The South’s Competitive Advantage and the Support of Angels: An Interview with Ramon DeGennaro

Ramon DeGennaro is the Haslam College of Business Professor in Banking and Finance at the University of Tennessee – Knoxville. He has served as a visiting scholar at the Federal Reserve Bank of Atlanta, as the DeGennaroUT[1]Tennessee Bankers Association Scholar and as a William B. Stokely Scholar at the University of Tennessee. He was also a visiting scholar at the Federal Reserve Bank of Cleveland, and is the author of “How the Stock Market Works,” produced by the Great Courses. His current research involves financial markets, small-firm finance, investments and prediction markets. Professor DeGennaro is also a Luminary Member of the Angel Capital Group, which has an office in Knoxville. He holds a Ph.D. in finance from Ohio State University.

Key Takeaways:

  • The Southeast’s business-friendly climate makes it easier to do business in the region than elsewhere in the country. Despite this, the Southeast still lacks large amounts of organized capital.
  • In order to receive funding from angel investors, entrepreneurs must be willing to accept coaching, have a proven track record of success and outline a clear exit strategy for investors.
  • There are real advantages to being financed by angel groups, but that doesn’t necessarily mean angel groups are the sole source of a company’s success.
  • With the political uncertainty surrounding the 2016 presidential election, investors will likely be more hesitant to invest in the coming year or two.
  • In the near future, evolving technologies will likely alleviate geographical shortages and surpluses in capital.

Q. How available is capital to middle market companies in the Southeast? Is it becoming more available or less available? Why?

A.  Capital levels are going to fluctuate. There are going to be good years and bad years, but it’s looking much better than in years past. That can be partially attributed to the fact that business regulations are much more favorable in the Southeast and we have more right-to-work states and lower taxes. Our region has gotten wealthier relative to other parts of the country, which translates into wealthier people with more money to invest, and that ultimately means more funding for businesses.

According to Eric Dobson, CEO of the Angel Capital Group, the South lacks large amounts of organized capital despite this wealth. Instead, we have highly locally-focused angel groups and one or two loosely organized syndicates. These angel groups tend to provide seed funding to startups and don’t interact as much with middle market companies.

In terms of the levels of investment capital available in the Southeast, it is more difficult to find funding in the $1.5 million to $5 million range. We also don’t have the large venture capital funds you have in other parts of the country, such as Boston and Silicon Valley.

Q. You’ve researched angel investments in depth and are involved with the Angel Capital Group. What are angel investors looking for? What can startups do to attract angel investors?

A. To make your startup attractive to angel investors, entrepreneurs need to have skin in the game. Angels are unlikely to invest in your business if you haven’t invested your own money in it. Angel investors understand incentives, and if making a fortune or losing everything depends on how hard you work, then you tend to say more focused. Sink or swim is a very powerful motivator.

They’re also looking for entrepreneurs with a proven track record of success in other endeavors. A company trying to get a $1 million raise is going to do much better if the owners were successful raising smaller amounts and demonstrated they’ll use the money well.

Entrepreneurs, particularly in the startup phase, must also be willing to take coaching. This can be a huge hurdle, as people who are successful tend to think they know best, and that can be a problem. Collectively, angels have vast experience and strong networks of business partners. I don’t care how good you are as an entrepreneur, you can’t possibly have the same kind of network as an angel group. Entrepreneurs need to be willing to listen to these people. If an angel investor suggests delegating a project to someone else and the entrepreneur refuses, it presents a red flag for the investors.

Angel investors also want to see the light at the end of the tunnel – a clear path to the exit. They’re not interested in tying up their money in a company for longer than about three years. They want to get in, provide funding, get out and then move on to the next company – that’s just how the model works.

Q. Are we seeing more angel investors in the Southeast than in other regions?

A. It’s hard to say in absolute numbers, because you’re going to have more in Silicon Valley and Boston than here. On a percentage basis, however, the number of angel investors in the Southeast is growing pretty well. The South’s growth rate is pretty competitive when compared with other parts of the country.

