Quick Take: New Seed fund may be on RightSide

By Milt Capps Last updated 7:35 a.m. March 17, 2010

Published March 1, 2010

Some experts say the "seed-stage" venture model is broken and even Angels are seed-averse.

Meanwhile, here in Tennessee the new TNInvestco funds have been encouraged to include seed investments in their portfolio mix; and, hundreds, if not thousands of Tennessee entrepreneurs are spending much of their lives on-hold, waiting for decisions from Angels, VCs, and any friends and family they can still look straight in the eyes.

Enter RightSide Capital Management, a Bay Area fund that recently announced plans to do at least 100 seed-stage deals, annually, beginning in the second half of 2010.

According to a recent TechCrunch report, RightSide's principals say they can fix the broken seed-cap model, in part, by standardizing term sheets and legal requirements, by requiring entrepreneurs' to have financial skin in the game and automating the scoring of startups' proposals.

RightSide says termsheet design will be standardized and values will be determined by computer-driven analysis of an array of startup factors, including the management team's experience, stage-of-development of the company's product offering and other factors that can be weighted. The computer will then cough-up pre-money valuation and other proposal elements.

RightSide stresses they're looking for $10MM-$50MM exits, rather than the oft-cited $100 million exits sought by many VCs.

VNC asked for some Tennesseans' their views on RightSide's model. Some observers seem to think RightSide gambit is worth a shot.

Belmont University Entrepreneur Center chief Jeff Cornwall (at right) responded generally, "I think we will be seeing all kinds of

changes emerging within entrepreneurial financing. The market is in such disarray that it is ready for some old-fashioned creative destruction and disruptive innovations.”

Steve Curnutte (at left) a principal in Tortola Partners, seemed to see some merit to RightSide's thinking, saying, "The maturity of the Angel Investing process has revealed common problems, like fragile processes, expensive barriers for entry, and ‘scarcity thinking.’ The move by the guys from Stanford at [RightSide] seems to formalize what was informal and standardize what was common between most deals. Since many Angels will reveal privately that their wealth was created mostly out of luck in the first place, a system to remove the ‘intuition about deals’ they claim to have is at least as good as the old way. Probably better."

At Vanderbilt University, Owen Entrepreneurship Center Director Germain Böer (at right) told VNC he

thinks RightSide approach is "a neat idea," but has reservations about removing the element of personal interaction with entrepreneurs in the initial phases. Böer said he worries some that entrepreneurs may be driven by their sometime-ill-founded optimism to "game the system," in effect, feeding overblown projections into the computer, with little or not individual pressure-testing of data.

Still, said Böer, "If you're trying to make [seed investment] work sort of like the public markets work," then RightSide has an appealing model, but the validity won't be known for five to ten years. Böer noted that the model is at least a distant relative of what Founder Rachael Qualls is attempting with the Angel Capital Group here in Nashville. Contacted by VNC about the RightSide model, Qualls was positive and said her group has, in fact, been in touch with RightSide, although she asked to defer providing details on those talks.

Pharos Capital Group Partner Jim Phillips (at left) agreed about the risk of gaming: "While in early stage investing (VC or Angel) there is justification for a diversification of your bets, it is hard for me to imagine where Rightside could be a contributor in any real regard to their portfolio interests. There will be plenty of ways to game a formulaic system," Phillips continued, "and would you want to invest in a fund that says we are going to do a max of two weeks due diligence on the entire portfolio. There have been many unsuccessful incubators that spread their bets over a good number of holdings. The overhead of tracking that many small investments would also be problematic. While supportive of getting more dollars for seed stage companies, this model seems a tough row to hoe."

Innova Memphis President and Innova Fund Partner Ken Woody (at right), based in Memphis, told VNC, "I certainly agree that the

standard VC model of investing does not work well for early-stage investing. Waiting for revenue and proven operational efficiencies before funding means most companies will never get out of the gate. I am skeptical of a model that lets a computer determine valuations and investment amounts, particularly without serious due diligence efforts into intellectual property merits, market competition, barriers to entry for others, scaleability and regulatory concerns, just to name a few."

Woody explained, "I would lean towards developing a simplistic model that invests only what is needed to determine if 'proof of concept' viability, then launch with support of backers. Simple term sheets, clear milestones, and promises of future investment mean more to an entrepreneur than a shotgun approach of throwing some money at them. One of the key items that appears to be lacking is management advice. Most startups are seeking wise counsel and great connections in their sector as much as they are initial capital."

Solidus Partner Vic Gatto (at left) noted, as previously reported by VNC, that his company is considering creating a microcapital fund, and will be announcing details later this quarter. He declined further comment at this time. He recently mention during a panel discussion that Solidus may put $250,000 or so in a fund to make a number of small, diverse investments.

Tom Rogers (at right), former head of Tech2020 and now in the Oak Ridge National Laboratory partnerships

directorate, responded, saying: "I’m a big fan of innovative new ideas to address the challenges of seed and early stage funding. It’s just too hard to get the funding needed to bring new ideas to the market. There are some elements of the described model which appear promising to me: reasonably quick decisions, standard legal documents, an appetite for more modest exits, etc. I’m personally not optimistic about so much reliance on computers in what I believe is fundamentally a people business, but it will be interesting to watch how this proposed new model performs."

Meanwhile, Bruce Lynksey (at right) a Böer colleague at Vanderbilt and himself a Boston-based entrepreneur, commends

RightSide, but is less excited. Lynskey told VNC, "Any new sources available for true seed-stage start-ups is only goodness."

However, Lynskey said that if RightSide is only going to invest "a few hundred thousand to get to a prototype stage," that won't be meaningful for "complex, sophisticated science-technology plays rich in new [intellectual property]" and struggling to get to prototype stage. Such companies, he said, must have $500,000 to $2 million to move "serious" startup concepts along. He said such funds as Founder Collective, .406 Ventures and Kepha Partners as willing to invest at those higher average levels.

Lynskey, also, is wary of the lack of intense personal interaction between the RightSide fund managers and entrepreneurs, explaining, "The fund managers have to have a deep grasp of the portfolio start-up team, market opportunity," and other factors.

Entrepreneur and former IBM technology executive Dave Chapman (at left), who is based the Boston area, but often conducts business in Nashville for his Northpoint Group, told VNC he thinks the RightSide approach is timely, in that his analysis indicates most venture-backed companies have demonstrated little in the way of disruptive innovative capability in the past few years.

Years ago, Chapman's designed software to help investors ascertain, among other things, whether or not startup management teams had adequate experience, and where skill gaps existed.

That software became the first of a suite of interrelated products offered by Northpoint, which Chapman founded. ♦