Badger Fund of Funds to Pump $90M-plus Into Wisconsin Startup Scene

The plan for Wisconsin’s new fund-of-funds program is starting to come into focus.

The headline: The Badger Fund of Funds could ultimately result in at least five new funds investing a minimum of $90 million in more than 100 Wisconsin startups over the next several years. That’s the biggest takeaway from a presentation Tuesday by two of the three managers of the fund-of-funds at an event hosted by the Wisconsin Technology Council’s Wisconsin Innovation Network in Madison.

Last year, Wisconsin legislators passed a bill to give $25 million to fund managers who would raise matching private dollars, then dole out the money to seed new funds that would invest in early-stage companies based in the state. The measure was smaller than previous failed efforts to create a state-backed venture capital fund of at least $200 million, but this bill was passed easily by legislators who saw it as a good start toward fostering a sustainable venture capital ecosystem here.

The legislature picked Sun Mountain Kegonsa to manage the fund-of-funds, an alliance of Santa Fe, NM-based Sun Mountain Capital and Fitchburg, WI-based Kegonsa Capital Partners.

Sun Mountain manages more than $500 million, include overseeing the $350 million New Mexico fund-of-funds program, several New Mexico co-investment funds that total more than $100 million, and co-managing an $80 million fund in the country of Mexico. Sun Mountain has also helped Ohio and Utah develop fund-of-funds programs. Its team includes managing partner Brian Birk and partner Lee Rand, who both spoke at Tuesday’s event.

Kegonsa’s early-stage portfolio includes exits by Wisconsin companies Jellyfish in 2007 and Idle Free Systems this month.

The Wisconsin fund-of-funds will put money into funds that will employ the “money for minnows” investment strategy, a phrase coined and championed by Kegonsa managing director Ken Johnson. The idea, which sounds similar to the “spray and pray” method, involves making a lot of smaller, earlier bets—around $500,000—in diverse startups, rather than making bigger investments in fewer companies in order to selectively search for big hits.

Investors can argue over which school of thought is better, but Sun Mountain Kegonsa’s leaders believe money for minnows is the right approach for Wisconsin because there’s a strong angel investment community here, but not enough early-stage venture capital funds that do deals in the $400,000 to $1 million range.

“We think that is the real fundamental gap in Wisconsin,” Birk said during Tuesday’s presentation. “When there are companies that need to raise $5 million, $10 million, or $15 million, we have found that venture capital funds based in California and in Massachusetts, even some in Chicago or other states, they actually are willing to travel. But when you have a $400,000 to $500,000 investment, those guys will not. Just the economics of the way those funds work, they are not willing to hop on a plane.”

The theory is the fund-of-funds will spur a bigger crop of Wisconsin investment funds for entrepreneurs to pitch to in the earlier stages, their startups will grow, and the bigger, later-stage deals led by out-of-state VCs will follow, Birk said.

“This is a much more fertile way to get the ecosystem moving and to really get a lot of companies launched that will then prove themselves in the marketplace,” Birk said. “Just the sheer numbers of that, eventually you’re going to have more winners coming out of the money for minnows strategy.”

And Sun Mountain Capital’s leaders are optimistic that they can help build a more robust venture capital industry in Wisconsin, pointing to their past experiences. In their first fund-of-funds in New Mexico, 15 of the 29 recipient fund managers went on to start another fund, including eight that started successor funds without additional state money, Birk said.

Birk was careful not to overpromise on anything, but here’s more details on the plan for the fund-of-funds:

—Size: In order to “unlock” the state’s $25 million investment, the legislation stipulates that Sun Mountain Kegonsa must raise at least $5 million from private investors before it seeks fund managers in whom to invest. The upper end of the goal would be a full $25 million match from private sources, according to Birk’s presentation. Sun Mountain Kegonsa’s managers must also put in at least $300,000 of their own money, and Birk said they’ll actually put in $500,000. That means when Sun Mountain Kegonsa closes on the Badger Fund of Funds, it will total between $30.5 million and $50.5 million.

In addition, for every $1 the new funds receive from Sun Mountain Kegonsa, they must invest in startups another $2 from other sources. This minimum 2-to-1 match means that a $30 million fund-of-funds could leverage another $60 million raised by the recipient funds, resulting in a cumulative infusion of $90 million into Wisconsin startups. If Sun Mountain Kegonsa is able to fully match the state’s $25 million appropriation, the total amount would rise to $150 million.

Of course, this all hinges on successfully attracting the private capital. Birk told the Wisconsin State Journal that the sources “could be from anywhere.”

—Recipient funds: It’s hard to pinpoint how many funds Sun Mountain Kegonsa will invest in until it’s done raising the private matching dollars, but the estimated range is four to eight seed-stage funds and one to four later-stage, traditional VC funds. They are expected to invest across the state in a range of industries, including software, medical devices, agricultural technology, and advanced manufacturing.

Although there will inevitably be some overlap in the companies being scouted by the new funds, that presents opportunities to work together, Rand said. Successful startup communities have been able to take advantage of the complementary skills of different funds’ managers, whether it’s technical or marketing expertise, or deep industry connections, he said.

“You can really start to form syndicates where you’ll see two to four funds consistently work together,” Rand said.

Sun Mountain Kegonsa will likely invest in new fund managers, but existing venture capital funds will also be considered for investment, Birk said. The Badger Fund of Funds can’t invest more than $10 million in a single fund, and each recipient fund’s pot won’t exceed $25 million total.

The 2-to-1 match is an aggregate requirement for the recipient funds, but Birk said the matching percentage for each fund could vary. If, for example, two funds each raise $10 million from external sources, Sun Mountain Kegonsa might put $1 million in one and $3 million in the other, he said. “The $30 million ultimately has to be matched 2-to-1 over time by the recipient funds,” explained Wisconsin Technology Council president Tom Still. “This in essence becomes a $90 million fund in time, as those co-investments are made.”

—Timeline: Sun Mountain Kegonsa intends to finish fundraising and close on the Badger Fund of Funds by the end of the year, after which it could start investing in recipient funds. The soonest that startups could get funded is early 2015, Birk estimated.

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