THE BLOG
12/21/2012 10:43 am ET Updated Feb 20, 2013

Midwest Primed For Action Despite Uncertain 2013 VC Climate

On December 19, the National Venture Capital Association (NVCA) and Dow Jones VentureSource released their 2013 Venture View predictions survey. If some of these industry forecasts hold true, it's starting to look like it may be tough sledding here in the Midwest.

Forty-four percent of investors predicted that the overall venture capital market was going to further contract next year, meaning fewer dollars concentrated into fewer funds. In addition, 45 percent of VCs surveyed said early-stage (or Series A) capital will be the most difficult type of funding to attract in 2013. For a region such as the Midwest, which has struggled to attract its fair share of VC dollars and Series A rounds even in a good fundraising environment, a marked decrease in dollars available will likely have a more severe impact on the entrepreneurial community. A decrease in overall capital, combined with the fact that 80% of venture dollars are typically invested on the coasts, will likely undercut the progress of budding tech scenes in places such as Detroit, Minneapolis and Milwaukee.

Here as well in Northeast Ohio, the region has developed an entrepreneurial ecosystem including incubators, accelerators, organized angels and a healthy array of pre-seed funds.

"Today, most Northeast Ohio startups with a promising idea with market potential have the ability to raise $25,000 to $250,000 from any of a variety of funding sources," says Lynn-Ann Gries, my venture development organization's Chief Investment Officer. But seed funding only gets a company so far, and our region has been challenged to help these companies find the follow-on funding needed to support their continued growth - particularly Series A and B capital that is locally managed.

The Venture View survey also has challenging news for our region's traditionally very strong sectors. Sixty-one percent of VCs surveyed predict a decrease in cleantech investment--a sector that, from waste heat recovery to advanced materials, trades on the Midwest's manufacturing infrastructure and technical expertise. Another 53 percent of VCs foresee a drop in capital invested in medical devices and 49 percent see a reduction in biopharmaceuticals investment; both of these sectors are core components of the thriving entrepreneurial scenes in places such as Minneapolis-St. Paul, Chicago and Northeast Ohio.

Although this collection of data and commentary seems bleak, I take it as a catalyst for action. It needs to serve as a wakeup call to the Midwest's stakeholders, including public policymakers, investors and entrepreneurs, who must react now to mitigate future damage to both companies starting and growing here and the economic benefits they can generate for our economy. Some of the steps we could take might include:

  • Corporate investing. This is an area of opportunity for the Midwest. The region has a good number of Fortune 500 companies; for example, Minnesota has 19, Michigan has 20, Ohio has 28 and Illinois has 32. With predictions of an upward trend in corporate investing-according to a separate early 2012 MoneyTree Report by PricewaterhouseCoopers and NVCA, corporate VCs took part in 15 percent of all 2011 VC investment deals, up from 12.7 percent participation in 2009--the time seems right for established Midwest corporations to step up and become strategic investors, putting money in young companies with appealing technologies related to their industries. This would certainly help close the funding gap. Some are already working to capitalize on this area of opportunity; Procter & Gamble recently contributed $25 million and office space to Cintrifuse, an incubator trying to lure more startups and venture capital to Cincinnati.

     

    Of course, for startups seeking capital from corporate partners, the path isn't easy to find, much less follow. Corporations don't operate like VCs. It's not always easy to find the correct person to approach--much less know if a corporation might have a strong interest in one's innovation. In addition, corporations first have to recognize the inherent value of investing in early-stage companies. For many corporations, this involves a pronounced mindset shift. In the past, they would traditionally want to buy a company that has already proven to be successful and integrate it into their existing business, rather than spend the time and money to invest in something that's less of a sure bet.

  • Work harder to ensure investment from other parts of the country. This could take the form of a fund-of-funds spanning across the whole Midwest, as was suggested in a 2010 in a Brookings Institute report authored by Frank Samuel. Or it could be an even more focused fund-of-funds; assuming the aforementioned Cintrifuse raises enough capital, it is also going to function as a fund-of-funds.

    In Ohio overall, we've have success with a state-formed, $150 million fund-of-funds called the Ohio Capital Fund, which was launched to help support local investors and to also stimulate seed or early-stage private investment in the state's companies.

    "Sixty-seven Ohio companies have benefited from the Ohio Capital Fund, with a total of $546 million in capital contributed by VC funds supported by this state-supported approach and their co-investors," says Gries. "We certainly would like to see initiatives like this continue, only at a much larger scale. One hundred fifty million sounds like a lot until you consider that we need to fuel activity across the entire state and support a significant number of companies."

    More tactics to address the lack of capital in Midwest states are also in the works. The University of Minnesota recently took steps to create two VC funds, including one which it hopes can raise $50 million to help commercialize technology out of university-created startups. And Silicon Valley venture capitalist and former JobsOhio President Mark Kvamme, after seeing the quality of startups in the Midwest, is in the process of creating a VC fund focused on investing in the region's highest potential companies (with a focus on Midwest startups). A fund like this would help address a Series A gap, something that's a growing problem everywhere. An idea like Kvamme's, which runs counter to traditional VC behavior and industry-wide trends of contraction and concentration, has great potential and I think this is a great idea that has huge promise.

  • Encourage more individuals to invest in companies. Ohio is already home to two of the largest organized angel groups in the country. Motivating more people to invest-and educating them on how to do so wisely--is critical for the region, as it searches for ways to close the funding gap. Programs like the Ohio Technology Investment Tax Credit have proven to have the ability to get angel money into young Ohio companies.

Still, the story of the Midwest as a hotspot is getting out there, as evidenced by the Venture View statistic that company CEOs asserted that the Midwest is the region with the most potential for growth. No doubt some of the reasons for this prediction are as follows:

  • The aforementioned strong angel community. This is poised to only get stronger, as public policy programs to foment and accelerate angel investing in the Midwest increase.
  • Sector strengths. The Midwest is known for strength in the B2B and healthcare IT sectors. These two sectors are positioned for near-term success: 61 percent of VCs surveyed foresee increases in Business IT investment, while 57 percent predict more Healthcare IT investment.
  • Infrastructure. Midwest cities now have entrepreneurial support ecosystems in place to flesh out ideas and provide necessary seed capital and non-monetary resources.
  • Good investment value. The region is full of competitive, capital-efficient companies with reasonable valuations--meaning they stand to be less risky and more profitable investments for VCs.

Of course, only time will tell whether the Venture View's 2013 predictions are correct. But, as always, it's important to keep the following in mind: While a challenging investment climate might make it difficult for some companies to get the money they need right away, at the end of the day, good companies can and almost always will get funded.

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