Q. How does having angel funding in the early stages of a company impact its potential to grow into a middle market company?

A. It’s an important factor, but you have to be careful when attributing causality to that. Is a company more successful because it had angel funding in the beginning or was it going to be successful anyway? Getting funding and advice from angel investors can certainly help any company, but at the same time, companies that received funding were probably better companies to begin with.

Q. What are the current roadblocks to supporting an even stronger deal environment in the region?

A. We live in an increasingly restricted business environment. Starting a business now involves far more paperwork than 30 or 40 years ago, and nearly all of that paperwork serves little to no economic purpose. It’s just jumping through legal and regulatory hoops. It’s increasingly difficult to legally start a business.

The Economic Freedom of the World Index, which measures how free a society is to conduct business, states:

“The United States, once considered a bastion of economic freedom, now ranks 16th in the world with a score of 7.73. Due to a weakening rule of law, increasing regulation, and the ramifications of wars on terrorism and drugs, the United States has seen its economic freedom score plummet in recent years, compared to 2000 when it ranked second globally.”

It’s just getting harder and harder to do business in the United States, but it isn’t as bad in the Southeast as it is elsewhere in the country. Georgia and the five states bordering it rank very well within the U.S., according to research by the Mercatus Center at George Mason University. Of these six states, North Carolina is the least free, and it’s still in the top half of the country at number 24. Tennessee is the best of the group at third, behind only North and South Dakota. This is a big plus for the region. It’s easier to do business in the Southeast.

Q. What can local governments in the Southeast do to support entrepreneurship and also support high-growth startups as they grow into middle market companies?

A. The real issue here is not a lack of support for entrepreneurship and business from the local government. It’s getting the federal government out of the way. The academic evidence is very clear on this – governments are terrible at picking winners when it comes to individual companies and industry sectors. They can’t do it. There’s example after example of the government taking taxpayer money and funneling it to preferred clients. This takes real resources away from small companies that are growing and puts it into legacy industries. Job growth in the United States isn’t going to come from those large companies, either. Job growth comes from small and mid-sized companies. Instead of handing out subsidies, the federal government should eliminate the regulations that make it difficult to start a business in the first place.

Q. What are your expectations regarding investment in the Southeast in the coming years? Are there any trends you foresee based on your research and expertise?

A. Over the next year or so, companies are going to be very hesitant to invest. We don’t know what’s going to happen with the presidential election in November 2016. Political uncertainty can scare people. We don’t know what the rules will be, and if you don’t know what the rules will be, you’re reluctant to commit capital.

The uncertainty that large and small businesses face right now is pretty high. It’s nothing like 2007 and 2008, but a lot of things are different and we don’t know where we’re going in the next year. People are going to say, “Let’s wait a year and find out.”

Q. What do you notice about capital coming from outside the region?

A. Crowdfunding money can come from anywhere and it can go anywhere. We’re getting more and more of that at the angel level now, too. We’re seeing the same phenomenon we saw with home mortgages a couple decades ago. When my parents took out a mortgage, they went to the local bank, got the money and then paid that bank back. That’s not how it happens anymore. Now, a bank gives you the money, and then turns around and sells the mortgage. Who knows where that money ends up?

Crowdfunding is not necessarily bad. The diversification and the liquidity it offers are good for our region. In four years or eight years, it won’t matter if the Southeast is tapped out of capital to invest in businesses. Entrepreneurs will be able to pitch to folks from all across the nation. Geographical shortages and surpluses will be alleviated by technology and the networks that are evolving.

At the same time, it would not be a good if this transcendence of geographical boundaries results in a surplus of capital in the South. When there’s too much money chasing too few deals, we start seeing inflated valuations. That’s great for companies being funded, but also means that you’re funding projects that probably shouldn’t be funded. That’s when resources go to the wrong place. But, I believe that in the world we’re evolving into, money is more available for good deals and doesn’t have to chase bad deals.

Brought to you by the team at FourBridges.

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