State Study Finds ‘Gazelle’ Firms Undercapitalized

In a finding that underscores the depth of entrepreneurship in Southern California but warns of serious roadblocks, a new state study concludes there is a $5.4-billion funding shortfall for fast-growth “gazelle” firms in Los Angeles and Orange counties.

California has 34,618 such companies, more than any other state and a third more than its nearest rival, New York, the study found. More than half those firms--16,854--are in the Los Angeles area, nearly twice the number as in the Bay Area.

But those rapidly growing small companies face “an intimidating shortfall” in capital, researchers found.

“The new economy is already emerging,” said Gus Koehler, one of the authors of the study. “It’s already out there in these little firms. If we fund them we can steal a march on the rest of the world.”

The study, to be released today, was conducted by the California Research Bureau, an arm of the State Library, at the request of Assemblywoman Susan A. Davis (D-San Diego).

Gazelles are companies--usually small, young firms--that show sales growth of at least 20% a year. The funding shortfall for these businesses in Los Angeles and Orange counties was computed by comparing the rate of early-stage financing in the region with that of Silicon Valley, researchers said.

They also concluded that San Diego has a relative funding deficit of $459 million, while the Sacramento Valley needs an additional $231 million.

In addition, the study found that gazelle firms, contrary to conventional wisdom, are not isolated to high-tech fields but are spread across a range of industries, including wholesale and retail trade, manufacturing, finance and services.

Entrepreneurs raise funds in the earliest stages by tapping their savings and credit cards, taking out bank loans and second mortgages, and borrowing from family and friends. Some receive financing from wealthy individuals known as “angels” or larger corporations.

In the Los Angeles region, only one in 200 is funded by venture capitalists, compared with more than 6% that receive such backing in the Bay Area, Koehler said.

Most studies to date have focused only on the level of venture capital financing.

“We felt we needed this information,” Davis said. “We really wanted to take a look at it and see what it meant and what we could do about it.”

Koehler said the findings are particularly relevant for Los Angeles, which he called “one of the most dynamic cities in the world. You have an economy that’s hooked up to the rest of the world.”

Small businesses helped lead the region out of the last recession, he noted, and can provide the foundation for future economic growth. “We need jobs. We have the companies that can do it,” he said.

Observers said the study confirms the widely held belief that early-stage financing is badly needed in Southern California.

“We’ve been too laid-back,” said Jack Kyser, chief economist at the Los Angeles Economic Development Corp. “You constantly have to work your economic base. You can’t just sit back and say times are good. That just doesn’t work.”

Another reason for the funding gap, Kyser believes, is that there are widespread misperceptions about the nature of businesses in Southern California.

“People don’t understand the broad range of industries that are here,” he said. “They think the only thing we do down here is make movies.”

Alan Carsrud, chairman of the UCLA Venture Development Program, a technology business incubator, said the new state estimate of the funding gap is probably very conservative.

What’s missing in Southern California, he said, is “a mechanism for tying these people together and an understanding that this is a technology-based region as much as it is an entertainment- or an aerospace-based region.”

Another problem, he said, is the enormous size of the Los Angeles and Orange counties area, which makes it difficult to form a sense of community. Onerous regulations also discourage business growth in some cities, he said.

The region needs more networking efforts that give entrepreneurs access to funding sources and incubators that provide start-up firms with resources, he said.

“It boils down to jobs,” Carsrud said. “It boils down to intellectual capital of a region to survive in a changing economy.”

The dearth of financing is most acute among very-early-stage businesses, said Tim Cooley, executive vice president of strategic initiatives at the Orange County Business Council.

Venture capital funds, which typically have hundreds of millions of dollars to invest, tend to put a minimum of $2 million to $3 million in firms that are already past the initial start-up phase and can produce a quicker turnaround on the investment.

Many entrepreneurs hit a wall after tapping out their savings, credit cards and other resources, but they’re too young to attract venture capital, Cooley said.

“That area between $500,000 and $3.5 million is not being addressed at all,” he said.

Beyond that, said Cooley, entrepreneurs need investors who can help them build a mature business.

“In addition to the capital, what you want in an investor is someone who’s been through it before and has marketing and management expertise, someone who can connect the dots,” he said.

Davis said she hopes to initiate a dialogue over a possible government role in boosting funding for young companies. A partnership with private investors, in which the state provides some matching funds for promising entrepreneurs, could be one response, she said.

“There are a lot of companies out there with good ideas,” Davis said. “We need to work a little harder to find ways to help them.”

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Patrice Apodaca can be reached via e-mail at patrice.apodaca@latimes.com