Last month, Los Angeles-based Watertower Group (www.watertowergroup.com) announced a new venture fund focused on $500K to $1M deals in the technology and digital media sector. The firm is geography agnostic, and invests in not just Southern California but any U.S. company. To get a better idea of the goals of the fund, and how it hopes to fill the funding gap between angel and venture capital investment, we spoke with Managing Partner Derek Norton.
Derek, tell us a little bit about the goal of your fund and target investments? Derek Norton: The idea is that there are many companies who don't need to raise more than a million dollars. These companies can be in-between institutional funding, in advance of first institutional funding, or might need $100K to $1M to prove an initiative and move a company forward to the position of raising Tier 1, institutional financing. We see so many promising entrepreneurs, who are not perfectly positioned for the venture community--perhaps because they just haven't proved enough, because they're a youner entrepreneur, or need that kind of capital and resources to help them build the business, and prepare to raise Tier 1 venture.
It sounds like you're really focused on getting your companies to the next round?
Derek Norton: Absolutely. In order to protect our capital that we invest in companies, we're doing what we've been doing for six years, which is managing fundraising on their behalf. We'll make sure the proper material is created, the road show managed, and that they get the proper meetings with the highest and most likely investors. What we found over the years, is that management teams are not particularly good at raising capital. They are good at building businesses, applications, and services. But, when it comes to capital raising, it's a distraction, and it's not a core skill set. Working with someone that has a set of relationships, understand the marketplace, and how to position a company so that they can go out and be effective with their time, energy, and resources is a big benefit to entrepreneurs out there. That's certainly been proven over the six years we've been assisting companies doing that.
What's the background on Watertower, and why did you decide to start the fund?
Derek Norton: Having assisted portfolio companies in raising capital, we were seeing first hand how difficult that process is, and that management could really benefit from our platform, our relationships, and skill sets in raising capital. The model we've always employed is a retained and success-based model. Success was a blend of cash and equity. The reason we went for a fund is two-fold. One, it was to increase our equity positions in companies we either directly invest in and work with, and two, we just saw a void in the marketplace for this size of capital and focused on our specific markets.
Talk about the markets you are focused on?
Derek Norton: We're investing in technology companies that are touching or impacting music, digital media, and consumer internet.
Have you made any investments out of the fund yet?
Derek Norton: We have made three investments. One was made in advance of the announcement of the fund, LX Networks, which was just acquired by NBC. The other two have not been made public yet. We have three more deals in the pipe.
The response from entrepreneurs has been overwhelming, in a sense. People have found us, but we've seen a continual opportunity in the marketplace for companies who don't need a lot of capital. Those companies don't need to raise a $3-5 million Series A venture round--it's too much capital for the company. Or, the company is just at a stage where they need a little capital to prove a significant milestone before Tier 1 venture, before raising that $3 to $5M.
It seems that companies aren't needing as much capital nowadays to start?
Derek Norton: Yes, that's the genesis behind the fund. Frankly, there are companies that don't need to raise that much capital, an investment of $1M or $500K can put them in profitable territory.
Is that particularly true in the New Media and Internet area?
Derek Norton: The barriers to creating a company have been lowered. The ability to outsource servers and high cost infrastructure has enabled entrepreneurs to get creative, and build businesses -- not just products -- with much less capital than was required five or six years ago. We're seeing that trend happen across a number of areas, not just in digital media, but in the consumer internet as well as some technology companies.
You've been plugged into this market for awhile, and it seems we may be finally seeing a convergence between the media and Internet industry. What are your thoughts on this area?
Derek Norton: We're certainly seeing that the novelty factor has worn off for consumers--the ability to access new media through broadband is the norm. And, it's not going to go backwards, the next few years it will grow in terms of adoption. The WGA strike has also been another help in fostering this among consumers--the idea that they can't get anything new on TV, has driven them to more broadband media experiences. I don't think they're going to go back after the strike, and I think those numbers will continue to grow. It's an opportunity for investment, and a growth area. When I say effective, what I mean is that new technology offers a new means to reach consumers with advertising, that's measurable, and will be much more effective than in the past.
However, I think that the challenge moving forward in this sector -- by which I mean consumer Internet-type businesses focused on digital media -- is that we have an overabundance of venture backed companies. Many of them are chasing the same consumers, with a similar, or nearly identical product. Their business models don't account for the number of advertisers out there, and I think too many people think that ad dollars are infinite, when in fact they're very finite. I think we'll see some people evaluating the effectiveness and CPMs they are paying on certain sites. I see a little bit of a challenge over the next 18-24 months, and that some attrition will happen, through a weeding out process, and the me-too companies will go away.