Venture capital - the lifeblood of high-tech startup companies - fell by nearly half in Arizona last year as investors retrenched nationwide.
But a new Arizona-based venture capital fund and other recent initiatives are aimed at building a local pipeline for such private equity investments, and driving high-tech economic development in the bargain.
The amount of venture capital invested in Arizona companies fell to $110.6 million in 2009, down 47 percent from $208.8 million in 2008, according to the latest MoneyTree Report by PricewaterhouseCoopers and the National Venture Capital Association.
There were just 12 deals statewide last year, down from 20 in 2008.
Arizona's decline in part reflects a nationwide trend blamed on the struggling economy.
Nationwide, venture capitalists invested $17.7 billion in 2009, down 37 percent from 2008 and the lowest level of dollar investment since 1997, says the MoneyTree Report.
But Arizona also is seen as a laggard in attracting venture capital - private money typically invested in companies in exchange for equity, or an ownership stake, in those firms.
The state ranked 39th in growth in venture capital investment from 2002 to 2008, says a Milken Institute report on Arizona high-tech development issued in December.
Since a $600 million infusion in 2000 during the height of the dot-com boom, statewide venture capital investments have averaged $161 million annually.
Lack of access is a hindrance
Venture capital has helped nurture companies like Tucson's Ventana Medical Systems, which attracted $20 million in venture funding in the 1980s. Ventana grew into a major local employer and successful public company before being acquired by Swiss drug giant Roche for $3.4 billion in 2008.
But several recent studies - including the Milken Institute report - have concluded that a current lack of access to venture capital is an obstacle to high-tech economic development.
"Many companies don't need venture capital - they can 'bootstrap,' " said local venture capitalist Harry George, referring to self-funded development efforts.
"Most high-tech companies, they're going to go through a period of two or three or five years when they are developing their products and don't have revenues," said George, co-founder and managing general partner of Solstice Capital.
Arizona is home to few venture-capital firms, and those - including George's Solstice - manage funds that are already fully invested or committed.
Arizona also has active groups of "angel" investors - affluent individuals who are accredited to make private equity investments, typically early-stage "seed" deals ranging in the hundreds of thousands of dollars.
But for multimillion-dollar venture deals, Arizona entrepreneurs often must hit the road to court funds in venture hot spots such as Boston or San Francisco.
When Tarek Makansi went looking for money to get his Tucson-based company's technology for energy-converting computer chips into production, he soon found he'd have to look beyond the state borders.
About two weeks ago, his Tempronics Inc. announced that it had landed a $2.7 million venture financing round led by the San Francisco-based venture firm Nth Power, which specializes in the energy sector.
Makansi, an electrical engineer who spent 21 years with IBM Corp., said the venture funding will help Tempronics move from research to prototyping and limited production of its thermoelectric computer chips.
The technology, which exploits heat conversion on the microscopic level, has the potential to create a whole new category of solid-state devices for cooling, heat conversion and power generation, Makansi said.
Though Tempronics' venture round included investments from members of Tucson's Desert Angels angel-investor group, the lack of local venture capital funds troubles Makansi.
"We are fortunate that we're in three hot areas - clean technology, energy efficiency and nanotechnology," he said.
"I can't overemphasize the importance of having venture capital in Arizona. There are a lot of interesting technologies in Arizona that would merit a startup company getting funding - if we were in Silicon Valley a lot of them would be funded."
A decade-long effort
George and other Arizona investment and high-tech industry leaders have tried for more than a decade to attract more venture funding to the state - including proposals to create a venture fund partly with state money.
The idea isn't new. About 40 states have some type of venture fund backed with state money or other support from the state, such as insurance-premium tax credits earmarked for venture funding.
Efforts to create an Arizona venture fund have included a 2001 proposal to raise $200 million at least partly with state funds. But such initiatives have failed in the face of opposition from conservative lawmakers who call such arrangements unconstitutional giveaways.
