There’s a lot of money out there. Some of it has made its way to North Carolina.
The past 12 months has seen Durham-based Humacyte go public via a special purpose acquisition company at a valuation of $1.1 billion. Charlotte’s AvidXchange raised $660 million in an IPO last summer with an initial valuation of about $5 billion. Raleigh software company Pendo landed $150 million in capital. Pendo has now raised $356 million since forming in 2013 and is valued at $2.6 billion.
Then there was the July announcement by SAS Institute co-founder and CEO Jim Goodnight that the company is planning to go public by 2024 in a transaction that could value it as high as $20 billion.
Capital begets capital. The challenge for the state is to recycle some of that cash into new companies and new investment vehicles, laying the foundation for the kind of “virtuous circle” that has underwritten the growth of California’s Silicon Valley and Austin, Texas. These large liquidity events are a good place to start. “Are these billion dollar plus exits good for capital formation and reinvesting in the ecosystem? The answer is absolutely yes,” says Hunter Young, head of capital at the Council for Entrepreneurial Development in Durham.
“The flywheel is in motion and gaining momentum,” adds David Jones, co-founder and general partner at Bull City Venture Partners in Durham. “We’re definitely seeing more and more people who want to invest, more angels coming into deals, and more mid-level managers wanting to start something new.”
Something else that’s new is that West Coast and New York firms are coming to the state, further deepening the pool of available capital, Jones says.
All that sounds great, but one well-known N.C. investor begs to differ when it comes to early-stage companies. David Gardner, who started Durham-based Cofounders Capital in 2015 and is among the state’s most active angel investors, says, “These big exits have no bearing at all on early-stage capital in the state.” The reason is simple: The larger pools of capital can’t be invested efficiently in small startups. “The funds are so big they can’t write small checks.”
The math is pretty straightforward. A typical VC can manage 15 to 20 portfolio companies per fund. “Once a fund approaches $100 million, it’s impossible to deploy any money into early-stage startups,” says Gardner. At the same time, smaller investors, who are the traditional sources of seed capital, are being squeezed as the funds lift minimum capital commitment requirements in order to attract more dollars.
Angels and LPs
It’s been a good period for raising money in North Carolina, to be sure. Total funding hit a record $3.4 billion in 2020 and was on track to possibly top $4 billion in 2021 with a 10% increase in the number of companies funded, according to the CED. (PitchBook puts the 2021 number at $3.6 billion, flat with the year before, and 328 deals.) However, more than half of the 2020 funding went to a single company: Cary-based Epic Games, which attracted $1.8 billion. It gathered another $1 billion last year, putting its valuation at $28 billion.
Like Epic, more highly touted private companies are putting off IPOs as capital remains available, enabling private-market investors to capture more of the upside. When it comes to attracting capital, “liquidity events help a lot,” says Gerald Cohen, chief economist at the Kenan Institute of Private Enterprise in Chapel Hill. There’s the money, of course, but there’s also the confirmation that you’re in a place where money can be made. Cohen calls it “home bias, where if locals have a liquidity event they are more likely to invest locally. You had success here, you know the area, you know the people. Take some of that money and put it where you live.”
CED’s Young says investors often tend to spread the money around. “They’re dabbling in everything from angel investing and club deals to coming into an existing fund as a [limited partner].”
Ted Zoller, who teaches entrepreneurship at UNC Chapel Hill, agrees that the impact of the new capital will be felt across the investing landscape, initially with new angel and “super angel” investors and limited partners and then, over time, larger funds. “The $50 million funds will become $250 million funds,” he says.
But larger funds also tend to migrate away from the early-stage segment of the market. That’s because of the economies of scale and the lower risks of more mature companies. “It’s not the later-stage companies that are a challenge,” says Art Pappas, managing partner at Pappas Capital in Durham. “It’s the early-stage.”
