Growing Pains

Venture Capital with a Capital V

IdleAire President Mike Crabtree was in a funk. He was driving from Ohio into West Virginia on a sun-baked freeway, alone in a rented Ford Taurus. His flight from Knoxville to Washington had been diverted to Akron. It was Tuesday, Sept. 11, and he was thinking of little else than the tragedy of the morning. His fledgling company in Knoxville, where he was now returning, was hardly on his mind when his cell phone rang.

His executive secretary, Katherine Ragle, had said he'd probably like to talk about anything but the airliner hijackings and the fate of all those people on the planes, at the World Trade Center and at the Pentagon. The caller wanted to know about Crabtree's company and its quest for venture capital to fuel its growth.

The question may have distracted Crabtree, but it didn't improve his mood. "I gave up, basically, last year," he said of his prospects for raising capital from local investors. "The venture capital market fell off with the financial markets, and it hasn't recovered." He said he had a prospectus for his firm, IdleAire Technologies, ready to show to possible Knoxville investors at the time, but he didn't bother to deliver it. Now he's looking elsewhere, and it isn't easy, he said.

Where he was set to look last week was New York. After two days in Washington, talking business on Capitol Hill, Crabtree was headed for Thursday and Friday consultations with investment bankers, including Morgan Stanley executives in the World Trade Center. By the end of the week, he had not been able to contact the officials at Morgan Stanley, which occupied multiple floors of the destroyed skyscrapers and was reporting many of its people missing. 'They've got more to worry about than me," he says.

His own worries, though pale in comparison, are real. IdleAire Technologies Corp., with Gay Street offices in Riverview Tower, has a great product with a great future, he firmly believes, but it is in need of growth capital. The company, formed in early 2000, is just starting commercial deployment in the Northeast of systems installed at truck stops that deliver heat and air conditioning, telephone and Internet access and satellite television to parked truck cabs, allowing the driver to shut off his diesel motor. The savings in fuel and in air pollution are significant, Crabtree says.

He fits the criteria for a manager of the kind investors demand, with a sure-footed track record for growing businesses. A 51-year-old University of Tennessee engineering grad, Crabtree was a founder of CTI, a medical imaging company that was sold to German giant Siemens. He then ran US Internet, a web service provider here until it merged with another firm that was eventually absorbed into Earthlink, the nation's second largest Internet provider. Both are success stories of the sort that impress investors, but he's unable to gain the investment he needs from Knoxville area financiers. He wants to stay in Knoxville, but, "If the capital we need requires that we move, we will," he says.

Jan Haerer, director of technology transfer and economic development for Oak Ridge National Laboratory, is not surprised at the story. "Venture capital is thin, very thin," in the Knoxville area and in the state of Tennessee as a whole, she says.

Recognizing how poorly the state and region rate as venture capital centers and encouraging the measures some East Tennesseans are trying to take to rectify that condition are vital to the future economic climate here, Haerer and many others in the business and industrial community contend.

She opens many presentations with a story of two companies, each licensed by ORNL to develop the same technology for commercial applications. She doesn't name the firms or the technology, but says that one of the companies got its startup money from California and moved to Palo Alto. The other stayed here. The one that left is capitalized at $40 million now and is growing rapidly, she says. The one that stayed is ailing.

Haerer knows how that feels. "I was with an entrepreneurial company, a tech company, that moved to Tennessee and languished," she says. Since April of 2000, she has been trying to hook up technologists with capitalists to exploit the products of research in her role with ORNL. "A few years ago, it was easier to get early-stage funding," she says, "but the failure of the 'dot.coms' and the [decline of] tech stocks has made a lot of investors sit back and take stock."

Hardest to secure here, she says, is high-risk, start-up capital. "When investors don't see a long-term return, they don't make a short-term investment" that could get a small business up and running, Haerer laments.

Tom Rogers has hopes for securing a pool of start-up money in East Tennessee for tech firms, but he reckons it will be a long process. A veteran economic developer with TVA and chamber of commerce credentials, Rogers is CEO of Technology 2020, a non-profit corporation established in Oak Ridge with $1.5 million in 1995 to lead firms in the state in the development of commercial applications for new technologies statewide.

With its roots here, Tech 2020 is almost sure to look here first. But Tennessee has hardly been a hotbed of venture capital, despite the fact that the Knoxville-Oak Ridge area has what Haerer calls "an abundance of technologies and technologists." ORNL counts nearly 2,500 research scientists and more than 5,000 engineers among the area's population. Her boss, Bill Madia, the president of UT-Batelle, LLC, the ORNL operating contractor, has expanded upon an ORNL policy of farming out technologies turned up by its researchers. He strongly advocates licensing those methods for general uses.

