,” Walls said. “We viewed ourselves as a catalyst.”

After three years, $12 million in fund-raising, a 3-to-1 match from the U.S. Small Business Administration and a 20-year, $2 million ADFA loan, Diamond State has hit a few home runs and has struck out.

But that’s the way the VC worm wiggles.

“[Diamond State] raised the perception of the investment community in and outside of the state. They’ve exceeded my expectations,” said Dale Dawson, vice president of banking at Stephens and a former DSV investment committee member. “You’ll have companies that don’t make it, give you money back or make you lots of money.

“That’s the nature of venture capital.”

While Walls said hard numbers on DSV’s statewide impact are hard to come by, Hays said there had been a tenfold increase in venture capital financing of Arkansas companies since DSV’s founding.

About $3 million was invested in Arkansas companies in 1999 in a combination of Diamond State and federal matching programs, based on SBA figures, Hays said. That figure, as of Sept. 30, 2002, had surged to $33 million, with most related to DSV.

About $20 million from Diamond State has gone into 12 companies, Hays said, leaving about $36 million untouched. An “investment horizon” — or, day the money runs out — is expected after 2006.

So far, DSV has invested:

• about $1.5 million in a loan to Trans-State Lines Inc., a Fort Smith trucking firm, that needed a cash infusion for a management buyout in February 2000. By March 2001, the company had apparently ceased to operate and most of its assets had been sold to an Indiana company.

• in HealthScope Benefits Inc., an 18-year-old employee health benefits management firm. DSV no longer has an ownership stake in the company.

• about $950,000 in Mercari Technologies Inc., a Fayetteville software firm that has apparently shut down.

• in CWK Networks of Atlanta, led by former Little Rock residents Sam and Stacey Allison Dewitt, which produces Connecting With Kids reality programming, content and education materials for TV, print and the Internet.

• about $2 million in webTPA, an Irving, Texas, software firm specializing in Web-based health plan administration software.

• in MedEvolve Inc., a 20-year-old Little Rock company specializing in customized patient management software.

• in TrestleTree Inc., a Fayetteville firm specializing in health management software for companies that self-insure employees.

• in DMD Inc. of Springdale, a distributor of party supply, scrap booking, paper crafting and stationery products. Formerly DMD Industries, the 6-year-old company merged last year with Westrim Crafts of Van Nuys, Calif.

• in Three Dog Bakery, a Kansas City, Mo., company that sells gourmet dog treats online and in a small chain of stores.

• in Veriplas Containers Inc., a Little Rock company that makes a variety of plastic bottles.

Hays won’t say how much has been invested in several of the companies or what sort of profit has been generated by DSV on most of the successes.

A winner for DSV appears to be propane marketer and distributor Inergy LP of Kansas City. The company’s stock traded in the $30 range in April, compared with its $22 initial public offering price in July 2001. Diamond State had bought into the company in February 2001, months before the IPO, but the size of its investment has not been made public.

DSV is locked into a no-sell clause that expires in June 2004.

“I wish they all could be that successful,” Hays said. “[Inergy] had a good management team, track record and business plan. They were unusual for a small company.”

A loser has been Divine Inc. (OTC: DVINQ.PK), a Chicago firm that produces online and in-store customer transaction analysis software, which has filed for Chapter 11 bankruptcy and been delisted from the Nasdaq. It traded in April on the OTC at less than 5 cents per share.

DSV ended up as an investor in Divine after its original portfolio company, Digital Archaeology of Kansas City, was acquired by Delano Technology Corp. of Markham, Ontario, which was in turn acquired by Divine.

It’s not a topic Hays or Walls like discussing, although Hays said DSV did get back a chunk of its original $750,000 investment in Digital Archaeology, even if the investment did ultimately lose money.

“Businesses fail, and you just hope your batting average is high enough,” Hays said.

For the most part, DSV has focused on mid-range risk companies — what Walls called “patient” capital — with about half of current investments in non-Arkansas companies.

“During the dot-com craze, things got a little wild [for investing] but we didn’t do that,” Walls said. “We felt it was unreasonable and didn’t get caught up in it and didn’t suffer like a lot of venture capital firms around the country.”

Gene Eagle, vice president of development and finance for ADFA, said the agency was pleased with DSV’s efforts so far and supported out-of-state funding, which has built a venture capital network including firms such as Kansas City Equity Partners, Davis-Tuttle of Tulsa and Corporate Southwest of Dallas.

“You can’t limit investment opportunities to within the borders of the state or one specific industry, sector or stage of a company’s growth,” Eagle said. “[DSV] could organize an investment four, five or six times what they can do on their own.”

About 2,000 companies and proposals have been considered in DSV’s short life. Rejecting proposals has angered some.

“In this business,” Walls said, “it’s a case of nobody’s baby is ugly.”

Arkansas Capital Corporation Group also has a higher-risk venture capital fund, Arkansas Ventures, in the works.

Most of DSV’s investments have been as five-year subordinated debt with options for conversion to shares, Hays said. ADFA has 80 shares as collateral for its $2 million loan — the largest partner investment in DSV, which divides returns among partners. DSV is current in the terms of the loan from ADFA, Eagle said.

With about $36 million left to invest, Hays said hot sectors right now are business services — outsourcing, business processes and health care management. Trucking and natural resources sectors are unlikely to gain intense DSV interest.

Meanwhile, DSV will continue networking to build a strong Arkansas venture funding base.

“There’s a simple saying around here,” Hays said. “Activity begets activity. I hope through our efforts and working with Arkansas we can provide a positive example to show that we can do it here … and build a venture capital industry. There are lots of worthy ideas.

“There is no reason it can’t happen here.”