Venture Capital 101

Exit strategy. Exit strategy. Exit strategy. If the 13 students in Mark Grovic’s MBA class at the University of Maryland want good grades this semester, they’re going to have to do a lot of thinking about exit strategies.

By Ellen McCarthy

http://www.washingtonpost.com/ac2/wp-dyn/A53216-2004Feb18?language=printer

In Grovic’s class the students aren’t just students. They’re considered associates with New Markets Growth Fund, a $20 million venture capital fund that Grovic and his partners run out of the university’s College Park campus. New Markets is a venture capital firm like any other — created to invest in small companies and generate big returns for investors — but the fund is embedded in academia and pays its young associates with credits and grades rather than six-figure salaries.

Next week, New Markets will announce its first investment — a $500,000 infusion of capital into Navtrak Inc., a Salisbury, Md., company that sells technology to track the locations of service fleet vehicles.

The Navtrak deal has been a long time coming. Grovic first brought his idea for an MBA-student led venture firm to Maryland’s Robert H. Smith School of Business in March 2001. Grovic wanted to combine his newfound love of teaching with his experience in the ruthless world of venture capital. As it turns out, Howard Frank, dean of the Smith school, and Donald Spero, director its Dingman Center for Entrepreneurship, had a similar idea.

Convincing the university that it was a worthy program took a full year. Raising capital took another year. New Markets’ $20 million fund closed in March 2003 and comprises $10 million from the Small Business Administration and $10 million from limited partners and angel investors, including private financial firms CapCity Ventures, Capital One Financial Corp. and Calvert Group. Other limited partners include Baltimore Development Corp., that city’s economic development arm, and the Smith school itself. The fund focuses on deals with companies in Maryland, the District and Virginia.

The 10 students who showed up for class on Tuesday afternoon looked the executive part — plenty of ties, no baseball caps. The classroom is like a boardroom: Four flat-panel television sets, recessed lighting and retractable projection screens add to the ambience. Animated discussion exceeds studious note-taking.

"The partners in the firm treat us like associates in the firm," said Ethan Foxman, a 27-year-old student. "We really have control as to whether we’re going to move forward in a deal or not."

The students are expected to dedicate 12 hours of work a week to the program beyond the three-hour class, much of it spent investigating potential new deals. They call customers and suppliers of start-ups looking for money, research market potential and evaluate the competitive landscape. They create financial models and meet with entrepreneurs. And, before investments are made, they look for exit strategies. Who would acquire this company? When and why and for how much? Is it an IPO candidate?

It’s a lot of work for three academic credits each semester. But the class, called New Markets Growth Fund practicum, turns away two students for each one accepted. The chosen ones have spent an average of seven years in the business world before entering graduate school, Grovic said, so the level of intensity is not foreign to his "associates."

"It was working with real money and that’s not something you get to do much in business school," said Jeff Schollaert, a second-year MBA student who said he wants to work in the venture capital industry at some point.

Because of an SBA restriction, New Markets must invest 80 percent of its capital in companies located in "economically distressed" areas. The classification includes large swaths of the metro area, including much of Baltimore, parts of the District and Montgomery County and the city of College Park. The fund is looking at early-stage companies in a variety of industries, such as software and biotechnology. Its main criteria, though, is the size of the deal. New Markets seeks companies in which a small investment — less than $2 million — will lead to a significant profit.

In the end, it is about using other people’s money. So final decision-making powers rest with Grovic and four other partners. The fund has also brought in a board of experienced executive advisers, including Jonathan Silver, managing director of Core Capital Partners in the District, and Jack Biddle, of Bethesda-based Novak Biddle Venture Partners.

The status leap that venture capitalists took during the tech boom prompted many business schools to create classes and programs focused on the sector. Pennsylvania State University, North Carolina State University and the University of Michigan have similar funds. Still, it is notoriously difficult to break into the venture industry, even for fresh MBA graduates with energy to spare. Grovic says he makes that abundantly clear to his students.

"I tell them [the program] is probably not going to succeed in getting you into venture capital. But it’s the only way you’re going to have the chance," Grovic said. "I tell them ‘maybe one of you,’ but they all think that they’re that one."
New Fund Branches Out

New Enterprise Associates today will announce that it has closed its 11th fund. All but 5 percent of the $1.1 billion fund came from previous investors. The new fund will continue to focus primarily on early-stage investments in information technology and health care companies, but will also branch out to later-stage deals and "new geographies, like China," said Peter Barris, the firm’s Reston-based managing general partner.

But even for a firm like Baltimore-based NEA, the process of raising capital has changed dramatically from the easy-money boom time. NEA 10, the last fund, raised a whopping $2.3 billion in 2000.

"I think our limited partners went to greater depth in digging, even going to our entrepreneurs, visiting our entrepreneurs," Barris said. "They got to know us better and we got to know them better in the end."

Ellen McCarthy writes about the local tech scene every other Thursday. Her e-mail address is [email protected].

© 2004 The Washington Post Company