Matchmaking May Be An Old Concept But It Still Makes Money
Tal Golan knew he invented potentially game-changing technology in the fight against spam. Proving that to investors was a different story.
While venture capitalists in 2003 were intrigued by Mr. Golan's product, a hardware box that checks for spam before the message reaches corporate email servers, they kept telling him the same thing: He lacked the right pedigree for an investment.
"I didn't have the right degree. I didn't work for five years at Cisco and Oracle, then start up three companies," said Mr. Golan, who previously founded a small software development and consulting firm. "The reality is that VCs invest in people first, second and third, then the technology."
Undeterred, Mr. Golan operated out of his garage in Costa Mesa, Calif., for three years and invested roughly $750,000 in his company, Sendio Inc., by maxing out credit cards and refinancing his mortgage, betting the financial security of his wife and young children. By late 2005, the device was selling, but it was clear he needed to take his business to the next level. That is when he linked up with Momentum Venture Management LLC, an unconventional firm that promised to give him the credibility needed to court VCs.
Matt Ridenour and Andy Wilson, veteran start-up executives, incorporated Momentum in late 2004 to work full time with company founders to shape their business plan, find credible management, finish a product and gain customers -- a process that typically takes them about nine months to complete. At that point, they shop the company to VCs with hopes of securing a Series A round of between $4 million and $5 million.
Momentum is one of several firms that have cropped up in recent years to fill a funding void left by VC firms shifting their investments downstream and bypassing the traditional guy in a garage. That shift left many unseasoned entrepreneurs such as Mr. Golan to fend for themselves in bringing intelligent ideas to fruition. But it is also opening up an opportunity for smaller firms willing to take on higher risk and lend more credibility than do traditional angels.
"If you're an entrepreneur, seed and Series A deals are really tough to get right now," said Beau Laskey, a managing director at Burbank, Calif., early-stage firm Steamboat Ventures. "Venture firms are looking for customers and traction."
Los Angeles-based Momentum has a distinctive model that dedicates far more time than a typical angel or seed-stage investor would, while also assuming considerable risk. Momentum first spends about six weeks -- usually for a fee of less than $20,000 -- validating a business plan, confirming the chemistry with the founding team and completing due diligence before committing to the start-up.
Upon approval, one of three Momentum partners then installs himself as the chief executive officer, moving the founder to the role of chief technology officer and eventually bringing on a new CEO a few months later. At some point during the process, Momentum provides a bridge loan -- typically $250,000 to $500,000 taken from a small bridge fund pooled from wealthy individuals -- to keep the company going, all for a "nominal" monthly stipend.
"We're solving an intractable problem in the early-stage business ecosystem," Mr. Wilson, Momentum's managing director, said. "Entrepreneurs are often stuck in that vicious business cycle of needing money to recruit business talent, build a product and attract customers, yet they can't raise the money unless they have those pieces in place."
Typically a Momentum partner works with two companies at a time, spending half of his time on each, with an operating associate subbing as a project manager and director of operations. Momentum's ultimate goal is to deliver the company to venture capitalists and secure that first round of capital, when the firm's bridge investment converts, often at a discount, into Series A preferred stock. It is at this point the firm gets paid for its work after having deferred the majority of its management fees during the previous nine months.
Longtime venture capitalist Lou Volpe, a managing general partner at Waltham, Mass.-based Kodiak Venture Partners, believes Momentum's model is unique and would consider investing in a start-up seeded this way, but questions the firm's scalability. "Whipping a company into shape, enforcing operating discipline and building an executive team takes a lot of energy and time," Mr. Volpe said. "These guys are going to be limited with their scale."
Thus far, the firm has taken all seven of its start-ups to the Series A level, focusing on Los Angeles-area technology companies that require less than $10 million in funding to break even on a cash-flow basis. The seven have raised a total of $30 million in Series A funding from venture capitalists. The firm had its first exit in 2006 when Discovery Communications Inc. acquired Academy123 Inc., which had raised a $5 million Series A round the year after Momentum brought the company to venture firms Arcturus Capital and Hanseatic Group.
For Mr. Golan, it took about 10 months to get Sendio through the Momentum-coached process and into the hands of VC investor Kline Hawkes & Co., which provided $4 million in Series A capital in October 2006. Sendio now has about 275 customers. Earlier this year, it estimated it would have 1,500 customers and sell $7.8 million of product by the end of 2007.
Before linking up with Momentum, Mr. Golan said, he pitched his plan to angel coalitions, but found them as unwieldy as investors. "You have to make like 100 presentations to 100 guys and the only thing that qualifies them is money," Mr. Golan said. "It's kind of like 'American Idol.' You make the pitch, move on to the next round, and try to get 10 people to agree on everything. I'd rather take the risk on the credit card than have to deal with angels."
Klaus Koch, a Kline Hawkes investor who led the firm's investment in Sendio, said a firm like Momentum is especially beneficial to VCs because it is bringing only companies with proven business models and customers.
"Momentum comes in and takes out the significant risk," Mr. Koch said. "They're pitching us with all the information we need and cleaning up the legal issues. They really understand what a VC wants, and for a firm like us that manages $270 million, that's very valuable."