The trade group for venture capitalists in Michigan wants to form a $100 million fund to match millions in private capital with public investment.
Under the proposal that’s being pushed by the Michigan Venture Capital Association, private investors would put $75 million into a fund to seed new venture capital funds, an amount the state would then match with $25 million, MiBiz has learned.
The underlying reason: They want to maintain the growth in venture capital investing that’s taken shape over the last decade in the state.
“The state’s basically putting in an ante and the private sector can raise the larger pot,” said Mark Olesnavage, incoming chairman of the MVCA and the managing director of Hopen Life Science Ventures in Grand Rapids.
The plans differ from two prior fund-to-funds created by the state in that it relies largely on private investment that’s coupled with public support, rather than all public funding. It would require a much smaller state investment, at a time when many in Lansing have sought to cut funding for the prior programs.
State investment in a partnership for a new fund-to-funds would leverage the private investment that could go elsewhere without the public match, Olesnavage said.
“Those investments by private institutions, why not have them put it in our state? They’re probably going to invest those dollars somewhere in professionally managed funds,” he said. “Why not provide an impetus for those funds to be invested in our state? It’s not like they’re not going to be investing. We’re giving them incentive to invest right here.”
The Ann Arbor-based MVCA has been pitching the idea quietly to state legislators for months and will continue to “make our case” through 2016, then mount a “main push” next year when the new Legislature takes office, Executive Director Maureen Miller Brosnan told MiBiz.
The association “has been in discussions” with private investors who “are anxious to make sure Michigan’s economy continues to move in the right direction that it’s begun to move,” Miller Brosnan said.
They’re open to investing in a new fund if the state’s willing to invest as well, she said.
“What becomes important in that scenario, though, is that those organizations that wish to become part of a third fund-to-funds, they want to make sure the original creator of that program remains committed to entrepreneurism in Michigan,” Miller Brosnan said. “Their commitment will be as strong as that of the state of Michigan. As soon as they see that the state of Michigan is willing to continue its commitment to entrepreneurism, they’re going to be there.”
SETTING THE FOUNDATION
The MVCA believes a new $100 million fund-to-funds would draw even further investment from within Michigan and outside of the state. Research shows that every $1 in in-state investment attracts $4.21 in out-of-state funding, Miller Brosnan said.
Twice in the last decade, the state government put millions into two similar venture capital funds through the 21st Century Jobs Fund. That program was created to diversify the state’s economy with money from the landmark national settlement with the tobacco industry.
The formation of the $95 million Venture Michigan Fund I in 2006, plus a follow-up $120 million Venture Michigan Fund II in 2010, is largely credited with helping to drive strong growth in the state’s venture capital industry.
“It’s not theoretical. It has worked, and a lot of that’s happened right here in West Michigan,” Olesnavage said.
Not pursuing a third fund-to-funds would “be like building a foundation to a house and saying, ‘Well, that’s good enough. We have our foundation,’” he said. “I think we need to move forward and continue to build the house.”
At the end of 2015, capital under management by both state-based and out-of-state venture capital firms with a presence in Michigan reached a record $5.26 billion, up from the $4.84 billion in 2014 and about double the amount of five years earlier, according to an annual research report from the MVCA.
Seventy-four companies in Michigan collectively received venture capital investments of $282.5 million last year, a 48-percent increase over five years earlier. That’s up 174 percent over the level of investment a decade ago. The 2015 investment level included the funding of 32 new startup companies.
Michigan is presently home to 141 venture capital-backed companies, up 48 percent from 2010, according to the MVCA report. There are now 25 venture capital firms based in the state, plus another 11 out-of-state firms with an office in Michigan.
‘FILL THE EARLY GAP’
The MVCA has pushed its idea amid a political environment in Lansing that’s against creation of a third venture capital fund-to-funds. However, a study the Michigan Economic Development Corp. commissioned to examine the effectiveness of the 21st Century Jobs Funds supported the concept.
“Now is not the time to withdraw from the risk-capital investment scene. Michigan has made great strides in the amount of risk capital it is now attracting to the state and having invested in Michigan innovative firms,” according to the study from Columbus, Ohio-based TEConomy Partners LLC.
