CommonAngels for hellacious times- Angel Groups plan ahead to survive hellacious market

Technology investors often talk about keeping enough ”dry powder” (read: cash) on hand to back promising start-ups and sustain their existing portfolio companies through hellacious market conditions. For CommonAngels, Boston’s highest-profile group of individual investors in young tech companies, the more descriptive term might be dry pixie dust. And the group, now five years old, is debating whether to gather significantly more pixie dust this year, setting up a $30 million fund to follow the original $10 million fund CommonAngels raised in 2000, a third of which has already been invested.

By Scott Kirsner Boston Globe

The new fund would be a reaction to the current financing climate for early-stage companies, which remains tempestuous. It’s also an indication that CommonAngels hopes to be around for the long term — and is serious about protecting its portfolio companies. To help lay the groundwork for the $30 million fund, CommonAngels member David Solomont has joined the group as a full-time managing director, working alongside James Geshwiler, the executive hired in 2000 to manage the collective of more than 50 individual investors.

Angel investing is, at its heart, a way for individuals — usually successful entrepreneurs — to supply seed money and expertise to fledgling companies. Groups like CommonAngels gather individual angels together and organize regular monthly meetings at which members can hear presentations from companies seeking funding.

Among CommonAngels’ members are John Cullinane, founder of CulliNet, the first publicly-traded software company; John Keane, founder of the IT consulting firm Keane Inc.; Bob Frankston, the codeveloper of the first spreadsheet program; and Ira Stepanian, the former chairman and CEO of Bank of Boston. New members continually sign up, like Shore.net founder Lowell Gray, and some others, like Paul Egerman of eScription, drop out.

Angel investors had a ball during the stock market ramp-up of the late 1990s, as the companies they backed received follow-on funding from venture capital firms and then were quickly taken public. ”When we first formed CommonAngels, you could be dead blind drunk and still make an investment that paid off,” says Howard Anderson, a CommonAngels member and the founder of Cambridge’s YankeeTek Ventures.

But as the stock market soured on tech IPOs, angel investors discovered their portfolio companies weren’t going public and weren’t being acquired by other companies. That meant far fewer ”liquidity events” that repaid the angels for their risky initial investment. And the unprofitable companies in their portfolios either needed to be shut down, or given more money to survive. That money could come either from CommonAngels’ individual members writing checks, alongside a matching investment from the group’s $10 million ”sidecar” fund, or it could come from a traditional venture capital firm.

The problem, though, was that if a venture capital firm took over at a later stage of investment and CommonAngels didn’t participate, CommonAngels’ stake in the company would vanish. That has happened only once thus far to CommonAngels, says Geshwiler. The group decided not to ante up in a later round of funding for Members Connect (now known as eGrad). ”We were washed out,” says Geshwiler. Other portfolio companies, like Firespout and Espanol.com, have been shut down.

But the firm has had some hits, like BargainDog.com, which produces an e-mail newsletter about online bargains. Boston-based BargainDog was sold to About.com, a New York company, in 2000.

”That one was a 10x deal,” Geshwiler says, meaning it returned 10 times CommonAngels’ original investment. Another CommonAngels company, Collego, which made software for online catalogs, was sold to MRO Software of Bedford in 2001 for ”not a bad return,” said Geshwiler.

And he’s hopeful about several other investments, including BitPipe, an aggregator of market research about the information technology sector, and Newton-based WorldWinner.com, which runs online games of skill.

Raising a larger second fund would help CommonAngels sustain its portfolio companies over a longer time period, without having to rely as heavily on other investors to step up and participate in later rounds of financing. It would let CommonAngels invest in sectors that venture capitalists aren’t attracted to. And it would also allow the group to invest in start-up companies that need slightly larger first rounds of capital. ”There are a lot of companies we just don’t pursue because they need $2 million to $3 million,” Geshwiler says.

”It’s not 18 months and flip anymore,” says Doug Levin, a member of CommonAngels and founder of Black Duck Software, a new company still in stealth mode. ”You’re looking at more like three to seven years for the ultimate exit. That’s not just a doubling of the time horizon. It’s a tripling and quadrupling. So on a pragmatic level, [CommonAngels’ second fund] is necessary.”

The larger fund will allow CommonAngels ”to be an equal player in determining the terms of the [later-stage] financing,” says Levin, a former Microsoft exec. ”It’ll give the group more negotiating heft when they sit at the table with other investors.” But the new fund, which could be closed as early as September, will also bring new voices into CommonAngels — a group already known for sometimes vibrant dissent, given its 50-plus very vocal members.

”We’re thinking about bringing in [as investors in the second fund] small institutional investors who have a regional focus, economic development agencies, and maybe some software companies that have tried to do investing on their own in the past, but don’t have the resources,” says Solomont, who also serves as chairman of a CommonAngels-funded start-up called PLEJ, which is focused on simplifying electronic payments.

The challenges ahead for CommonAngels: integrating those new voices and using the bigger bankroll to navigate investment waters that are still roiling. ”The weather has changed,” Geshwiler says. ”When there are rough seas, you need a bigger engine on your boat to get through the waves.”

But the angels have continued to power forward, doing two new deals in the first quarter (PLEJ and OrgSupply, a company that helps universities manage purchasing) and sealing at least one new investment in the second quarter.

Already, it’s a pace that’s calling attention to the group. For the first quarter of this year, CommonAngels was listed by PricewaterhouseCoopers as one of the 20 most active VC firms in New England — despite the fact that its average investing pace is just one or two new deals a quarter, and it is not technically a VC firm. But with other venture firms taking on water, the MV Pixie Dust seems to be cruising ahead.

VC viewpoints

Last year wasn’t an easy one for Atlas Venture, a 23-year-old firm with more than $2 billion under management and a local office in Waltham.

Atlas shut down its Seattle and Silicon Valley offices and reduced the size of its current fund, from $967 million all the way down to $600 million. This year, the only investment the firm’s Waltham office has been involved with so far has been a $14 million fourth round for Ellacoya Networks of Manchester, N.H.

That might be why Atlas’s partners struck me as much more grounded and realistic than many of the investors I’ve spoken to recently. Here are some of their assessments of the tech world, circa May 2003:

Corporate tech buyers are still doing whatever they can to squeeze their vendors. ”The operating philosophy out there is, `I’m not going to pay a lot for this software,’ ” said Michael Feinstein.

One of the cardinal rules of venture investing right now is that the ”last money in wins.” That’s because the most recent round often wipes out the positions of investors who had put money in earlier. ”As long as you’re part of the last round, you can do OK,” Jeff Andrews of Atlas said. Of course, ”80 percent of entrepreneurs who come in here say it’s going to be the last round,” said Axel Bichara, laughing.

One new approach for venture investing is what Andrews termed the ”bootstrap-plus” model. A start-up that is already bringing in some revenue from customers gets ”a little juice” from venture capitalists to accelerate growth. (Obviously, though, that doesn’t help companies that need money for initial product development.)

Investors are still slow to shut down ”lost cause” portfolio companies, the Atlas trio said. ”You see a lot of companies with money left [in the bank], but they really have no sales, and no market,” Andrews said. Feinstein added: ”The management cuts [the headcount] in half, and then they can last twice as long.”

”We have to wait for more of the existing tech companies to go out of business,” Feinstein said. ”We need more white space in the market, which would mean fewer potential competitors in every possible niche.”

Things started looking up for Atlas this spring: Two of its portfolio companies, WaveSmith and SpeechWorks International, were acquired.

Scott Kirsner is a contributing editor at Wired and Fast Company magazines. He can be reached at [email protected].

© Copyright 2003 Globe Newspaper Company.

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