Editor’s note: Over the past two decades, Durham’s entrepreneurial community has flourished as new and rebuilt infrastructure combined with the city’s talent and rich culture ignited a spark that turned into a flame. But a persistent lack of funding – the oxygen for startups – remains hard to find and thus is a limiting factor on further growth. In 2012, for example, venture funding statewide plunged. Quarterly production of $15 million, $41 million, $54 million and $86 million across a mere 37 deals a year ago was documented by PricewaterhouseCoopers MoneyTree , leaving North Carolina short of $200 million. That’s a long, long away from the Top 10 national ranking years of previous years. Dow Jones reported $192 million in deals, just over half the 2011 total of $392 million.

How tight has the VC market gotten? At its peak, North Carolina generated $1.8 billion in venture deals in 2000.

In this the 10th day of our “New Bull City” series, WRALTechWire’s Jason Parker examines the challenges of the funding shortage.

DURHAM, N.C. – If technology and life science startups in Durham as well as the Triangle had to rely solely on venture capital funding for funding – the oxygen, the life blood of new and emerging businesses – then the “New Bull City” would not be what it has become in 2013.

Since the “dot com” boon and bust from 1996 to 2002, venture funding has become more scarce, leaving a lot of entrepreneurs gasping for breath and cash. But a number of new and different sources of funding as well as the birth of startup accelerators, the recent phenomenon of crowdsource funding, grants, startup-focused loans and angel investors who survived the 2008 recession have given a needed transfusion of capital.

An example is Square 1 Bank, which chose Durham as its headquarters for a national network of branches focused on venture capital-related industry in 2005.

In fact, Square 1 Bank is itself a startup, according to co-founder and senior vice president of venture banking Peter Meath.

“We’re entrepreneurial in nature,” said Meath, “we started a venture bank from scratch, which had never been done before.”

Meade, who runs the southeast and mid-atlantic regions for Square 1 Bank, compares the story of the bank’s formulation to the emerging story of Durham.

“We’re underdogs,” said Meath, “We were the little guy who was trying to make a splash.” The co-founders (there were seven) felt “a huge untapped potential.”

“We wanted our headquarters to mirror the community in which we were based,” said Meath, “and the community we chose – Durham – was gritty, scrappy, and also an underdog.”

The venture bank is just one financial firm to call Durham home. Durham also houses investment groups Hatteras Venture Partners, Intersouth Partners, IDEAS Fund Partners, the SJF Fund, and Pappas Ventures. Each group has moved into their headquarters location in downtown Durham in the last decade.

The reason for the change?

“There were barely any startups in downtown Durham seven years ago,” said Zack Mansfield, vice president at Square 1 Bank. Mansfield also runs the Square Roots program, a division of Square 1 Bank that assists early-stage entrepreneurs by facilitating connections within specific regions – Boston, New York City, Washington, DC and the Triangle.

“Now, when you look around, there are dozens and dozens of companies,” said Mansfield. More than 270, according to CED’s TriangulateNC, which maps current life science and technology firms across the Triangle.

“Overall, the natural resources that this market has have been relatively consistent since I’ve started working here in 2004,” said Mansfield, mentioning the quality of the local universities, the overall quality of life, and the region’s temperate climate.

“The capital piece has become a bit more constrained,” explained Mansfield, “there are bigger, more established firms who have been active historically, who have not been extremely active lately.”

“This is especially true on the tech side,” said Mansfield, as the current trends and deals that are getting made in venture capital markets these days are in SaaS environments, which hasn’t always been the strength of the Triangle.

If this is true, then where are the current funding opportunities for early- and growth-stage startups? How has the funding environment changed – shrunk – despite the growth of the entrepreneurial economy of downtown Durham?

Venture Capital: In A Down Cycle?

“Venture capital is a cyclical business,” said Eric Linsley, general partner at Pappas Ventures, a Durham-based venture fund that focuses solely on life sciences, and on therapeutic companies, specifically. “And unfortunately, it has become even more cyclical since the tech boom [of the late 90’s].”

Fact is, said Linsley, “right now, we’re in a down cycle.” It’s the worst since the early 90s, according to Linsley, “and there’s no clear indication that we’re coming out of it.”

A few things contribute to this current funding environment, said Linsley, stressing that Pappas only focuses on the life sciences.

First, there have been major changes to regulatory issues and how science is conducted. “Investors have wanted to see how these new systems work,” said Linsley, especially “before they want to make bets.”

Second, in the past decade, companies in the life sciences “just haven’t performed well,” explained Linsley.

The contraction of venture capital is not news – there’s been ample discussion of the Series A crunch in this publication and across the technology and entrepreneurship blogosphere for quite some time.

“In 2000, and you were a serial entrepreneur who wanted to start a company,” said Clay Thorp, general partner at Hatteras Venture Partners, “there were six or eight really good funding options you could pursue.”

“There were a good number more options in those days,” said Thorp, who built Novalon Pharmaceutical Corporation in the late 90s and sold the company in 2000 to KaroBio AB, a Swedish company, for a deal worth $105 million. “There were upwards of two or three times as many,” said Thorp.

Hatteras Venture Partners and Pappas Ventures focus specifically on the life sciences. Intersouth Partners carries two types of portfolio companies – life sciences and technology.

Intersouth, whose portfolio includes OpenSite, Overture Networks, SciQuest, Sphinx Pharmaceuticals and SmartPath, remains committed to Durham as well as the southeast. Partner Jimmy Rosen says that Durham stands out among its Southern peers in offering that collision culture.

