The idea sounds simple: Create a $150 million to $200 million fund supported by foundations and university endowments to back venture capital investors in the Great Lakes states.
Actually pulling off such an ambitious idea likely would prove difficult, given the complexities involved and the kind of collaboration required in starting the fund, the need for which was outlined in a recent Brookings Institution paper.
“If it’s done, it would be a heroic thing,” said David Brophy, a University of Michigan finance professor and founder of the annual Midwest Growth Capital Symposium who’s skeptical about whether the concept could ever come to fruition.
“It’s going to take a lot of work for the Midwest to come together because everybody’s got a much different angle,” Brophy told MiBiz. “It’s a wonderful thing if it can happen, but it’s a long putt.”
The report by the Brookings Institution, Chicago Council of Global Affairs, and University of Michigan executive MBA candidates was published in December and updated this month. It evaluated venture capital in the Great Lakes region and suggested the formation of a regional “fund of funds” backed primarily by investments from universities and foundations. With an initial round of $150 million to $200 million, the fund could support Series B and later-stage co-investments with local venture capital funds, and provide capital across a company’s life cycle.
In addition to the logistical hurdles and the big question of who would lead such an effort, Brophy questions whether university endowments and foundations would want to put money into something as risky as venture capital investing.
Their investment strategies have different objectives, said Brophy, who instead prefers to see universities focus their attention on supporting technology transfers and commercialization of innovations coming from their research labs.
“I’d rather see energy at the state and local level put into supporting startups and so on,” he said. “What I would like to see is every institution in the Midwest to put some elbow grease into interacting with whatever the local community is and see where common ground exists and begin to engage with these opportunities.”
Authors of the Brookings Institution paper conclude that a Great Lakes fund of funds is “neither a panacea, nor is it a novel idea for a mechanism in further scaling the region’s venture capital industry. However, this (fund of funds) will not have the structural shortcomings of some of its localized predecessor funds.” Those “shortcomings” include investment restrictions, a lack of repeat funding and “minimal” regional coordination.
A Great Lakes fund of funds “also has the benefit of timing.”
“Many of the region’s critical resources such as R&D budgets, talent, public policy, and investment activity have improved over the last decade. These resources are being better harnessed to maximize their impact,” the authors wrote. “As such, a truly regional, and properly structured (fund of funds) can create new growth industries and deliver for investors.”
In an article earlier this month, John Austin, a nonresident fellow at the Brookings Institution’s Metropolitan Policy Program, wrote that venture capital in the Great Lakes needs help despite its growth over the last decade. As a powerhouse for R&D and innovation, the Great Lakes significantly lags the West Coast and East Coast in venture capital investing and “continues to export wealth to coastal economies, even as investment leaders try to equalize growth between the coasts and the Heartland.”
The region also “sees only a tiny fraction of venture capital deals, despite producing one-quarter to one-third of the nation’s research and development, new patents, and top talent.” As well, “Great Lakes VC funds are currently seen as too small or too unknown for investors — at a time when VC is funding fewer firms with bigger exits.”
A regional fund of funds “would be a vehicle for in-region and out-of-region investors who put their dollars to work with investments in venture capital firms,” Austin wrote. “Such a fund would facilitate much-needed growth in the size and scale of the venture capital network in the Great Lakes/Midwest — allowing it to be competitive in today’s larger and later rounds of funding.”
Austin’s perspective echoes sentiments from insiders in Michigan’s venture capital community.
Fred Molnar, the vice president of entrepreneurship and innovation for the Michigan Economic Development Corp., called the Great Lakes fund-of-funds concept “easy to put on paper, (but) very hard to put into practice and reality.”
“Sounds like a great high level idea, but the difficulties would be in the details and implementation,” Molnar wrote in an email to MiBiz.
Dale Grogan, a managing director at Grand Rapids-based Michigan Accelerator Fund I LP, took a more optimistic track.
“I love the idea,” Grogan said. “It’s long overdue.”
“But being able to find some folks that are willing to lead that charge I think is the nice next step. First you have the theory, then you have the application,” Grogan said. “If we can move this into something tangible, that’d be great.”
The fundamental question of who could actually move the concept forward poses the first barrier.
While a Great Lakes regional fund of funds “makes lots and lots of sense,” Grogan said, “there are a limited number of folks that could do that effectively.”
Grogan also sees a need for public participation in a Great Lakes fund. Venture capital professionals in Michigan often credit the state’s 21st Century Jobs Fund with helping to grow the industry by investing in funds, yet lament that Lansing has been unwilling to continue that support with another fund of funds.
“It’s been done before and it works,” said Grogan, who sees a need for at least two states to “say we’ll throw in and do this” and provide some public money to get the idea for a Great Lakes fund of funds off the ground.
Public investment with a capped return that’s intended as an economic development vehicle could provide the incentive to lure private investors to participate, Grogan said.
Ara Topouzian, executive director of the Michigan Venture Capital Association, likes the concept as well. The Brookings Institution paper is “a conversation starter” across the region where “we all see the need for more capital,” Topouzian said.
“It’s definitely interesting. It definitely gets the conversation going,” he said. “It’s definitely addressing a need that we’ve talked about here, and I have to guess other states have as well.”
In demonstrating the need, Topouzian referred to Austin’s report, which noted deals in Great Lakes states are plentiful, but “the VC firms need some help with the fundraising end of things.”
“We need to look at whatever avenues there are to increase funding within the state,” Topouzian said. “We’re not the East or the West coasts.”
Even so, one recent fundraising round shows that venture capital firms in Michigan are capable of raising larger funds. Ann Arbor-based Arboretum Ventures Inc. last week said it closed on its fifth fund, which has commitments of $250 million.
The firm, which formed in 2002 and now manages more than $700 million in capital, invests in health care startups with a “special interest in ‘under-ventured’ geographies such as the Midwest.”