Lister Delgado is managing partner at Durham’s Idea Fund Partners, which typically invests in startups. He has been seeing increased interest in the firm’s funds among investors and entrepreneurs. “The significant thing is how the ecosystem is maturing,” he says. “These exits create more capital, but they also increase the demand for capital as the pool of people who are looking for money grows. The money comes into the system and feeds the system. It’s getting more and more momentum.”
Justin Wright-Eakes is a Durham native who worked in New York at Citibank and distressed debt fund Aurelius Capital before returning to North Carolina in 2015. He has a slightly different take. He launched Raleigh-based Oval Park Capital in 2018 to invest in early-stage technology and enterprise software companies, ultimately raising $20.5 million. But it wasn’t easy.
“We don’t see enough local angel investors willing to take venture risk at the earliest stages, which is what our ecosystem needs most,” Wright-Eakes says. “We often see groups of angels teaming up to write a small number of $3 million to $5 million checks to Series A or even later-stage companies. But we believe the ecosystem would be better served by angels investing more independently and writing a larger number of $50,000 to $100,000 checks to pre-seed companies.”
Of course money isn’t everything. “If you have good people, you can attract capital,” Pappas says. “I’d rather rely on new or existing entrepreneurs than on someone bringing in a pool of capital.”
Keeping talent in North Carolina has been an issue. “As far as people making money and staying in the state and creating further pools of capital, I think that’s been a bit of a disappointment in North Carolina,” Pappas adds. “It’s a short list of those who made a lot of money and who stayed to be entrepreneurs or to put that capital to work.”
Cofounders’ Gardner adds, “I had a list of everyone who made money on (IBM’s purchase of) Red Hat and I emailed them. The only response I got was from [former Red Hat CEO] Jim Whitehurst and he told me he was no longer living in the state or investing here.” Whitehurst became IBM president but resigned last year and is now a board member at Tanium, a Kirkland, Wash.-based cybersecurity company.
Delgado thinks that may be starting to change. “Fifteen or 20 years ago you didn’t have the number of (liquidity) events, and if entrepreneurs exited a company, you never heard from them again. Only a handful continued to invest. Now there are more role models, people who are exiting companies and then investing. We see lots of companies getting started because entrepreneurs fund them. It’s part of the evolution of the area.”
Another issue, says Jones, is that “we haven’t had a ton of companies that have gone from $15 to $20 million (in sales) to $100 million so the talent to do that had to be recruited from other cities. You need money and people, but people are the most important part.”
CED’s Young adds, “We have always seen the Duke, UNC, or N.C. State grad who moved away in their 20s, went to San Francisco or New York, and then came back home to start a company. More recently, we’re seeing folks with very little historical affinity for the area coming here — some of them CEO-founders and C-suite executives. Having those CTOs and CFOs locally helps.”
Entrepreneurial people like to talk with other entrepreneurial people, says the Kenan Institute’s Cohen. “Apple, Google moving here — all of that can create really positive network effects.”
Here again, liquidity events help. Several former Red Hat executives have become CEOs, and more have come out of companies like Bandwidth. Not all stayed in North Carolina, but some have.
“We’re just emerging to the unicorn level ($1 billion-plus valuations),” Zoller says. “We’re not quite San Diego or Seattle but we could easily become another Austin. We could be the next big hot spot not only for venture capital but also private equity,” for which the state’s historic strength in banking is an advantage.
The good news is that North Carolina is well positioned in many core technologies such as business-to-business software, biotech and genomics that are expected to grow massively. Epic Games is a bit of an outlier but is poised to compete with Apple and Meta in augmented and virtual reality, Zoller says.
Agriculture-related biotech is another important N.C. industry that is set for huge growth. Pappas Capital recently announced a new initiative to expand its presence in the sector as part of its specialized funds portfolio and has paired with SAS to provide analytics and data-science expertise to agtech startups.
Every last dollar may not stay in North Carolina, but that’s the beauty of working with a bigger pile — it doesn’t have to. “At the end of the day, if 20% of the wealth stays here, it’s great for the state,” says Pappas. ■