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Don’t call them venture capitalists. Or even angel investors. But make no mistake: Dan Keelan and Patrick Drew have cold, hard cash to lend to promising startups.
The two veteran entrepreneurs have launched an Austin-based investment firm that provides capital in exchange for a share of revenue rather than the typical equity stake in companies.
Keelan’s and Drew’s Next Step Capital Partners will invest up to $500,000 in Texas-based companies. The duo won’t say exactly how much capital is at their fingertips, but they’re clear about the fact that they’re using a revenue-sharing arrangement designed to give entrepreneurs capital without giving up ownership. The nascent venture, which is neither a venture capital firm nor an angel investor group, plans to make less risky investments that yield solid returns instead of the high risk and high returns generated with the conventional VC approach, Keelan said.
“The prime thinking behind the philosophy is, if the [portfolio] company is successful, it’s enabled by our investment — but not because of our investment,” he said.
Next Step Capital’s investment model may be a welcome option to Austin’s startup community that has raised funds mostly through angel investors or VC firms, both of which demand equity in their portfolio companies. Those stakes can be significant in Austin, where there’s less competition among VC firms than in other parts of the nation.
During 2010, Central Texas companies received $350.8 million in venture capital versus $214.6 million during 2009, according to Dow Jones VentureSource. Meanwhile, the Central Texas Angel Network, which invested $5.7 million in 15 companies last year, has more than quintupled its investing during the last two years.
Next Step Capital’s formation highlights a trend in which investors are realizing the value of backing early-stage companies. The dynamic is benefiting Austin’s startup environment, CTAN Chairman Jamie Rhodes said, adding: “It’s great to have a real variety of funding sources and deal types for entrepreneurs to choose from.”
Next Step Capital, which is funded by Drew and Keelan, has already invested an undisclosed amount in Hellfire Games Inc., an Austin-based company that employs five workers. They expect their firm to invest in 10 to 15 companies across several sectors during the next 18 months to prove their model. If it’s successful, Next Step would then consider raising an investment fund from limited partners.
Drew and Keelan, former colleagues at Dallas-based i2 Technologies Inc., had previously teamed on three angel investment deals and struck upon the revenue-sharing approach last year. They both have experience running or starting fast-growing companies.
Since Next Step Capital doesn’t require an equity stake in a portfolio company, the need for an agreement on a company’s valuation is eliminated and the firm doesn’t require a board seat.
Gaming industry experts have likened the revenue-sharing strategy to the moviemaking industry, in which investors back individual projects rather than entire studios.
In early 2009, Alan Kane, a former gaming executive and now the chief operating officer and chief financial officer of Austin-based Phunware Inc., launched a game-industry-focused investment firm called Archangel Ventures with a model similar to Next Step Capital’s. At the time, the firm was raising $12 million to $15 million and considering investments ranging from $250,000 to $500,000 each, Kane said.
Archangel has invested its fund, but it’s too early to talk about how its portfolio companies are faring, Kane said this week.
Hellfire Games was founded in 2008 as HardCore Software Inc. Last year, the company needed capital to hire the contractors to produce Novus Prime, a space combat game that launched in December 2010 for the Sony Playstation, said Gavino Morin, Hellfire Games’ vice president of business and legal affairs.
But the amount needed, which he declined to disclose, fell into the proverbial “capital gap” that exists between angel investors and VC firms. Next Step Capital filled the gap without requiring Hellfire founders to forfeit any ownership, Morin said.
“That was huge,” he said. “If you give up equity, as you grow you’re giving up more and more to the investors.”
Keelan and Drew said their firm has an investment horizon of one to three years. Although the investment model defies conventional categories, Drew said it will provide startups with an option other than venture capital and angel investing.
“I think it’s an alternative to either one of those,” he said. “We’re not VC, but maybe we’re a good step before VC.”