Are Angel Investors Filling a VC Gap for North Carolina Startups?

Xconomy Raleigh-Durham — 

Investor purse strings loosened to fund North Carolina companies to the tune of $266 million in the first half of 2014, up more than 31 percent compared to the same period last year, according to a new report. But perhaps more surprising than the dollars are the investment trends suggested by the report. Angel investment seems to have stepped up in North Carolina to fill an investment gap left by venture capitalists. And for the first time in recent memory, total technology investments have eclipsed life science investments—by a wide margin.

The findings come from the Council for Entrepreneurial Development (CED), a Durham, NC-based organization that supports North Carolina entrepreneurs. CED’s mid-year update to its annual Innovator’s Report counted 127 North Carolina companies raising money in the first half of the year. Of the 127 companies, 75 raised equity financing.

To put those numbers in some context, the National Venture Capital Association’s tally for investments in the first half of 2014 was $91 million invested in 21 North Carolina companies. That’s far short of dollar and company totals CED counts for the first and second quarters. Joan Siefert Rose, president of CED, says “undisclosed investors” participated in two-thirds of the 127 equity deals that CED counted. These investors include high net-worth individuals, families, angel investors, and syndicates of angels. Rose says the growth in angel investment shown in CED’s report is consistent with increased angel investment that the Angel Capital Association (ACA) sees throughout the country.

“This is a whole new class of investors that are starting to make an impact,” Rose says.

Analysis from others suggests that North Carolina is not an outlier. The University of New Hampshire Center for Venture Research has researched the angel market since 1980. The center’s figures for 2013—its most recent figures available—showed that angel investment totaled $24.8 billion nationally, up 8.3 percent over total angel investment the previous year. The number of U.S. entrepreneurs receiving angel funding in 2013 totaled 70,730 in 2013, up 5.5 percent over 2012. The high mark for angel investment occurred in 2007 when funding reached $26 billion, according to the center.

Rose says angel investors give startups an alternative to venture capital funding. Those angels come with their own professional networks, which bring to North Carolina startups a different investor mix than they have seen in the past. That means startups don’t necessarily need to turn to venture capital firms for money, she says.

This is the third year that CED has done its Innovator’s Report, but this is the first time that CED has noted the growth of angel investment. Dhruv Patel, CED’s program director, says the methodology has not changed—the council is talking with the same people. CED used information from the National Venture Capital Association, the North Carolina Biotechnology Center, Ernst & Young, and Small Business Innovation Research grants.

Jim Roberts, executive director of the Center for Innovation and Entrepreneurship at the University of North Carolina-Wilmington, says he’s seeing more “quiet individual angels,” but not angel syndicates, stepping up to support companies he works with. Wilmington startup Next Glass, which is developing software that uses machine learning to help consumers choose wine or beer, found support from angel investors after initially bootstrapping its efforts. NCino, also based in Wilmington, last year raised $9 million in a Series A round funded by individuals. But nCino, whose cloud software manages bank operations as well as bank customer relationships, might not be representative of individual investors stepping up to invest in North Carolina startups. Most of nCino’s investors are prominent figures in the banking industry.

Abhi Muthiyan, co-founder and chief technology officer of electronic health records company Patagonia Health, looks at CED’s findings with some skepticism. Muthiyan’s Cary, NC-based company has grown from a startup founded in the 2008 recession into a company now serving medical practices throughout the Southeast—without raising angel or institutional funding. Muthiyan acknowledges that the investment climate appears to have improved. But he views investors as still being conservative, choosing to put their money into companies that are further along in development and already generating revenue, rather than seeding early-stage companies. In other words, they’re funding lower-risk investments, Muthiyan says.

According to CED’s data, North Carolina technology companies raised $184.0 million in the first half of the year. By comparison, the state’s life science companies raised $54.9 million. The imbalance comes as a surprise, considering the cluster of pharma companies in the Research Triangle and the emergence of life science companies in other parts of the state. Rose interprets the data as representative of economic breadth.

“North Carolina’s entrepreneurial economy is not dependent on any one sector,” she says.

But direct comparisons between biotech and tech investing can be misleading. Efficiencies of cloud-based technology have reduced capital requirements for tech companies. On the other hand, drug development has a long life cycle that requires companies to test experimental therapies in three different phases of clinical trials that take years. Those capital needs have not changed—pharmas still need to raise tens of millions of dollars to finance these trials.

Offsetting pharma companies’ need to raise capital from private investors is the improved market for initial public offerings in the last two years. Durham companies Argos Therapeutics (NASDAQ: ARGS), NephroGenex (NASDAQ: NRX), and Scynexis (NASDAQ: SCYX), are all in various stages of testing their respective drug candidates. All of them succeeded in going public in the last year. Had those companies remained private, each would have needed to raise tens of millions to finance clinical trials, which likely would have tipped the balance of CED’s figures toward life science investing. Instead, the companies are funding those trials with proceeds from their IPOs.

Patel says CED doesn’t know for sure if this is the first time that private tech investment has outpaced life sciences. Classification of companies is one issue. More health IT firms have emerged in recent years, and CED classifies these software developers as tech companies. But medical device companies are grouped in life sciences. CED’s analysis also does not break down the companies in any sector by their stage of development.

“Different industries classify startup stages differently, so we are reporting the funding deal size but we wouldn’t have a breakout of company stage,” Patel says.