The capital of Massachusetts

The liquidity in the Boston area is giving young companies a host of funding options

Boston Business Journal—December 1, 2006
by Craig M. Douglas

Innocentive Inc. makes its money by providing a forum for scientists to tackle tricky problems. About two years ago, the Andover-based spinoff from pharmaceutical giant Eli Lilly & Co. began tackling an issue that was decidedly in-house: fund-raising.

The effort took roughly a year, a process that saw senior executives vet a variety of venture-funding sources, according to Chief Marketing Officer Ali Hussein, who said the company generated a solid amount of buzz among VCs.

In February, Innocentive closed a $9 million venture capital round that included Lilly Ventures, the investing arm of Eli Lilly (NYSE: LLY). The cash helped retire a majority of Eli Lilly's ownership.

"When you raise capital, you inevitably look at all of the traditional sources," Hussein said. "We were fortunate enough to have many interested parties."
Innocentive isn't the only startup to enjoy a healthy amount of investor interest.

Spurred by a sophisticated, technology-driven economy, the Boston area has reached an unprecedented level of liquidity, from venture capital to debt financing to bank loans.

The confluence of financiers, brought on by low interest rates and a mounting pool of investment dollars from institutions in the United States and abroad, has resulted in a virtual money tree for young companies hoping to inject a little growth capital into their business.

Startups sitting pretty

According to information from The VC Deal, the 50 top-funded startups in the Boston area received a total of $942.5 million in seed, first, second and third rounds between Nov. 28, 2005, and Nov. 28, 2006. The figure represents a $226.6 million year-over-year increase. (For a list of the startups, see Page 42.)

This year, venture capital investing in Massachusetts companies has dropped from $924.8 million in the first quarter to $697.4 million in the second quarter and $513.3 million in the third quarter, according to information from PricewaterhouseCoopers and the National Venture Capital Association. Even so, early-stage funding increased by $114 million quarter to quarter, according to the results.

And the more sophisticated the business plan, the more leverage an entrepreneur has.
"If you know what you're doing, the money is there," said Leon Sandler, executive director of MIT's Deshpande Center for Technological Innovation.

Beyond VC

Debt funds, many of which spun out of Bank of America Corp. after it acquired FleetBoston Financial Corp. in 2004, are originating loans at a frenzied pace. Traditional banks, meanwhile, are pouring more and more money into their commercial loan portfolios to offset other operating pressures. Highpoint Capital, Crystal Capital and NewStar Financial are but a few of the debt firms making waves locally.

Area bankers are also scrambling for a piece of the pie, increasingly taking on riskier projects and rolling out new services so as to stay relevant amid a flood of sophisticated, yet lightly-regulated competitors.

"I'd say it's a good time overall for businesses right now," said John Hall, a vice president and lending executive at Salem Five Bank. "There was a time when we might be the only bank vying for a piece of business. These days, we're looking at between two and five competitors for every loan."

To minimize their risk exposure, banks have been quick to lean on the federal government. Massachusetts lenders originated $383 million in federally backed loans last year, tapping a handful of programs run by the government's Small Business Administration in Washington, D.C.

While that number was relatively flat on a year-over-year basis, SBA officials said activity in certain areas of its Massachusetts loan portfolio were up roughly 30 percent for the year ended Sept. 30.

Primarily through its 7(a) and 504 loan programs, the SBA promotes loans to unproven and somewhat risky ventures by guaranteeing, or insuring, portions of bank loans each year. To qualify for that backing, banks must be SBA-registered institutions.

"Lenders are tripping over each other to put money on the streets," said Maurice Dube, the SBA's district director in Boston. "I don't see access to capital as an impediment to starting or expanding a business in this area."

Finance experts say the competition has prompted some banks to tap new markets by loosening their credit policies. Others have rolled out new, more favorable products and special online banking services to reward their most loyal customers.

The result has been a full suite of loans that cater to virtually every borrower's needs.

"It gives the business a better deal," said Salem Five's Hall. Salem Five awarded nearly $7.7 million in SBA (7)a loans in 2005, according to Boston Business Journal research.

Which way to go?

Chris Covington, an investment banker with Covington Associates in Boston, said the decision on funding—weighing SBA financing, say, against venture capital investing—should boil down to whether the startup wants to lay financing risk on top of business risk. And that issue, he said, often comes down to whether a company can stand on its own feet, financially.

"If it's a very early-stage company, and they still think they have business risk, then they probably want to stay away from debt," he said. "The bad news about debt is that it has to be paid back."

Despite the area's cash flow, Sandler warns the Deshpande Center's entrepreneurs and inventors to take it slow. In fact, he cautions them to get their ducks in a row—that is, provide a concept or business model supported by strong data—before even approaching financiers. Otherwise, Sandler says, easy money can quickly equate to problems.

"If you're sitting in Boston right now, it's a fantastic place to be raising money. There are all sorts of resources," he said. "But I always tell our clients that they'll get the leftovers after everybody else has got their piece of the pie."

Craig M. Douglas can be reached at cdouglas@bizjournals.com