Exit Strategy: Wisconsin Investors Seek Next Wave of Startup Wins

Xconomy Wisconsin — 

Tom Shannon started getting nibbles from potential suitors for Prodesse in 2005, three years after he came on as president and CEO of the biotech firm based in Waukesha, WI.

The company was founded in 1996 by Kelly Henrickson, a Medical College of Wisconsin pediatrics and infectious diseases professor. Shannon and a professional management team came in to run it in 2002 after Henrickson recapitalized the business, Shannon said.

Prodesse (pronounced pro-DESS-uh) became a market leader in molecular testing for infectious respiratory diseases like the flu. As the company’s sales continued to swell, so too did management’s estimate of its worth, Shannon said. Buyers’ valuations of Prodesse also rose, but from a lower starting point than what Shannon and his team previously had in mind.

“Their expectation goes up, but it’s still from their framework,” Shannon said, chuckling as he recalled one potential buyer in particular that was never on the same page as Prodesse. “It took until 2009 to get a number I wanted.”

The magic number: $72 million, which Prodesse got from San Diego-based Gen-Probe. (Gen-Probe is now a subsidiary of Hologic, based in Bedford, MA.) All told, Prodesse exited for 16 times the amount Shannon said he and about 20 investors put into the business.

Prodesse is one of at least 19 major exits by technology-based startups in Wisconsin in the past six years, with deal size ranging from Madison-based Nerites’s $20 million sale to Kensey Nash, in 2011, to Hologic’s 2008 acquisition of Madison’s Third Wave Technologies for a whopping $580 million.

“Wisconsin has a lot of good companies,” said John Taylor, vice president of research for the National Venture Capital Association, based in Arlington, VA. “You can see that there are companies that get acquired and companies that go public, but it’s a smaller region of the country. You’re not going to see the numbers like we see in Silicon Valley.”

(Every other region in the U.S. is essentially chasing California, where 53 percent of venture dollars have funneled since the start of 2012, according to Taylor.)

In talking with Wisconsin investors and entrepreneurs, a major theme I’ve heard is that they’d like to see more in-state startups grow to the point of acquisition or an initial public offering.

Exits are crucial to the state’s startup ecosystem for a host of reasons, they said. These include grabbing the attention of large companies, private equity firms, VCs and entrepreneurs around the country; building up a stable of experienced serial entrepreneurs who (ideally) continue to start new companies in Wisconsin; and sprouting a crop of new angel investors who will take their returns and plow them into the next wave of startups.

That’s exactly what Prodesse’s investors did. Andy Shrago, who served as the company’s senior vice president of sales and marketing, estimated that Prodesse’s backers (he’s one of them) turned around and invested in at least 30 early-stage companies since the acquisition. Shrago now co-manages the angel investor group Wisconsin Investment Partners in Madison.

Meanwhile, Shannon said his current investments include AquaMost, a Madison-based water treatment technology company; Okanjo, a Milwaukee-based e-commerce platform with a community bent; Somna Therapeutics, a medical device company based in Germantown, WI; and HarQen, a Milwaukee-based digital-voice software firm.

“When Prodesse exited for $72 million, I think of the branches of the tree that come off,” Shannon said. “That really provides new blood for lots of other startups. These exits are really important.”

But right now some Wisconsin investors seem to have reached their investment limit and are waiting for a payday.

Investors, “especially the angels, have been having two, three, four [investing] rounds and are very tapped out and need some exits,” Shannon said. “When you’re at a meeting, they’re all looking at each other with glazed eyes like, ‘We need an exit, we need an exit.’”

That’s an issue Shannon and several other high-profile investors and businesspeople want to help address with BrightStar Wisconsin Foundation, a nonprofit organization formed this year to invest charitable donations in Wisconsin startups. Shannon serves as its volunteer CEO.

Not surprisingly, both Shannon and Shrago expressed optimism that more exits are on tap for Wisconsin in the next three years. They declined to name any of their own portfolio companies that might soon be acquired or go public, but Shannon pointed out that it’s still early: the investments made by Prodesse backers have matured for only four years at most.

“We expect to see a number of exits in years five, six, and seven,” Shannon said. “That’s right on our time horizon. We’re feeling good about where most of those companies are going.”

 Standing in the Way

The region has some barriers to overcome, however. A lack of available capital, particularly venture funds, continues to hold back startups and exit activity in Wisconsin, several sources said.

