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Startup Fundraising: What Works in Minnesota | Part 2

[Note: Part 1 of this story is here.]

Two Different Funding Approaches – One Repeat Tech Entrepreneur

Daren Klum is a Minnesota tech entrepreneur who first cofounded LiquidCool Solutions (formerly known as Hardcore Computer) in 2006, based in Rochester, MN. More recently, he founded Secured2, Minneapolis, a data security company. What did he do differently in those experiences? “In both my startups, we initially followed a similar path. We raised capital from friends, family, and small funds. In the case of LiquidCool, we went the VC route for our Series A and B. At Secured2, we’ve bypassed the dilutive nature of VC. Instead, we’re doing alternative financing to scale the business, working with the largest sell-side M&A firm in the country.” 

What has been his experience finding capital here in Minnesota?We had tremendous support from friends and family in Minnesota for the early rounds in both my companies. However, the bulk of the $40 million we raised for LiquidCool came from out-of-state sources – in North Dakota, Wisconsin, and California. And most of the $6 million raised so far for Secured2 has also come from out-of-state — Virginia, Ohio, and Michigan. We’ve found larger capital amounts to be very hard to find in Minnesota.” 

Klum said he bootstrapped both his companies in the early years. “Without showing a proof of concept and customers, we couldn’t ask anyone to invest. Was bootstrapping a viable option? Yes, I recommend all entrepreneurs bootstrap to minimize the risk for their investors,” he said. Bootstrapping can replace a seed round if you do it while you have a job. I built my first company this way. I worked a full-time job and, at night in my free time, I would build my new business. Once I had enough built to justify investment, I was able to raise capital and quit my day job.”

How did Klum find and connect with angel investors?I found all my angel investors through my network of friends, family, and colleagues. As well, I’ve been fortunate to get a couple investments from customers and relationships I built while growing the business.”

How long can a funding round take? “In the early stages, it can go very fast, because you’re generally working with people you know – friends, family, colleagues,” Klum said. “The more time-consuming capital raising comes when you get to your Series A and B rounds. The stakes are higher, there’s more due diligence, more risk, and obviously a lot more capital in play. So, generally, any round past your seed round logically takes more time to land. It can be months or even years to close larger funding amounts. It depends on the type of financing —debt, equity, or convertible.”

How Easy (or Hard) Is It Getting That First Check?

I asked Daren Klum what it was like taking that first investor check.The first check is always the hardest – it’s usually family, and can be a very sobering experience. Once you take someone’s money, you’re committed and there’s no turning back. I see far too many first-time entrepreneurs take that first check, and then the going gets hard and they quit. Quitting is final. If you quit, you can’t reach success.”

Another viewpoint came from a founder we wrote about in Part 1, Markus Mueller of FashionBrain. “Getting the first check wasn’t hard at all — at least it didn’t feel that way. But there was a lot of effort that went into preparing the first pitch deck and engaging potential investors. Pre-work is key — by the entire team. They had my back, as the CEO and key fundraiser. Without their help, I would not have been able to do it. It does not get easier – in fact, I believe it gets harder. So my advice is to focus and raise money as fast as possible with all effort on fundraising, and then return to driving the company’s business development. I made the mistake to raise funds over more than two years — and I regret the lack of focus the came with that. Know exactly how much money you need — raise exactly that. Don’t oversubscribe by more than 10%, for example. And use the funds to grow your company, to create value. Then, if necessary, raise more money at a higher valuation.”

How hard does Eric Martell of Pear Commerce say it is to get that first investor check? “I think this is a total case-by-case question. It was super hard to get early investors at EatStreet, then easier. I’ve seen companies exactly the opposite. You might have a very compelling vision or track record and get first checks easily, but then need to prove results. Likewise, if you’re a Minnesota tech company doing over $10 million in revenue, you’re flying in some rarified air and are likely to get a ton of love on a larger round.”