A breakthrough of sorts came in July 2008, when a nonprofit state advisory group proposed an Arizona "Fund of Funds" - a venture capital fund aimed at raising $50 million and attracting another $150 million in funding - with no state money.
The Arizona Economic Resource Organization, or AERO, initially said the fund would raise money from both the private and public sectors. AERO got a commitment of $325,000 from the state Commerce and Economic Development Commission to help develop the fund.
In September, a coalition of state and local business organizations, including AERO and the Arizona Department of Commerce, announced they had retained Sun Mountain Capital of Santa Fe, N.M., to establish and manage a "privately funded" Fund of Funds program for Arizona.
And for now at least, the funding effort will remain private - AERO never claimed the seed money awarded by the Commerce and Economic Development Commission, said Larry Hecker, a Tucson attorney and AERO board member long involved in local economic-development efforts.
Hecker said a 2007 lawsuit over tax breaks given to a north Phoenix developer and subsequent court rulings - including a state Supreme Court ruling in January specifically declaring such private use of public money illegal - have frozen any attempt to use public money for private uses.
"Fantastic building blocks"
The Arizona Fund of Funds kicked off its effort to raise $200 million in venture capital funding Feb. 1, said Brian Birk, managing partner of Sun Mountain Capital.
Birk said his firm - a major regional venture firm with more than $500 million invested - signed on to manage the Arizona fund because of the unrealized potential of the state's technology entrepreneurs.
"Arizona has just fantastic building blocks for an entrepreneurial community, an entrepreneurial-based economy," he said, citing drug research at the University of Arizona and the Translational Genomics Research Institute (TGen) in Phoenix.
"This is a compelling story," Birk said. "There are tremendous investment opportunities in the state, and not a lot of capital pursuing that."
Birk said he expects the fundraising effort to take a year to 18 months.
The goal is to seek commitments for $100 million in venture investments from participating funds, with a goal of attracting another $100 million in additional capital, he said.
Since initial venture rounds generate follow-on investments, Birk said he expects the effect of that initial $200 million to be multiplied.
He cited the New Mexico Private Equity Investment Program, a state program managed by Sun Mountain Capital, which has shown that every $1 invested has attracted $6.60 in additional investment.
George said the initial multiplier and the expected follow-on investment rounds create a powerful leverage effect.
"In every round, you're likely to be bringing in money from out of state," he said.
Other recent initiatives show there may be pent-up opportunities for Arizona venture investment.
In 2008, a group of biotech-industry and economic-development leaders created the Translational Accelerator LLC (TRAC), a private, $20 million venture capital group focused on Arizona biosciences companies.
The TRAC fund already is fully invested in seven companies, including three in Tucson, said Eric Tooker, one of TRAC's managers.
In March 2009, Tucson-based startup Salutaris Medical Devices Inc. received $1.5 million in financing from TRAC, along with funding from the Desert Angels to bring the investment to more than $2 million.
TRAC also has made investments of undisclosed amounts in Tucson-based Calimmune Inc., which is developing a stem cell HIV/AIDS therapy; and Cancer Prevention Pharmaceuticals, which is initially focused on colon cancer therapies.
"I think if we just get more capital here in Arizona, it would be put to good use," Tooker said, adding that TRAC looked at about 75 companies before choosing its initial investments.
George, who said he will decide next year whether to start a new Solstice fund, said he knows of a dozen to 15 Arizona companies with potential for venture backing and market success.
"Right now, there's more venture-backable, early stage companies than I've seen in 15 years."
What is venture capital?
Venture capital is a form of private investment in which money is invested in promising but high-risk companies in exchange for equity, or ownership, shares in those companies.
Funds are often targeted toward certain industries, such as biotech, and may specialize in certain stages of development, such as early-stage or growth.
Venture funds - typically backed by institutional and wealthy individual investors - typically take seats on the boards of the companies they invest in, and have a hand in management decisions.
They typically hold their equity stakes for five to 10 years before cashing out with an "exit event" such as a sale of the company or a public stock offering.
Contact Assistant Business Editor David Wichner at email@example.com or 573-4181.