While much of the media reporting has focused on the financial difficulties of major industries/companies such as financial institutions and autos, the recent financial environment has been particularly challenging for early to mid stage companies.

Even before the downturn of the last 9-12 months, capital availability was becoming more of an issue for these companies. The consolidation of the venture capital community led to substantial increases in the minimum size investment considered by many VC firms, often reaching $5-10 million. At the same tine the financial capability of high net worth angels and/or angel groups typically limited their ability to provide more than $1 million for an individual funding. The resulting “gap” in funding availability has been particularly troubling for companies that are frequently the most attractive investment prospects – those seeking $1-5 million in growth capital to roll out or expand already proven product and service concepts.

As the financial environment has worsened, traditional sources of limited partner capital for VC firms such as pension funds and university endowments have reduced their allocations to risk capital categories. This has further accelerated VC community consolidation, and caused VC firms to focus more on existing portfolio companies rather than new investments. Stock market losses have had a similar effect on individual angel investors, who have pulled back their participation in early stage investing. The combination has contributed significantly to further reduce the availability of traditional sources of capital for early to mid stage companies.

While some traditional funding continues to be available in the gap range, we have been advising our clients to also focus on strategic affiliations as sources of growth capital. Larger corporations are not expected to play the role of a multi-industry VC investor, but facing their own financial challenges, have become more receptive to affiliations that could combine a strategic business purpose with providing growth capital.

Examples could include expansion of customer/supplier working capital considerations, joint marketing or product development, licensing and other forms of strategic relationships, potentially coupled with direct minority investment. Clearly companies where there are existing relationships are the most likely targets, but properly crafted, an approach that coupled the prospect of a strategic relationship with an investment opportunity could be a new business initiative as well. In either case, a careful review of all the implications of these types of discussions, and a well crafted and targeted business and financial rationale are key.

The first step is thinking out of the box to expand financing options beyond traditional VC and angel capital sources. The current market challenges place a priority on that approach, and strategic affiliations are becoming a more viable alternative.