Gov. Rick Snyder “supports innovative ways to spur new venture capitalism,” although consideration of a new fund-to-funds along the lines of what the MCVA proposes will have to wait until the next budget cycle, spokesperson Anna Heaton wrote in email to MiBiz.
“Any discussion of a new fund likely wouldn’t start for some time, as the budget for the next fiscal year was just signed and didn’t include the funding,” Heaton wrote. “So it’s a discussion that could take place down the road but not something the governor is going to commit to right now.”
Although “not in support” of a third fund-to-funds, the MEDC is looking to improve access to capital at the pre-seed stage, said Fred Molnar, vice president of entrepreneurship and innovation.
The MEDC may form two early-stage seed funds of $1 million and $2 million each that would award startup companies in Michigan grants of $5,000 to $10,000. Recipients could use the funding, for example, to validate an innovation or market demand, or to develop a prototype, Molnar said.
As venture capital investors moved upstream in recent years, a greater need for capital has emerged for companies at the earliest stages of development, according to Molnar.
“We’re going to try to fill the early gap,” he said. “We’re looking heavily at that very, very early stage because no one wants to take that risk.”
The creation of seed funds would help to support the formation of more startup and early-stage companies in the state, creating a fertile ground for venture capital investors to scout for investment prospects, Molnar said. That would then draw more venture capital into Michigan from outside of the state.
“Our focus will be that early stage to keep priming the pump, if you would, and then the VC side will take care of itself,” Molnar said.
The proposal, which remains in the “idea-formation stage,” would need to go through the MEDC’s budget and appropriation process for the upcoming 2017 fiscal year, he said.
FINDING A MODEL THAT WORKS
To further grow access to early-stage capital in Michigan, the study of the 21st Century Jobs Fund by TEConomy Partners recommends the formation of additional pre-seed and seed funds by the state, as well as the restoration of an angel tax credit in Michigan and greater support for the formation of angel networks. Lawmakers eliminated the state’s angel tax credit five years ago when they rewrote Michigan’s business taxes.
This month, State Rep. Jeff Farrington, a term-limited Republican from Macomb County, introduced two bills that would allow an investor to receive a 20-percent tax credit against the state’s personal income tax for qualified angel investments.
TEConomy Partners also suggested that the state create a third fund-to-funds “with restructured terms and strong ties to the Michigan Pension Fund and other institutional investors to ensure that the momentum that has been built does not wane and the funds that the two previous funds have created do not disappear.”
The prior Venture Michigan Funds offered tax vouchers for lenders to use as collateral for capital they provided to the funds. TEConomy Partners suggested the state look at other methods for creating a third fund-to-funds.
“If policy makers are uncomfortable with the existing terms, it is certainly within their purview to structure a different funding model for the third fund,” according to the TEConomy study. “That being said, it would be extremely shortsighted to simply do away with such catalytic and impactful investment activity altogether.”
Rather than use tax vouchers, the MVCA proposal would have the state make a direct, minority investment in a new fund-to-funds.
Miller Brosnan hopes the TEConomy report “lights a fire under everybody and says, ‘Hey, we’re doing a good job. We have to keep our foot on the gas.’”
“If we are a state that is run based on pragmatics, based on facts, based on proven success, then we won’t back away from something that we already know to be successful,” she said.
A ‘FRAGILE’ CLIMATE
The TEConomy Partners study on the 21st Century Jobs Fund noted that without continued state support, the momentum that’s been built in venture capital in Michigan could disappear. The broad consensus across the industry is that although the “risk capital climate has greatly improved, there is also a widely held belief that the investment culture is at great risk of disappearing without further additional investments by the state.”
Even with the growth of the last decade, Michigan still ranks below the national average for venture capital investments, according to the analysis by TEConomy.
“It is a widely held belief that the national venture-capital funds are monitoring Michigan’s risk capital landscape, and, if investors think the state is not committed to supporting entrepreneurial development, then they will disengage and invest their funds’ resources in regions that are committed to building an entrepreneurial culture,” according to the TEConomy report. “As a result, the risk capital climate is very fragile and can easily be disrupted.”