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Wednesday, 18 April 2012 09:12

Private capital from in and out of state looks to invest in West Mich. companies

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WEST MICHIGAN — Stephen Benoit knows unequivocally that his current company would not have been able to start up and get to where it is today without the help of capital from West Michigan.

Metabolic Solutions Development Company LLC, a drug development and discovery company focusing on compounds that show promise in treating diabetes and other metabolic diseases, has raised more than $55 million since former Upjohn Company researchers Jerry Colca and Rolf Kletzein founded it in 2006. The vast majority of that capital came from investors in West Michigan.

“We are certainly a direct beneficiary,” says Benoit, who was named CEO in 2010. “Until Southwest Michigan First and its Life Sciences Venture Fund and the groups in Grand Rapids like Hopen Life Science Ventures were around, it was almost impossible to get a startup off the ground.”

Benoit should know. Before Metabolic, he was the CEO of NanoMed Pharmaceuticals in Kalamazoo. When he joined the company in 2001, it was a very young startup, and the capital market was much different, with few resources available to the company’s founders.

Fast forward just a couple years later when Metabolic formed in 2006, and the landscape was much different, mostly because the community put resources into keeping talented scientists in the area after Pfizer scaled back operations across the state.

“By the time Metabolic Solutions Development started, there was quite a bit of that activity,” he says of venture funding around for life sciences companies. “It’s another good illustration of the ability of scientists to form companies when the capital exists. We know how to make connections here. It’s a different place in 2012 than in 2001.”

Despite 2011 ‘blip,’ VCs see positive trend

In 2011, venture capital firms invested $82.6 million in 31 Michigan deals, according the MoneyTree report from the National Venture Capital Association and PricewaterhouseCoopers. That’s the lowest amount in 15 years, down some 46 percent even from 2010. Nationally, venture investing totaled $28.4 billion for 3,673 deals, the NVCA recently reported.

While the MoneyTree report showed a lull in VC investing in the state last year, Merrill Guerra, executive director of the Michigan Venture Capital Association, was quick to point out that venture investing is not a linear process.

“I don’t think it was a downward trend. It was one of those blips we see occasionally. All indicators are pointing in an upward direction,” Guerra says. “We’ve already seen several investments this year – on the angel level and also on the VC level. That’s a good sign.”

Tim Petersen, managing director of Arboretum Ventures in Ann Arbor and current MVCA chair, says that while the number of VCs nationwide has shrunk since their peak in 2003, Michigan has actually seen a reversal of that trend and a growing number of VC firms headquartered in the state.

While 15 firms were headquartered in Michigan in 2007, there were 19 in 2010, the last year for which data is available. Capital under management grew from $900 million in 2007 to $1.2 billion in 2010. The numbers increase to $2.6 billion when out-of-state VCs with a Michigan presence are added to the mix. The average fund size has hovered around $40 million in that same period, according to MVCA data.

The report also showed 83 out-of-state venture capital firms have investments in Michigan companies.

According to MVCA data, 84 percent of VC capital had been deployed, while 13 percent was reserved for follow-on financings and 3 percent was available for new investments.

Over the past decade, Michigan’s ranking compared to national statistics has been moving up, Petersen says. Membership in the MVCA is also at an all-time high.

“If you look back 10 to 15 years ago, everything is better,” Petersen says. “We have more entrepreneurs, more funds, more sophisticated funds, and more technology transfer. The big thing for the venture industry overall is to not let the financial climate of the last few years (impact what they’re doing).”

Life sciences strong,but portfolios diversifying

MVCA’s 2010 annual report noted that 45 percent of all the capital managed in Michigan is in life sciences-based companies, 30 percent was in IT, and 6 percent was in business services. Media, alternative energy and consumer products each had a 3 percent share of capital; advanced materials and manufacturing was at 2 percent.

That changed in 2011 with a steep decline in the VC funding of life sciences companies. Guerra attributed that change to VCs wanting to diversify their company portfolios.

“Now they’re looking at other deals and … they’re interested in a wider range of sectors,” she says.

Funds across the state also diversified the stage of their investments. From 2009 to 2010, firms invested in more startups and seed-stage companies and less in growth or expansion.

In 2010, 64 percent of funds measured by dollars of investment were in startups or early stage companies, 19 percent were in growing or expanding companies, 14 percent were invested in seed-stage companies and 3 percent were invested as mezzanine funds.