Rob Walling is the founder of TinySeed, a startup accelerator designed for bootstrappers. (Previously, he founded Drip, acquired by Minneapolis-based LeadPages, which adopted the Drip name.) I asked him if raising friends and family money is important before looking elsewhere. “Prior funding is less important than how much traction – for example, revenue – a startup has. I’d rather write a check to a founder who is capital efficient enough to make it to revenue without raising any funding.”

Should VC funding be so glorified? When is it the right way to go? “VC funding is simply one way to start a company,” said Rob. “It should not be viewed as a goal or having ‘made it.’ VC funding comes with a pretty major set of drawbacks, and founders should know what they are getting into before signing a deal”

Can the Crowd Help?

A non-traditional option some have pursued here in Minnesota is crowdfunding. Since Kickstarter entered the national scene several years ago, many founders have tried it or its competitors. But, frankly, only a few startups in Minnesota have had great results. That may be changing. Wes Wierson, cofounder of Rochester startup LEAH Labs, is out to cure cancer in dogs. Here’s what he had to say: “Instead of Kickstarter, where you get a deal on a new tech gadget, the crowdfunding platform we chose—WeFunder—actually gets you equity in the companies you support. It’s been amazing for us. In addition to validating the market through testimonials of angel investors who know we’re building a cool product. and pet owners donating on behalf of their fallen furry friend, it brings much-needed seed investment to our business.” 

Traditional VC did not fund Wes’ business early on, after he went through a recent biotech class in the famed Y Combinator accelerator program in Mountain View, California. “I think it’s because they really don’t understand our technical science, and, secondly, they’re more risk-averse than they want you to believe. With equity crowdfunding, we’re able to ignite our business based on the passion of dog owners, and the support of angel investors who understand the high reward market we’re building.”

What’s The Current State of the Minnesota Angel Community?

“When we founded Gopher Angels seven years ago, the angel community was limited to hard-to-find individuals or one angel fund,” said Dave Russick, cofounder. “Gopher Angels was able to provide a home for individuals and micros funds to collaborate on deals, which helped fill the funding gap for seed and early-stage companies. Frankly, there was still a greater need for funding than could be provided by GA. Over the last few years, the funding landscape has improved greatly. There are several new funds available to entrepreneurs, many of whom target specific industries. We also now have active accelerators such as Gener8tor and Techstars Farm to Fork that provide seed funding while helping the companies prepare better for the funding chase. There are also multiple individuals and organizations that are serving to connect founders and investors. We even have some funds such as Urban Innovation that have set up offices in the Twin Cities. In short, the angel investor scene here has changed tremendously and changed for the better!”

Joy Lindsay, partner, Sofia Fund: “I think the angel community in Minnesota is healthy and growing. I’ve been an angel investor for 20 years, and it’s probably the most active I’ve seen during that time. There are many new participants to the angel community. When we raised the original Sofia Fund, we purposely targeted women to join the fund who had never invested in the asset class before. These are people who are not only bringing their money but their expertise and network to engage with companies and help them grow.”

She continued: “Dave and Sara Russick have done an amazing job growing Gopher Angels. I was just at their meeting last week. Again, these angels are smart, engaged individuals from a variety of backgrounds and industries. Many have never invested before, but they join the group and learn from each other. The Minnesota Angel Tax Credit has also been a driver of bringing new people to angel investing. As we all know, investing in startups is very high risk, so anything that can be done to support that activity the better. Minnesota has a rich heritage of ‘giving back.’ While that has historically meant we are very philanthropic, more and more I also see successful entrepreneurs and corporate executives giving their time and talent to invest in and then to mentor entrepreneurs. Like philanthropy, this work is critically important to the economic growth of the state.”

How does startup attorney Jeff Robbins, who also heads the Angel Pollination investor group, assess the current state of the Minnesota angel community? “I’d say better educated on investing and increasingly not doing so. I would add some color to that – our prime angel community is aging out. They’re moving to warmer climates and investing in funds rather than companies. And the recession has delayed the emergence of next-gen angel investors.” 

Is that a clarion call to younger angels out there – time to step up?

