Midwest VCs Hope For Replenished State Capital Funds, Despite Tight Budgets
When the Michigan Venture Capital Association (MVCA) released its annual report about the state of venture capital earlier this summer, there was plenty to be optimistic about. In 2013, Michigan bucked national trends by increasing the number of VC professionals statewide by 84 percent, compared with a 13 percent decline nationally. VC-backed companies in Michigan increased by 66 percent over the past five years, and according to the MVCA data, Michigan also vastly outpaced Indiana, Minnesota, and Wisconsin when it came to the number of venture-backed deals brokered in 2013.
But despite the gains the Midwest has made in the past five years, it still lags behind many regions in terms of a robust VC environment. Illinois is the only Midwestern state in the top 10, and it’s ranked ninth.
“Michigan doesn’t really have an organic VC community like Silicon Valley or Boston,” says Mike Flanagan, the Michigan Economic Development Corporation’s (MEDC) manager of equity capital programs. “The state has really had to drive that. We’ve had really significant growth, from a handful of VC firms 10 years ago to about 35 now. We’ve had some really good successes that have helped diversify our economy. It would be a shame to see that end.”
Michigan’s successes in increasing access to capital aside, a potential problem lurks. Many Midwestern states, Michigan included, rely on state-supported fund-of-funds like the 21st Century Investment Fund to beef up venture capital. Without those programs, access to capital becomes much more difficult. In Ohio, says investor Jonathan Murray of Early Stage Partners, entrepreneurs are already being affected by the $150 million Ohio Capital Fund being fully committed, with no new funding sources in sight.
“The current governor of Ohio doesn’t really support these initiatives because he believes the private sector should do it all,” Murray says. “It’s a disappointing thing. They spent 10 years building the [entrepreneurial ecosystem’s] momentum, and now they’re allowing that momentum to diminish. There’s some risk of that happening in Michigan, too.”
Could the same thing happen in Michigan? Potentially, Flanagan says. The MEDC administers the state’s three major fund-of-funds, the 21st Century Investment Fund and Venture Michigan Funds I and II, which represent more than $300 million in capital. All of those funds are now tapped out, and Flanagan says there’s no new capital available at the moment from state-sponsored programs.
“In terms of the problem, we’re very cognizant of it,” Flanagan says. “It’s the main issue I’ve been working on for the last several months. We’re trying to figure out a solution, but it’s difficult because we had clear sources of funding that we don’t have anymore.”
In 2005, Michigan passed legislation that allocated $1 billion from the state’s share of the settlement from a national lawsuit against tobacco companies and established the 21st Century Jobs Fund, a 10-year initiative to diversify the state’s manufacturing-dominated economy. To get capital flowing to early-stage Michigan startups and jumpstart the state’s entrepreneurial ecosystem, the state created the 21st Century Investment Fund and the Venture Michigan funds, along with the $185 million InvestMichigan Growth Capital Fund and the $130 million InvestMichigan Mezzanine Fund. Michigan’s tobacco settlement money has now been fully deployed.
Flanagan says other Midwestern states used a similar strategy to fund capital programs. The Wisconsin legislature, after failed attempts to create a state-backed VC fund of at least $200 million, has committed $25 million to the Badger Fund of Funds, which will make investments in Wisconsin-based VC funds. However, the fund is not up and running yet, as it is still seeking at least $5 million in private matching dollars.
Murray, like many in the VC community, is hopeful that Michigan Governor Rick Snyder’s history as an investor—he co-founded two Ann Arbor-based VC firms: Avalon (with Ted Waitt, the co-founder of Gateway) and Ardesta—will help create the political will necessary to allocate more of the state’s budget toward funding capital programs. But Snyder is in the midst of a re-election campaign, and though polls show that he currently leads, victory isn’t certain.
However, in a state that couldn’t summon the votes necessary to pay for desperately needed improvements to our roads and bridges, prying budgetary dollars away to fund venture capital programs seems like a long shot.
“The budget is tight,” Flanagan admits. “The governor and the legislature have a lot of tough decisions. We’re trying to prioritize within the MEDC, too. There has been an increased commitment in general to the MEDC, but that doesn’t necessarily filter down to venture capital programs. It’s important for the state to invest in this market until it gets more mature. Eventually, if it’s mature enough, we’ll see VCs raise money without needing the state. But we’re just not there yet.”