Private equity matures

John PollockThe developing private capital market isn’t limited to VC funds. Over the past five to 10 years, the private equity industry has matured locally and nationally, says John Pollock, the managing director of LV2 Equity Partners, which has offices in Lowell, Midland and St. Johns. Underlying that growth, he says, is the fact that West Michigan companies are an attractive investment for PE funds.

“Private capital in Michigan has been evolving for a while now,” Pollock says. “There has always been a lot of quiet private capital in West Michigan. Family offices and successful business people have gotten deals done in private, quiet ways.”

At the same time, he’s seen more capital coming from outside West Michigan to invest in local companies. He attributes that to a growing West Michigan economy and an industrial base that has diversified out of being so narrowly focused on the automotive supply chain and office furniture. At the same time, he says the private equity industry has also matured and grown its ranks.

“They have more capital to deploy and they’re looking farther downstream at smaller companies and smaller communities,” he says.

In the past five to seven years, Pollock says he’s seen more local investment groups formed to start raising PE capital in their communities. It’s not just a couple of buddies going in together to buy a business anymore, he says.

“It’s become more structured, just like private equity has,” he says. “I think we’re going to stay on the same trajectory. We have a dynamic business community, and we’re going to see private equity evolve and become more structured and have more options, just like we’ve seen it evolve in the last five years. I’m fairly bullish that we’ll see good things continue to happen.”

Martin SteinThat’s a sentiment shared by Martin Stein, founder and managing director of Grand Rapids-based Blackford Capital. Last year after Blackford relocated to Michigan, the private equity firm looked at “dozens” of potential transactions in West Michigan and hopes to announce a couple of deals very soon. Stein says his firm is noticing increased activity in 2012 compared to 2011.

“There are more deals being closed and more exits that are occurring, and those are signs of a good economic cycle,” he says.

Question of inside versus outside

Earlier this year, Stein’s firm announced the creation of a Michigan Equity Investment Fund, which aims to raise $10 million to $20 million from investors over the next year. The fund will invest in mature manufacturing, distribution and business services companies that “have a history of profits,” a potential for growth and whose ownership wishes to sell.

Since the announcement in February, Stein says he’s been talking to high net worth individuals and family offices and getting good responses. He said it could take 12-15 months to raise the capital, but he expects to announce the fund’s first investment within the next month or two.

The idea behind the fund was to create a way for Michigan to retain the value created by local companies rather than losing it to outside investors when the owners of those companies looked for liquidity or to sell their businesses.

“Those companies grow and create value over time, but (the out-of-state PE firms) take that value out of the state,” he says, noting Michigan had about 40 private equity deals per year, mostly by out-of-state firms. “Our state deserves to keep some of that value. Our communities … provided a culture and a business environment for those companies to succeed.”

Pollock takes a different view. He says he doesn’t worry about outside investors eroding the “family-owned business” nature of West Michigan – nor does he lose sleep over any lost IP, another concern often voiced over outside funds picking up local companies.

“Access to more capital, whether from outside or the inside, is good for the business community,” he says. “It’s good to get outside ideas to complement what we’re doing here. I see no negative. It feeds the growth of our own (private capital).”

Pollock says it’s also important for any investors to share in the culture of the communities in which they’re placing their capital. In West Michigan, that translates into being “above board, honest, very ethical and relatively conservative.”

“I think investors in companies in West Michigan need to be aligned with that way of conducting business, and I think most are. To they extent they may not be, that’s problematic. We need to use (the region’s culture) as an asset and lever that,” he says.

State ramps up capital assistance

The state has also taken some proactive steps in trying to spur more capital to move to Michigan companies, industry insiders say.

Many trace back a momentum boost in the state’s VC activity to the creation of the Venture Michigan Fund in 2006 and the selection of Credit Suisse to manage the funds. The funds invest directly with VC managers that focus on Michigan-based early stage companies. The first fund in 2006 put $95 million into 11 VCs, including TGap Ventures in Kalamazoo. The second fund, launched in 2011, aims to invest $120 million.

“It’s undeniable that Venture Michigan Fund I and II – managed by Credit Suisse – has made investments in Michigan-based funds and helped attract funds from outside the region to be active in the state,” Arboretum’s Petersen says.

