High-Net-Worth Michiganders: Time to “Get Off the Dime,” Brophy Says
When the Michigan Venture Capital Association (MVCA) unveiled the findings in its 2017 annual report at a public event in April, there was a lot to celebrate: a 48 percent increase in venture-backed startups over the past five years; every dollar invested by a Michigan firm attracting $4.61 in out-of-state capital; and a total of $4 billion ($2.4 billion of which is from Michigan VCs) in venture funds currently under management in the state.
The number of VCs living or working in Michigan has increased by 41 percent in the past five years, and the amount of venture activity continues to rise in the state even as it slows nationally—growth indicators no matter how you slice them.
But the report also revealed a couple of potential trouble spots on the horizon, most having to do with sustainability, confidence, and funding gaps for tech startups. (More on that in a minute.)
At the springtime event unveiling the annual report, the MVCA’s associate director, Emily Heintz, didn’t mince words. “What’s slightly concerning is that the earliest rounds [of a startup’s venture funding] are heavily weighted with out-of-state money,” she told the crowd. “From an economic development standpoint, companies will leave Michigan if that continues.”
Later, MVCA director Maureen Miller Brosnan told the audience that 383 different VC firms had invested in Michigan companies out of a nationwide total of 898, meaning just under half of U.S. VCs have invested in the state. “VCs remain committed to the idea that Michigan is a great state to be operating in,” she reassured the crowd.
Michigan, like some other Midwestern states, relied on state-supported investment funds to jump-start its venture community in the early aughts. Early last decade, the legislature passed measures establishing those funds with one-time settlement money from the national tobacco lawsuit. The state’s three major fund-of-funds—the 21st Century Investment Fund and Venture Michigan Funds I and II, representing more than $300 million in capital—have been fully deployed, leaving open the question of where follow-on investments for portfolio companies will come from in the future.
At the MVCA event, some of Michigan’s VCs seemed anxious that the community they’ve worked so hard to build over the past decade is at risk of a contraction, although some, including Brosnan, say what’s happening is mostly the result of normal market maturation. We talked to a variety of local investors, including David Brophy, the founder of the annual Michigan Growth Capital Symposium, for their takes on the report and what the numbers indicate.
First, let’s look at the MVCA report’s other bright spots:
—Michigan has 93 venture professionals working at 33 firms, and is home to 141 venture-backed startups, representing a 48 percent increase in the last five years.
—According to the MVCA, $222 million was invested in 54 Michigan startups in 2016.
—Ninety-four percent of the state’s venture investors believe things are the same as or better than three years ago.
—Total venture capital under management in Michigan has increased by 34 percent since 2011.
Now for the numbers that spark a bit of angst:
—Michigan’s 141 venture-backed startups are projected to require $504 million in follow-on funding. There is currently $424 million in VC reserved for existing portfolio companies, leaving a potential $80 million gap.
—Although there is $4 billion in total VC under management in Michigan, that represents a 24 percent decrease over the previous year.
—Eighty-five percent of VC firms here currently raising money or planning to raise money by 2019 are confident they will be successful—but 44 percent are less than confident they’ll be able to raise that money from Michigan investors.
—Seventy-one percent of VCs are less than confident they can attract top-tier talent to their portfolio companies in the state.
—Of the $222 million invested in Michigan companies by VCs in 2016, only $16.9 million went to a company led by a “diverse CEO”—a paltry 7 percent.
—Nine percent of CEOs from the state’s venture-backed companies were a woman, an LGBTQ person, or a person of color, besting the national average of “approximately 4 percent at Fortune 500 companies.” The report goes on to say that “Michigan’s venture-backed CEO population still looks much whiter and more male than the rest of the U.S. labor force, [where] 21 percent of workers are a minority.”
Michigan’s Market is Solid, So Where Are All the Institutional Investors?
Brosnan says the numbers that matter most are trending up. “For being newer to VC, Michigan has done an amazing job of attracting capital,” she says. “Companies here are strong. Ninety-four percent are very confident that we’re on an upward trajectory. The Michigan market is solid.”
Brosnan says she’s not sure why the total amount of capital under management in the state is down 24 percent from last year, but she plans to keep her eye on it. (If you look only at firms headquartered in Michigan, the total amount of capital under management is up by 9 percent, she points out.)
“The number of venture-backed companies here (141) speaks the loudest,” she maintains. “It shows we have capital and investors willing to take chances. That 141 number is really one of our greatest indicators that there is capital here, and great ideas are getting funded and growing here.”
The biggest challenge now, she says, is building on the successes of the past. Her members have clearly indicated that there is a shortage of talent, particularly in the managerial realm, but “we’re hoping to work with the state to attract and retain talent,” she adds.
Some investors feel that it’s past time for Michigan’s wealthy families with investment offices, corporations with investment arms, and other institutional investors to come off the sidelines and start putting some of their money into in homegrown companies.
According to Forbes, the state is currently home to 12 billionaires with a combined net worth of $40.9 billion. The University of Michigan, ranked 10th in the nation when it comes to churning out billionaire graduates, boasts an alumni roster flush with high-net-worth people, including Larry Page, the co-founder of Google and one of the wealthiest people in the country. Oakland County, adjacent to the city of Detroit, is considered the fourth wealthiest county in America. In short, there are a ton of rich people that call Michigan home.
David Brophy is a University of Michigan professor who is considered the godfather of Michigan’s VC community, and he’s also the founder of the state’s largest annual venture event. This year’s growth capital symposium, which took place in May, had 60 presenting companies—the most in the event’s nearly four-decade history, he says.