Sara Russick of Capita3 (and also a cofounder of Gopher Angels) assesses the current situation thusly: “There are so many awesome entrepreneurs who are working so hard. Many more of them deserve funding than are actually getting it. A small number of angel investors can’t fund them all – it’s that simple. We have tons of resources to help grow the startup community. We need more resources pointed at growing the angel investor community.”

Mary Grove, Minnesota-based partner in Revolution’s Rise of the Rest Fund, sees things in a similar vein: “Minnesota’s startup ecosystem has scaled impressively over the last half-decade. It’s an attractive place to start and scale a company. From the density of Fortune 500s to the talent pool to the capital efficiency of building here. That said, there is still a large gap at the early stage in the funding landscape, especially at the Seed and Series A stage across most sectors.”

What Does the Future Hold for Startups Trying to Raise Capital in Minnesota?

Rob Walling of TinySeed says things look good: “The more Minnesota startups that have success, the more our ecosystem grows. I’ve been in town for three years, and, even during that short time period, I have noticed more events, more startups, and generally more action in our local startup ecosystem.”

Sofia Fund’s Joy Lindsay also likes what she’s seeing. “Raising money for a startup is never easy. But I think there are a few trends in Minnesota that are making it easier. Most of the very early capital invested in startups comes from investors in the general geographic region. We do have an active and growing angel community. But what is also encouraging to me is the growth of new venture funds. In recent years, Capita3, Matchstick Ventures, Great North Labs, The Syndicate Fund, and even funds like the student-run Atland Ventures have all closed new funds to invest in seed and early-stage rounds. These funds didn’t exist five years ago and are actively investing in companies, many of which are based in our state. Then there are funds like Vensana Capital, led by seasoned VC Kirk Nielsen, who recently closed a $225-million fund. Obviously, that capital won’t all go to Minnesota companies, but it’s great to have Kirk based here. We could use more of these large Series A and Series B venture capital funds in our state, but it’s encouraging to see so many new funds starting.”

Joy continued: “One area that excites me is the focus on getting all members of our community interested in entrepreneurship and investing. The Sofia Fund was one of the very first groups to focus on growing the number of women angels, and then investing in women-led companies. Capta3, another local fund, focuses on women-led companies in healthcare. Lunar Startups is a local incubator doing great work to support women, people of color, and other high-potential entrepreneurs. The Aspen Institute, the Center for Economic Inclusion, and the Case Foundation recently held a summit to discuss ‘inclusive Investing’. Here in Minnesota, MEDA has provided capital to minority entrepreneurs through its $1 Million Challenge.”

Does attorney Jeff Robbins see things improving? And how do we compare to other states? “Improving over the 2008 recession days? Yes. Minnesota fares well among Midwestern states, and we do have cool companies.”

“The future is bright,’ said Sara Russick. “We’re turning a corner and growing from a nascent entrepreneur ecosystem to one that is being supported from all sides, taking advantage of Minnesota’s awesome people, education, big corporations, and communities. Our state is attracting attention from investors from around the country because they see what’s happening here. As more of our startups begin to mature, we could see the Series A/B gap grow. I hope we see many more Series A and B funds come in to support their growth, and keep our innovation and talent here in Minnesota.”

Mary Grove of the Rise of the Rest Fund provided this perspective: “The good news is, more investors are paying attention and seeking opportunities to establish a local presence here or simply seek out local startups to fund. I believe we’ll continue to see expanded access to capital and the opportunity for more innovative companies to start, and equally importantly, to scale and stay here. Our recent Twin Cities Startup Week was a great example of this trend. I connected with investors and startups alike who had flown in from other cities in the region as well as the coasts to participate. At Revolution’s Rise of the Rest Seed Fund, we’ve invested in six Twin Cities-based companies. I’m proud to be based here and part of the Minnesota entrepreneurial community.”

[Note: The second Rise of the Rest Seed Fund was announced October 28 – another $150 million fund focused on backing entrepreneurs outside traditional coastal hubs: https://www.revolution.com/press-release/revolutions-rise-of-the-rest-announces-second-150-million-fund-to-invest-in-startups-based-outside-of-silicon-valley-following-faster-than-expected-deployment-of-first-fund/ ]

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