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Startups Chase Cash As Funds Trickle Back

Startups Chase Cash As Funds Trickle BackStarting a new business is easier than it was a year ago, but wealthy investors, venture-capital firms and banks are still trickling out money very selectively.

Bryan Cooley started Langlearner, an online language-learning tool, in October with $330,000 in startup money, including $200,000 of his own cash and the rest from a partner. He has talked to several groups of angel investors. From small ones that typically put small amounts into very young companies but remains in limbo.

“They want a sure bet,” says the 32-year-old Mr. Cooley, who worked at a defense-consulting concern before starting his company in St. Louis. “We’re caught in the situation where we need the money to become profitable, but they want to see profitability.”?

Small businesses under the age of three are as much as 50% less likely to get a loan or line of credit than more established businesses that are similar in other respects, according to a recent survey of small-business credit conditions, which was undertaken to gauge the impact of the recession by the National Federation of Independent Business.

“They always have more trouble than mature businesses,” says William Dennis, a senior research fellow with the federation. “But that’s pretty high.”

Another problem is that about 84% of startup businesses are typically funded in the early phases. Funding is by using savings from company founders. Such funding is along with support from family members, friends and credit-card and home-equity loans. This according to an analysis by Paul Reynolds, a professor of entrepreneurship at George Mason University, in 2008.

But now, many of those avenues have been cut off by the battered values of homes, retirement accounts, and other assets? In the 2009 fourth quarter, the share of home refinancings in which the owner cashed out equity was 27%. This is the lowest level since at least 1985, according to Freddie Mac.

John Nettesheim, a San Francisco resident, has been trying to open an 890-square-foot neighborhood wine bar called InnerFog for the past year. “I wasn’t about to borrow money,” he says, citing tight credit conditions. Instead, he’s had to rely primarily on his savings. Constraints on financing startups hurt the economy both short and long-term.

On average, about a half-million new businesses are born each year, creating about 3.3 million jobs annually, according to Ron Jarmin, the chief economist for the Census Bureau, who co-wrote a recent study on job creation by big and small employers.

While most startups fail within a few years, he says, the survivors add jobs much more quickly than older businesses.
The startup rate, or share of U.S. businesses that are new businesses, was 9.1% in 2008, the latest data available. This can be compared with an average of 10.4% between 1997 and 2007, according to the Census Bureau. “There are fewer new businesses opening,” Mr. Jarmin says. “This clearly has an impact on the economy’s ability to recover and generate new jobs.”

Startup money is rarely easy to come by. However, as investors heal from the financial crisis, they’re even more likely to be skittish about putting money into new companies with untested ideas. As a result, some investors are moving more slowly, while others are choosing to nurse along firms in which they already have a stake.

The St. Louis Arch Angels, a small angel investor group in the St. Louis Area, invested a total of $1.2 million last year in one new company and five companies the group had already invested in.

The year before they had invested $2.5 million in three new companies and six follow-on investments.
“If I’ve already put money in a company and that company is hitting its milestones and then you present me with a new company that needs money, the answer is I’m doing the old company because I already have money in that deal,” says Gilbert Bickel, chairman of the group?

Banks say that capital for startups remains tighter than usual. Greg Becker, president of Silicon Valley Bank, which lends to new-technology and life-science ventures and wineries, says access to capital is much better than last year, but it may take another 12 to 18 months before conditions are back to normal.

Meanwhile, venture capitalists say financing has improved markedly in recent months. But Ryan Howard says he couldn’t raise venture capital for an online medical-records startup that he founded in 2007? Because he hadn’t run a startup before. To start his company, Practice Fusion Inc., he sold his house. and then, the next year, his BMW.
By early last year, the company was attracting customers, but it was running out of cash, says Mr. Howard, 34 years old. Touting the company’s growth, he finally raised $750,000 from several angel investors last April and another chunk of money from Internet software company Inc. in June.

All that finally got the attention of venture capitalists. In December, as the economy improved and some venture capitalists began loosening their purse strings again, Practice Fusion closed on $5 million from Morgenthaler Ventures.

Raising venture capital “was the hardest thing I’ve ever done,” says Mr. Howard. “If you’re a first-time entrepreneur, you just won’t get venture funding unless you have a product or customers.”

By Conor Dougherty and Pui-Wing Tam

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