In March, the Michigan Strategic Fund and the MEDC approved the creation of the Pure Michigan Venture Match Fund, designed to be a market-driven solution to help fill a funding gap for companies just before revenue kicks in or as revenue starts to ramp up.

Companies can apply to the fund once they’ve raised between $700,000 to $1 million from a VC, and the state will match 50 percent – from $350,000 to $500,000. For companies that have raised between $1 million and $3 million, the state match is capped at $500,000.

In a competitive process, companies will apply to the fund via an online application by submitting a business plan of no more than 35 pages, plus supporting documents. The qualified lead VC firm must also submit a valuation and an evaluation of why it made the investment in the company. The cost to apply is $1,000.

The applicaitons will be peer reviewed, and successful projects will be put to the Michigan Strategic Fund manager for a final decision. The entire process is expected to take from four to six weeks.

Arboretum’s Petersen says the extra half million dollars from the Venture Match Fund on a particular deal is “a pretty valuable thing, even for a fund our size.”

Arboretum just closed on its third fund, which is valued at $140 million.

“The guys constructing this program understand our business quite well,” Petersen says. “They solicited our opinion and made some tweaks. At first blush, this will be easy for the VCs to get their arms around.”

MVCA’s Guerra says she couldn’t underscore enough the venture match program’s importance, or the fact that the state is taking an active role in helping bring new capital into Michigan.

“It’s a really important step for attracting more capital to the state and being able to do more deals in the state,” she says.

In 2011, the MVCA also received a $3.1 million grant from the MEDC to launch two new programs: one aimed to create a talent pipeline for the VC industry and another designed to support the growth of angel investing in the state.

The Michigan Venture Fellows program provides “graduate-level experience” for people to do hands-on work with a VC firm for 18-24 months. Each fellow would work with a portfolio company and ideally be hired by the firm at the end of the term, Guerra says.

Angels seek more members

The goal of the second MVCA initiative, the Angel Network Growth program, is to encourage more people to consider angel investing. While VCs have seen positive movement, she said angels have struggled to attract new partners because many people don’t know much about angel investing or its potential as part of an alternative investment portfolio.

The program supports “resource-constrained” angel groups in the state by providing them up to $18,000 per year to help with costs related to due diligence and accounting and to do programs to educate people about angel investing.

“People are looking to diversify their investments beyond the stock market and want the opportunity to invest in a broad array of asset classes,” says Jody Vanderwel, president of Grand Angels, a West Michigan-based angel group. “For Michigan, the other good news is that our several angel groups are all active and in touch with each other. Everybody is hoping to be able to syndicate deals and improve the quality of work.”

In 2011, the organization was the lead angel investor in AzulStar Inc., but it partnered with Blue Water Angels, which provided about 20 percent of the capital for the deal. The deal marked the first time two angel groups in Michigan partnered on an investment.

In 2011, Grand Angels – which now has 15 active deals in its portfolio – invested $1.8 million in eight new deals. Over its eight years of existence, the organization has invested $8.3 million in 21 deals. Grand Angels plans to invest $2 million in eight deals in 2012.

Success breeds success, attention

On the other side of the coin, Metabolic’s Benoit says more companies need to break out and be public examples of successful investments if the state and West Michigan in particular want to attract even more private capital activity.

“For an area like this in the middle of the country, in a non-traditional startup environment, the current private capital markets have to continue to make investments and have success to attract outside capital from either of the coasts,” he says. “Companies like ours need to be successful and be highly visible successes to bring more capital from the outside and spawn increased capital to be available from within the state.”

Metabolic is in the middle of raising another $40 million in financing to continue the development of its compounds, both of which are in Phase 2 clinical trails. Another compound should go to clinical trials next year, Benoit says. He expects to announce either a partnership with a drug company or another venture round of financing by the third quarter of this year.

“It’s a good opportunity for us to bring in one of the upper-tier venture funds from somewhere else in the country and augment the investment primarily from the West Michigan community,” he says. “However we accomplish that, it’s a really good sign for the company and the community as a whole. We have a strong investment thesis here and we’re priming the pump for more venture-backed life sciences in West Michigan.”

“People have had to step up and decide to do this, to create a start-up life science community in West Michigan and the state as a whole,” Benoit continues. “Someone has to want to make that happen, and the private capital investors have done that.”

Read 1660 times Last modified on Thursday, 09 August 2012 16:16

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