Wary angel investors answer fewer prayers

Due diligence replaces `just do it'; entrepreneurs scramble for funds

by Mark Walsh

Glenn Laumeister is beginning to get antsy.

The Manhattan startup he runs, Partsearch Technologies, has revenue. It has a major customer in Best Buy, the electronics chain to which it sells replacement parts. It even has backing from idealab!, the Web incubator from which it was hatched

Yet convincing angel investors, typically high-net-worth individuals, to ante up for a $1 million financing round in Partsearch has proven tougher than grabbing a subway seat at rush hour.

"There's a lot more looking and a lot less commitment than there was a year ago," says Mr. Laumeister. "We're just trying to be more patient."

Startups suffering

Mr. Laumeister's frustration is hardly unique these days. While the technology crash has depressed venture funding at every level, private equity has become especially scarce at the earliest phase, or seed stage, where angel investors can play a critical role in getting a fledgling business off the ground.

Burned by bad dot-com investments and wary of an uncertain technology sector, many of the high-profile financiers who emerged in New York have retreated to the sidelines. That high-powered group of professional investors and retired executives includes Wit SoundView Group Chairman Robert Lessin, former e-citi Chief Executive Ed Horowitz, former Liz Claiborne Chairman Jerome Chazen of Chazen Capital Partners, and venture capital mogul Alan Patricof.

The few who are still investing are looking for more than a couple of guys with a good idea. Due diligence has replaced the just-do-it mentality. "My perception is that there is almost a fear of making a decision," says Mr. Patricof, whose firm last year earmarked about $20 million for seed investments but has yet to close on a deal. As a result, angel investors are still gun-shy more than a year after the Internet bubble burst.

Early jump-starter

No one exemplifies the rise of high-net-worth New Yorkers who eagerly banked their own money on dot-com dreams better than Mr. Lessin, the veteran Wall Street dealmaker who joined then-upstart Wit Capital three years ago. Taking stakes in as many as 100 Internet ventures in the last several years, Mr. Lessin almost singlehandedly sought to jump-start the region's angel funding activity.

Today, with half of his Internet bets having gone bust, he's turned off the spigot. "I'm very negative on angel investing right now," says Mr. Lessin, who has not made any new angel deals this year.

He says his reluctance stems mainly from a lack of later- stage financing needed to sustain a company's development beyond the startup phase. And he doesn't expect conditions to improve until early next year. In the meantime, he is focusing on shoring up his existing portfolio.

Although half of his Internet investments have gone bankrupt or folded, including makehisday.com and PredictIt.com, Mr. Lessin says several "home runs" in the remaining 50 or so ventures have yielded overall returns exceeding the benchmark 30% for angel investors. Among those he lists in the win column are GoTo.com, 1-800-Flowers.com, Register.com and VerticalNet.

Securities records indicate that in 1999, for instance, Mr. Lessin filed to sell shares in VerticalNet worth an estimated $9.2 million, and that last year he filed to sell a stake valued at $7.9 million in GoTo.com. His stakes typically range from $100,000 to $2 million.

Many angels weren't as lucky. They didn't get to enjoy the benefit of the feverish initial public offering market for dot-coms before last year's crash ended the IPO parade.

Bruce Bockmann, a co-founder of TechSpace Inc. and a former colleague of Mr. Lessin's at Morgan Stanley, avoided Mr. Lessin's shotgun approach by putting his own money in just four Web startups. Two were sold, one was shut down and the other is TechSpace, which provides plug-and-play space to tech startups and has recently benefited from an influx of downsized dot-coms.

"No one is really sure of what business plans will work, and people are just sitting tight," says Mr. Bockmann.

Nationwide, angel investing is expected to fall this year to less than half the $60 billion that was pumped in during 2000, according to Chris Mutkowski, who heads Angel Alliance, a nonprofit group consisting of 23 U.S. and foreign-based angel investing organizations.

Greater sophistication

Those who haven't bailed out are getting more sophisticated about how and where they spread their wealth.

"The kinds of ideas getting funded at the angel level are ones in which development has been completed," notes Ed Horowitz, former CEO of e-citi, Citigroup's e-commerce division, who began investing in startups full-time last year. Besides having a product developed, investors increasingly want to see a sales pipeline and experienced entrepreneurs or managers at the helm.

So far, Mr. Horowitz has made investments in a handful of firms, including Consumer Direct Link, a mobile commerce firm in Irvine, Calif., and UnPlugged Games, a Manhattan startup led by Silicon Alley veteran Eric Goldberg that creates multiplayer wireless games. Typically, Mr. Horowitz takes a 20% stake in companies seeking to raise between $500,000 and $1 million.

The more rigorous approach by angel investors has left entrepreneurs scrambling to find other sources of financing. Partsearch Technologies' Mr. Laumeister is negotiating a $2 million strategic investment from Best Buy, for which it supplies original parts for everything from cell phones to ovens.

Another company, Silicon Alley's 7thOnline, is pushing to line up more retail customers for its fashion industry business-to-business exchange as it tries to raise a $4 million round. The 2-year-old venture has investment commitments from Mr. Patricof and Mr. Chazen, but CEO Max Ma says the going has been slow.

Valuations back to earth

Despite the pall hanging over angel investing, there's some reason for optimism. For one thing, Mr. Mutkowski says angels are more active now than six months ago, as valuations have come back to earth. The same company that would have had a preinvestment valuation of $15 to $20 million 18 months ago is now valued at something like $3 to $4 million, he says.

Locally, the rise of organizations including the New York New Media Association's angel investor group, the Tri-State Private Investors Network headed by Ellen Sandles, and Tri-State Ventures provide an institutional framework for angel investing that will help facilitate a rebound.

Mr. Laumeister, who recently made a pitch before a group of about 40 NYNMA angels, is still waiting anxiously for the checks to come in. Says the CEO, "I'm confident, but paranoid."