“The audience this year had more investors and a wider span of investment interests,” he says. “Everybody is getting the idea, after 36 years, that we’re here to stay. But we’ve still got a ways to go to make a bigger impact on the coasts.”
Brophy looks at the MVCA report and sees a “double-edged sword” in attracting $4.61 in outstate venture capital for every Michigan dollar invested.
“It’s nice they find our companies investment-worthy, but we really need more local institutional capital, such as from universities or corporations,” he says. “I can’t tolerate that ratio because if there’s a bump in the night and the funds can’t stand up, we’ll lose those companies. It’s time for the private sector to step up and get involved.”
Calling it a “hell of a problem for the last 36 years,” Brophy can’t hide his frustration with the state’s conservative investment culture—these are legitimate companies seeking funding that we’re talking about, he points out, not appeals for charity. He’d like to see Michigan’s universities lead this private-sector rally, seeing as it’s often their intellectual property being developed into tech startups.
“This attitude of ‘let the state do it’—I don’t understand it,” he says. “Everyone has to get involved if we want to build the state of Michigan. Get off the dime and get involved!”
He believes U-M’s alumni are “very eager to see that happen and participate, and there have got to be ways for universities to figure out how to get their alumni involved.” Brophy says he’s not aware of any formal statewide efforts in the past, only “lip-service.”
Brophy calls college graduation season an annual “flight to the border.” The only way to keep scores of young professionals from leaving the state is to offer them opportunities here, he notes. A commercialization class he teaches at U-M is now drawing graduate business students interested in monetizing their thesis projects. If they could become “welded” to local companies while they were still in school, he says, that’s the kind of stickiness that would keep students here after they graduate.
“But that won’t happen if we treat startups as simply California dreaming,” Brophy says. “We have talent galore, sources of IP galore—there’s no reason why we should be as slow off the dime as we are.”
Funding Gaps and the Swinging Pendulum of Politics
Chris Rizik, a Detroit/Ann Arbor Xconomist who leads Renaissance Venture Capital, a fund of funds, agrees with Brophy. He says the total amount of capital under management is “still looking good,” but he sees a potential capital gap, particularly for funds relying on contributions from Michiganders.
“The amount of VC here is still really strong—the past three years were the best ever,” he says. But shaking money loose from local investors remains a challenge. “A few Michigan VC firms have been really successful in raising money, but the concern is we’ll create a situation where we have haves and have nots. Some of this gap is the normal course of things, but to continue to strengthen the VC ecosystem, institutional investors and family offices have to be more engaged.”
Rizik says his firm has recently been making an effort to get major corporations involved in startup investing. “So far, it’s working really well,” he says. “But we still have a situation where major foundations and endowments are less active in Michigan than other places. The MVCA has done successful recruiting events that have borne some fruit, but we still have a problem.”
Rizik sees another dynamic at play: the number of smaller institutional investors in Michigan that are moving to an “outsourced Chief Investment Officer” model, where the person making the investment decisions is outside the state and may not have had much exposure to Michigan’s homegrown investment opportunities.
“The idea of outsourcing is good, but there needs to be some accommodation for the local investment community, like having the CIO set aside time to meet with local investors,” he says. He points to a recent deal where Renaissance invested in Next Coast Ventures, a firm based in Austin, TX, as a way of getting out-of-state VCs looking at Michigan companies. “Once people get exposed to Michigan, they see opportunities,” he adds.
Jonathan Murray, managing director at Draper Triangle Ventures, sees a combination of issues affecting Michigan’s venture capital picture, including a risk-averse Midwestern investing culture and changing politics at the state capitol. The “cycle of commitment” involved in economic development work, he says, is fairly lengthy compared to Michigan’s political cycles, where term limits kick people out of office after a handful of years.
“People lose interest, and we’re seeing that a little here, too,” he says. “Budget decisions have to be made and there are shifting priorities. We’re seeing a cycle now where money that could be available for VC is being put toward other things.”
The idea of using a fund-of-funds to attract more investment capital to Michigan has been a mixed success, in his opinion. While he praises the work done by the MVCA and Renaissance, he says there are two kinds of out-of-state funds: those that honor their commitments, and those that don’t. When legislators are looking at past programs, they want to know what kind of returns they yielded.
“Those can be hard questions,” he admits. “If legislators don’t hear the answers they want, the enthusiasm diminishes, especially when resources are limited. That’s where we are right now.”
Murray looks to Ohio as an example of what not to do. Like Michigan, Ohio’s government established a fund-of-funds in the mid-aughts, the $150 million Ohio Capital Fund, that was fully committed a few years later. Then the political winds changed direction, and a new governor was elected who felt the private sector should take it from there to avoid turning into corporate welfare. Ten years of momentum, Murray says, have now dissipated.
“Most Midwestern states recognized they needed to prime the pump, and Michigan did a particularly good job, but the support needs to be sustained over time,” Murray says. Reporting VC numbers annually is an artificial way to measure in the first place, he says, because looking at trends over a longer cycle is more meaningful.
After all, he says, the roots of Austin’s transformation, where a Texas college town morphed into a bustling, tech-driven metropolis over roughly the past two decades, had its roots in a series of meetings between the state government, the University of Texas, and the Texas Chamber of Commerce—that took place in 1957, about 40 years before the transformation began.
“The overall trend in Michigan is up, but there is a bit of a lull in support,” Murray says. “The MVCA does a good job in gathering and reporting data and educating legislators about the value of the sector, a lot of which is intangible. It’ll be interesting to see how it shakes out.”