“The first 15 years I was here, the Durham revitalization came in fits and starts but it never caught fire,” Rosen said. “In the last decade, it has.”

Intersouth, started in 1985, claims to be the largest venture capital fund in North Carolina, with more than $780 million invested.

Intersouth still invests, as do Hatteras and Pappas. A number of venture groups based in Durham that used to invest no longer do so. This includes Aurora Funds, which no longer actively invests, and The Wakefield Group, Thorp noted. Aurora and Wakefield continue to support existing portfolio nfirms.

Despite “a bit of resurgence in the past few years,” said Thorp, referring to new venture funds Rex Health Ventures and the new Bull City Ventures, “but its not nearly enough – not enough to support a robust innovation economy.”

There are alternative funding sources, including NC IDEA, which provide non-dilutive grant money up to $50,000 in qualifying early-stage companies, as well as incubator and accelerator programs, including the Cherokee Challenge, Groundwork Labs, and Triangle Startup Factory. Yet, this funding is limited, and must be supplemented by additional funding. (NC IDEA is a sister firm to IDEA Fund Partners.)

From what sources will this additional funding come? Who can step up to fill the early-stage funding gap?

Angel Funding: Increasing? How Rapidly?

On May 17, WRALTechWire published an article claiming that angel groups had declared an increasing interest in early-stage investment, and increasing rate of investment.

Two angel groups, RTP Capital, and Triangle Angel Partners, claimed that angel investment deals were increasing within the region and in consortium with angel groups in the southeast.

The underlying assumption was that more deals will be done in 2013 than were done in 2012. The Southeastern region – which includes Arkansas, the Carolinas Florida, Georgia, Kentucky, Louisiana, Mississippi, Tennessee, Virginia and West Virginia, – still only accounts for 12 percent of the overall angel deals, according to data from the Angel Resource Institute.

In contrast, California accounts for 21%, New England accounts for 14.6 percent and New York accounts for 6.6 percent.

“There has been a decrease in venture activity,” said Michael Dial, a panelist at CED’s Angel Workshop on May 15, which is why it is so vital that angel groups continue to show an increased interest in investing in early-stage companies.

Angel funding has changed since the 1990s, and angel groups have changed as well, said Andy Schwab, president of First Flight Venture Center and co-founder of RTP Capital, one of the established angel groups in the Triangle.

For example, funds in the 90s were often $4-5 million, whereas they are typically $2 million now, said Schwab. Despite lower fund amounts, interest in angel investing and in deal syndication is rising, said Schwab.

“The Angel Capital Association has grown in value and in stature,” said Schwab, which helps increase the pool of potential investors and disseminates information to potential angels. In addition, “angel groups in the southeast are syndicating,” said Schwab, noting participation from all Triangle-angel groups on bi-monthly conference calls with other southeastern angel groups to discuss deals.

This comes after a rough period in angel investment, which lasted from 2005 to 2010, said Schwab.

The first active angel fund in the Triangle region was the Tri-State Investment Group, or TIG, which operated in the mid-90s through the internet bubble and subsequent crash in 2001, according to local angel investor Bill Spruill.

“TIG was a group of local business people, executives, etc., that banded together to complete deals,” said Spruill, which resulted in three or four funds together.

“After TIG went away, there was a brief period where there was not a whole lot of angel activity,” said Spruill. Briefly, there were groups and funds started by Atlantis Partners and True Pilot Ventures, but those faded.

In 2005, “investors were ducking for cover,” said Schwab, but now, “I see us getting to critical mass.”

Furthermore, said Schwab, angel groups are “starting to fill the gap that venture capital used to provide.” This gap is the Series A funding required to quickly scale a business, and is often the first $1-3 million, said Schwab.

That doesn’t mean that everything is perfect, said Schwab, “we still have a funding gap for early-stage entrepreneurs.” The market is changing, and funding models are changing as well, said Schwab. “We’re going to need to figure out how to involve private equity companies,” said Schwab, “as well as attract non-traditional funding sources.”

Angels Key to Future

The growth of Durham’s entrepreneurial economy will result from angel investors, said Jeff Clark, managing partner at Aurora Funds, which no longer actively invests, “not from venture capital.”

“It’s always been a one-hundred to one ratio of angel deals to venture deals,” said Clark, “and that ratio is getting higher.” Importantly, said Clark, this is exactly how the ecosystem should grow. The companies and deals in the Triangle don’t require venture capital in order to succeed, said Clark.

“There’s a handful of high-flying deals that have received venture investment,” said Clark, “but these are the exception rather than the rule.”

Clark alluded to sets of angel investors who “are the real force in the community.”

“Angels are great for businesses that get to cash-flow positive relatively quick,” said Clark, “and that’s where Durham is right now.”

Schwab and Clark would almost certainly agree with Chris Heivly’s take on the angel environment – there could be more. Heivly, who strongly believes that great companies will always receive the funding they need to grow, does concede that early-stage funding is often hard to come by. That’s where angel financing comes in, said Heivly.

There needs to be a broader base of early-stage seed capital, ranging from $100,000 to $300,000, said Heivly. And this broader base of funding must come from outside of the technology industry, said Heivly.

“It needs to be from non-tech people,” said Heivly, “it has to be, if we are going to broaden the base of Durham’s entrepreneurial pyramid.”