Shannon said Wisconsin’s critical capital gap is in the mid-range between $2 million—generally the maximum investment from Wisconsin angels—and $5 million—typically on the low end of what VCs will chip in for an early round.

Proposals for a government-backed venture capital fund in Wisconsin shrank from $400 million to $200 million over the past couple years, as reported by the Milwaukee Journal Sentinel, before a much smaller $75 million bill passed this year.

“Wisconsin has been a very frustrating place in terms of availability of capital,” Shrago said. “It tends to be a very conservative environment financially. The politicians have just not been able to agree on anything substantive for a variety of reasons. It’s a very different environment than what you would find on the coasts or in some other areas.”

Changing that conservative mindset, perhaps ingrained in Midwest culture, will require more time and effort than passing a bill.

“In Silicon Valley if you fail, people think that’s great as long as you learn from it,” Shrago said. “In Wisconsin if you fail, they won’t back you again. We would do better if we embraced risk more than we do.”

Another barrier is a lack of large private equity firms located in Wisconsin that would tackle acquisitions of businesses with more than $10 million in earnings before interest, taxes, depreciation and amortization, said Andy Nunemaker, an Xconomist and the CEO of Dynamis, his second Milwaukee-area startup.

Golden Angels Investors and Infinity HealthCare sold their shares in Nunemaker’s first startup, EMSystems, to Los Angeles-based private equity firm Kayne Anderson Capital Advisors in 2007. EMSystems’ management and operations remained in Wisconsin, he said.

Three years later, EMSystems was sold to Intermedix of Fort Lauderdale, FL, with operations—and jobs—again staying put.

“Once companies hit [a certain earnings threshold], chances are if they’re looking for an exit, the next ownership group, there’s a high likelihood it will not be based in Wisconsin,” Nunemaker said. “We weren’t looking for buyers in Wisconsin. It wasn’t even on our radar screen.”

Wisconsin startups aren’t always on the radar screen of big-time investors and large corporations on the coasts, but Lisa Johnson thinks they should pay attention to the ideas spawned in this region. She’s the vice president of entrepreneurship and innovation for the Wisconsin Economic Development Corp., the Madison-based quasi-public agency. Before that she worked on two startups during a 22-year private sector stint.

“Sometimes the Midwest as a whole gets overlooked, and I think there are a lot of [good companies] with technologies sitting here,” Johnson said. “There was a time when Washington [state] and Colorado were not that well known. They’ve done a good job promoting themselves.”

 The Aftermath

The success of an acquisition is initially judged by the number of zeros on the term sheet, but the aftermath of the deal can be more nuanced.

The location of a buyer isn’t always a primary concern for a company’s leadership team and investors, but it can impact the community, Nunemaker said. The loss of a corporate headquarters can result in a loss in corporate philanthropy, for example.

Not to mention a potential loss of jobs. Logistics Health CEO Don Weber made keeping the company and jobs in La Crosse, WI, his top priority in seeking a buyer in 2011, he told the La Crosse Tribune. He found that match in OptumHealth, based in Golden Valley, MN.

Meanwhile, Hologic’s acquisition of Third Wave in 2008 turned sour for the Madison-area economy four years later when Hologic announced it would close operations there, leaving 130 locals out of work, the Wisconsin State Journal reported. Those operations are being integrated into Gen-Probe’s San Diego facilities, which Hologic acquired in 2012 in a $3.8 billion deal.

“You’re going to find a buyer,” Nunemaker said. “The question is what impact that might have to the community at large.”

What’s more, a sale isn’t necessarily all positive for the startup’s founders or the startup itself. It can mean a loss of control for the original management team and often can make the company less nimble and aggressive, Johnson said.

Perhaps a lesson here is that exits are an important piece of the Wisconsin growth story—but only a piece. And, for that matter, an exit isn’t the only measure of a startup’s success.

Wisconsin has plenty of business owners who skipped the angel and venture capital route and decided not to sell their company after it started generating strong returns, Johnson said. She cited Promega, a privately held Madison life sciences company founded in 1978 by current chairman, president, and CEO Bill Linton. Promega has grown to more than 1,000 employees in 15 countries and more than $280 million in annual revenue, according to BioForward.

“There is that area of our economy [where] people build [a company] and they stay, especially a lot of your family-owned businesses,” Johnson said. “There are successes going on that aren’t always true exits but bring a lot of value to our economy.”