Regardless of that labful of potential, Rogers says, the total investment of venture capital in Tennessee in 2000 was only $219 million. He says "only" because that represents less than two-tenths of 1 percent of the national total of $103 billion. That puts Tennessee almost at the bottom of the pack, ahead of only Alabama. Leaders include California, Texas and Massachusetts. Regionally, North Carolina and Georgia are high in the standings.

Considering the advantages offered by the technological community here, Rogers, like Haerer, calls that a disgrace. So does Jim Breitenfeld, vice president for economic development of the Knoxville Area Chamber Partnership. Breitenfeld's background was most recently in technological transfer for the state of Florida.

"One important reason I came here, just a year ago now, was the opportunity to take advantage of the potential for tech transfer from Oak Ridge and UT," Breitenfeld says. "What I've heard over and over for the last year is 'potential.' That's better than no potential, I guess, but there's got to be movement to match it."

Rogers is among a majority of people who have examined the venture capital dearth here and believe that the shortage is not so much a result of lack of money as in the application of management skills to ideas. "Most of the people seeking venture capital are not ready. They have no track record. At the end of the day, investors are investing in a management team and a marketing concept."

Breitenfeld agrees to some extent, but he says he thinks "we do have more [management] talent here than we've taken advantage of. There's a large number of recently retired executives here. We need to get them involved." He also cites the UT College of Business Administration as an underutilized local resource in the field of management.

His boss, Chamber CEO Tom Ingram, says he believes there are both sufficient wealth and sufficient managerial talent available to develop a strong venture capital base in the Knoxville area, and he says he's in favor of committing the chamber partnership to that task.

Ingram says he moved to Knoxville 17 years ago because, in the words of virtually everyone who has lived here, "It's a nice place to live.

"If my first priority had been business, I'd have gone some place else. We have to change that, make new business a priority or, things being as competitive as they are today, we won't continue to have the best place to live."

Otto Wheeley welcomes that attitude, despite the fact that, six years ago, Wheeley told Metro Pulse that the idea that "a booster committee or a chamber of commerce type can steer someone with a new business idea to the right people is horse manure."

Wheeley is himself a retired executive who, through his Venture First Associates and personal investment, has been involved in more than 60 business startups since he came to East Tennessee from Pittsburgh 17 years ago. At 80, he's referred to fondly as the grandfather of venture capital in the state.

"Some chambers have come to recognize that new technology will create more jobs over the long haul than ordinary, established manufacturing companies will create if you recruit them to your area," Wheeley says. He says chambers of commerce used to be in a hurry to see a big plant go up and "didn't have the patience to deal with start-ups."

That's exactly true, says Ingram, who calls venture capital for new businesses, high- or low-tech, "a critical area." His board of directors has made it a top priority for the chamber, which is about to name a task force to determine how much venture capital might be available here and how to get it flowing. He says the idea for a task force came from a workshop in July in which more than 40 board members, including movers and shakers of the community, set the priority themselves. Breitenfeld says the most important facet of the task force's work, once it determines the level of capital that might be available for venture investment, is to form a network of capital resources. "We've had a number of investment 'angels' in the area, but there's no working network." Some metropolitan areas have established venture capital networks that are very effective, he says.

Such a network, of sorts, was tried in 1994, when a group of local businessmen and women, augmented by a $2 million TVA economic development investment, formed what was called the "Venture Alliance."

Ingram, who was active in that gambit before he was hired to head the chamber, says there was nearly $25 million raised in all. It was invested in varying amounts in eight start-up companies, most of which were tapping into new technologies. Three of those investments did not pan out at all. One company was sold outright, two licenses were sold for future proceeds, and two companies are still growing. One of the successes, Ischemia Technologies, a medical firm, moved to Denver where it raised much of its capital, and the other, MachineXpert, an industrial diagnostics company, is still in Knoxville.

TVA's John Moulton says the agency is still waiting on a return on its investment. "We're told it may take several years," he says. Also waiting out their returns, says banker Bill Arant, are the other Venture Alliance investors, who included such Knoxville names as Jim Haslam and Jim Clayton. Arant says the alliance employed its own management skills to the ventures, but that the members underestimated the amount of time and effort it would take on their parts to build the young firms they were nurturing. "It was just too hard," Arant says. The alliance is now inactive and is counting on those fledgling successes it helped start to grow on their own or with other assistance and to provide an eventual return on the original investments.

Such a hands-on approach as the Venture Alliance took with its prospects is not agreeable to every entrepreneur. Terry Edwards, for example, is CEO of PerfectServe, a young company providing physicians with innovative communication links with their patients. Edwards, whose background was in voice communications when he came to Knoxville in 1992, used money from a prior business sale to prove his concept and show profit, then went to institutional investors in large venture capital funds, rather than angels or the Venture Alliance, to avoid management tinkering.

