Badger Fund of Funds Leader: Small Ball Is Best Way to Play
Ken Johnson, one of Wisconsin’s most successful venture capitalists, says a recent investment he’s proud of is buying season tickets for the Chicago Cubs. Seat prices at Wrigley Field, the team’s home ballpark, have shot up as the Cubs try to extend their surprising season into the playoffs for the first time since 2008.
Johnson’s plan for pumping more venture capital into Wisconsin startups is perhaps best captured in baseball terms: Investors need to be more focused on hitting singles and doubles, not home runs.
“When you are dead last, standard practices may be the best approach,” says Johnson. He’s referencing the Ewing Marion Kauffman Foundation’s state rankings for startup activity, where you’ll find Wisconsin at the bottom of the list.
Enter the Badger Fund of Funds, a state initiative five years in the making, where Johnson will be one of two general partners. He shared details about the funds—which could begin investing in startups later this year—and laid out his argument for why venture capital in Wisconsin needs a mindset shift before a crowd of investors Tuesday in Madison, WI.
Brian Birk, of Santa Fe, NM-based Sun Mountain Capital, will serve alongside Johnson, who comes from Madison-based Kegonsa Capital Partners. Together, they’ll run the fund of funds under the name Sun Mountain Kegonsa.
Sun Mountain Capital managed its first fund of funds in New Mexico. Fifteen out of 29 “recipient” fund managers later started another fund, eight of which were launched without additional state money.
The Badger Fund of Funds will manage $25 million from the state and at least $8 million in private investments, with $500,000 of that coming from Birk and Johnson. The idea is for small chunks of money, at least by venture capital standards, to trickle down to smaller funds around the state, each of which will have its own manager.
For every $1 the new funds receive from Sun Mountain Kegonsa, they must invest in startups at least another $2 raised from other sources. This minimum 2-to-1 match means the current $33 million across the fund of funds could turn into a $99 million infusion into Wisconsin startups when the other money is factored in. Or more, if private investors pledge additional dollars.
In three years, Johnson expects six to 12 funds to be collectively making about 50 investments annually. Johnson envisions two tiers of recipient funds: one that writes $500,000 checks to seed-stage startups and another that writes seven-figure checks to later-stage companies that have begun to bring in revenue.
Johnson brings this “money for minnows” investment strategy from his previous fund, where he and other investors made lots of small, early bets in startups from a range of industries, including biotechnology, manufacturing, and medical devices.
“Instead of looking for the next Google, we’d like to have 10 to 20 companies like Intelligent Bio-Systems, ConLinCo, and Jellyfish,” says Johnson, naming three of the companies his former fund invested in that netted an internal rate of return (IRR) greater than 200 percent.
Johnson mentioned that target several times during his presentation as a key investment benchmark. He pointed out that the average 20-year return on seed- or early-stage venture capital is 26 percent, according to the Thomson Reuters U.S. Private Equity Performance Index. Since venture investments are only successful one-eighth of the time, a 200 percent IRR is the mark venture capitalists must surpass.
“We want to make sure we’re making national average returns so people come to us,” says Johnson. “People say, ‘The reason I don’t come to Wisconsin is nobody is making money there.’”
Startups in the state can become victims of their own success when they achieve seed-stage valuations that, as time passes, start to appear unrealistically high, says Susan Healy, principal at Madison-based Ascendancy Advisors. That hinders their long-term fundraising ability, Healy says, because later-stage investors feel the need to put in preferences like liquidation rights and cumulative dividends to mitigate against the lofty valuations.
Companies who accept money from the fund of funds will get a “clean sheet of paper,” says Johnson, meaning they’ll be valued appropriately and the deals will use common stock only.
This, like the initiative’s overall investment strategy, is familiar territory for Johnson. “Kegonsa has done very few offerings when everything hasn’t been common stock,” he says, alluding to his previous fund.
Johnson cites “emotional investing,” where an investor’s initial love of a product overrides his or her better judgment, as one factor that plagues later-stage Wisconsin startups seeking more venture capital down the line.
A key next step is to name the recipient fund managers. Sun Mountain Kegonsa is doing “due diligence” on five prospects, says Johnson. If the fund decides all are fit for the job, two will be based in Dane County, with one apiece in La Crosse, the Fox Valley, and Northern Wisconsin.
One of the five is Michael Thorson of Inventure Capital, a Madison-based investment fund. If selected, Thorson says, he’d be running one of the Dane County funds.
Johnson says one benefit of the Badger Fund of Funds’ structure is the ability to pair senior fund managers with younger investors, who he says will have three to five mentors approving investments at first. The idea is to grow employees and venture capital as a whole in Wisconsin, says Johnson.
“I want to transfer everything I know to that next group so they don’t have to run into all the same problems I did,” he says.