"We went first to Chicago," Edwards says, to raise $6 million from a fund that manages $150 million in capital. Then to other cities, including Cincinnati, for additional investment. He says initially there was some pressure to move out of Knoxville, because many investors like to have their investments close at hand, but he kept his headquarters here. The toughest challenges he faces in maintaining his Knoxville offices on Weisgarber Road are the recruitment of managerial talent and difficulties with air travel arrangements connecting Knoxville with America's great population centers. "We have no plans to move now, but needs change," he says, reflectively.

Likewise, Barry Goss used personal assets to form Pro2Serve in 1996. The Oak Ridge firm provides professionals for projects on an outsourcing basis—much like a temp service, but for engineers, scientists and other professionals needed for special projects.

Early on, Goss, who was formerly a vice president of Science Applications International Corp. and was well-networked worldwide, went to Otto Wheeley, who brought other investors and became a board member. "Otto networked us with venture capital sources, and the first two we went to—in Atlanta and Tampa— invested substantially," Goss says. "Thank goodness we didn't do the Venture Alliance model," he says. "A corporation with an outside-control board prevents too much home cooking going on internally." He says his company broke $10 million in revenues two years ago. Fortunately, he says, his company has been able to grow out of cash flow. "Now's not the time to be out looking for additional capital," he says, pointing to a slowing market in technology investment.

Goss says some companies try to force growth too quickly. "One of the worst things is getting too far out in front of their headlights and getting themselves at the mercy of their bankers and investors. Some survive in that environment, but others don't."

ORNL's Haerer says no matter what a company's management situation may be, it has to raise capital to get going at all. "With enough money, you can buy the management you need," she says.

She quickly cites three companies licensed out of the ORNL lab that "could have been here but went with their investors." Graviton, which produces micro-sensors for extremely fine measurements, went to California's Silicon Valley and is capitalized at $100 million; Maxima, which is involved in laser transmission technology, also went to California, although she was not certain of its current capitalization; and nLine Corp. went to Austin, Texas, where its semi-conductor wafer inspection technology is capitalized at $40 million. Haerer seems concerned that Sarcon Microsystems, Inc., a Knoxville company engaged in providing affordable infrared technology for commercial and consumer uses, "just got funded, not locally."

There are also "a number of companies that we consider at risk [for survival]," she says, because of a lack of capitalization opportunities.

She then rattles off a list of new licenses that are begging for initial capitalization, including one that could construct levies using water as its own barrier, one that employs neutron detection with "lots of applications," several that would develop high-end scientific instruments, some that would perform environmental work and at least one that is transportation-related.

Tech 2020's Rogers says an initiative called the TennesSeed Fund is showing promise as a vehicle for start-up capital. Since it's a Tech 2020 affiliate, and it's organized as a limited partnership under the federal Small Business Investment Corp. program, it can get matching funds for the capital it raises locally. TVA has kicked in $200,000 and pledges from 16 investors total $13 million, so that the SBIC license, which is pending, could bring in another $13 million to be invested in Tennessee, Rogers says. He says a separate program called the New Markets Initiative, also administered by the Small Business Administration in Washington, will apply a 2000 law creating a Southern Appalachian Fund of $12.5 million for use in Tennessee and parts of four other states. Banks that lend to business start-ups in economically depressed census tracts in the region will get the kind of investment tax credits that were originally available only through housing loans, he says.

Rogers says $38-$40 million may seem only a drop in the bucket in the field of venture capital, statewide, but he believes that when it's applied strictly to getting companies off the ground, it is significant.

It had better be, if the prospects for state participation in such funds is taken into account.

Gov. Tom Ridge of Pennsylvania is out promoting his state as a venture capital resource in itself in a new TV ad. Gov. Don Sundquist is scrambling just to keep most of the state's services functioning. There's no money in the treasury for ventures, no matter how they might brighten the state's economic future.

The Chamber's Breitenfeld does see the TennesSeed fund as a bright spot because of its focus on start-ups. "The ones that start here and grow here have deeper roots and are more likely to stay here," he says.

Ingram believes the Chamber's role in promoting a "consistent, reliable, sufficient venture capital base" will follow suit. In his board's workshop report, just out this week, is a near-term proposal to take identifiable sources of venture capital and "encourage pooling of funds to create larger amounts for [individual] investments and to spread the risk."

The Chamber's two-year goals include generating $100 million of venture investment capital and getting at least one venture capital or investment bank to locate in the Knoxville area. A five-year goal is to become a benchmark for the state and nation in the creation of venture capital.

Such commitments can't be realized too soon, according to Haerer, who says bluntly that in today's tech market: "We're losing our future. We're losing our best people and our brightest technologies—that is our future."

© 2001 MetroPulse. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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