Venture Capital Comes to the Capitol

At long last, the Wisconsin Legislature has enacted a state-leveraged venture capital fund of funds, but now comes the real test — will it really help Wisconsin grow its strongest industry sectors and boost its comparatively lackluster business formation?

The $25 million program, which could be up and running by Jan. 1, 2014, and make its first investment sometime next year, will provide venture capital to qualified startup companies in the advanced manufacturing, engineering, agriculture, information technology, and medical-device industries. All of the funds must be invested in Wisconsin-based businesses.

Even some lawmakers who supported the program contend it’s too small and limited in terms of the industries it helps — biotech firms need not apply just yet — but after two failed legislative attempts to establish a venture capital program, a coalition of venture capital advocates purposely designed the program to avoid certain pitfalls.

The result was overwhelming votes in both legislative bodies, as the State Assembly adopted the program by a vote of 91-2 and the State Senate endorsed it by a vote of 29-3. For a bill that would commit millions of dollars of general-purpose revenue, those are legislative majorities that are almost unheard of.

“You always want more money, but it’s a positive first step,” stated Steve Lyons, government affairs advisor in the Madison office of Whyte Hirschboeck Dudek and president of the Wisconsin Growth Capital Coalition. “This sends a strong signal to investors and startup companies that Wisconsin is focused on this and understands their needs.”

A capital idea?

In terms of translating venture capital into economic growth, neighboring states have the jump on Wisconsin. More than 30 states now have a state-leveraged venture capital program, including several of Wisconsin’s neighbors. Minnesota, for example, can boast that 19% of its workforce is attributable to venture capital deployments. In Wisconsin, only 3% is attributable to VC investment, so there are high expectations for a program that promises to increase the amount of capital for businesses and job creation.

Now the work begins to establish the Wisconsin fund, starting with the selection of a private fund manager and then the identification of at least four private recipient funds that would be expected to provide the 2-to-1 ratio of matching capital called for by the law. According to Lyons, that means the $25 million initial allocation would leverage an additional $50 million, plus an extra $5 million to be raised by the fund manager, for a total of $80 million. Depending on the success of the program, more funding could be allocated in future state budgets.

Lyons believes one immediate benefit would be to prevent an exodus of fast-growing firms that could be lured out of Wisconsin by outside venture funds. It’s not a trivial concern, according to Mark Gehring, president and co-founder of Asthmapolis, a Madison-based startup that has developed respiratory health management technology and has attracted more than $1 million from the California HealthCare Foundation and a $5 million round led by the Social + Capital Partnership.

“There is some risk there,” Gehring said. “We just raised a VC round out of state, and we’re not moving out of Madison to secure that. So it’s certainly possible for a Madison company to raise a Series A round and not have to move the company, but it was an issue. There was probably a higher bar for our company to get that funding from a company located in Silicon Valley. So having local funding sources, both for early-stage and once you get to a more substantial round, is certainly very important.”

State Rep. Mike Kuglitsch, R-New Berlin, a co-sponsor of the fund-of-funds bill, believes the program could be an answer to the “brain drain” in which Wisconsin taxpayers invest money to educate young people, only to see them find better career opportunities, and become taxpayers, in other states. 

“We’ve talked about the brain drain in Wisconsin for years,” said Kuglitsch, recalling how entrepreneurs with ideas have had a difficult time securing funding. So not only has Wisconsin been losing these entrepreneurs, it’s been losing the ability of these new emerging technology companies to hire college grads. With the venture capital, “we are going to be able to keep the entrepreneurs, the ideas, and the college grads,” he said.

Tom Still, president of the Wisconsin Technology Council, believes there is a great deal of pent-up demand in Wisconsin for early-stage capital, but said the long-term success of the fund of funds will be measured in two ways — by return on investment, which the state will share, and by company and job growth. 

Whereas angel capital can get a promising business idea off the ground, venture capital is viewed more as an accelerant for growth. A good chunk of early-stage funding is generated by the state’s Qualified New Business Venture program, in which state tax credits are provided to investors who commit angel capital to Wisconsin firms. The QNBV, established in 2003 by legislation known as Act 255, leveraged $48.4 million in 63 firms in 2012, and investors who made commitments to Wisconsin firms received $12.1 million in tax credits. In all, 160 companies have been certified to receive investments.

In some cases, the new state fund of funds will work in conjunction with Act 255, potentially providing early-stage capital to companies that have already attracted angel capital under the decade-old tax credit program. 

The Wisconsin venture capital picture is not as bright as the angel capital scene. In 2012, a total of $95.2 million was invested in venture capital deals in Wisconsin. That only amounted to three-tenths of 1% of the nationwide total of $26.5 billion, but Still believes coastal and other out-of-state investors are starting to show more interest in Wisconsin companies. He noted that nearly half of the 74 angel and venture deals recorded here in 2012 involved at least one out-of-state or international investor.

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Toni Sikes, a general partner with Calumet Venture Fund, a small venture capital fund based in Madison, believes the new program will help Wisconsin grow its own venture funds. 

“The good news is we’re now building some investment experience with a number of angel groups who have become so sophisticated that they are sort of turning into small venture funds,” stated Sikes, co-founder of The Art Commission, an online platform connecting artists with people seeking commissioned art. “As we grow these very small funds, and hopefully get other new people to come in and start funds, that is going to make a huge difference. It is transformative, even if it only helps two or three or four new funds get started in the state.”

Biotech boycott

While biotechnology companies were left out of the program, several sources noted that there is nothing to prevent future legislatures from expanding the program to boost funding and allow biotech investments. 

Kuglitsch said the reason biotechs were left out is because they require more funding — two or three investments could eat up the entire $25 million — and because the other industry sectors were judged to have a shorter runway from idea to job creation. “This is a jobs bill,” he said. That was one of our top priorities. We’re going to get a bigger bang for the buck and spread the money around in a more efficient manner.”

There were reports that biotechs were left out because of concern over using state funding for embryonic stem cell research, but Kuglitsch said the discussion never really got to that point, or to the point of limiting investments to companies that rely on induced pluripotent stem cells, where adult stem cells are re-engineered to act like embryonic stem cells, bypassing the social controversy. 

“When we are able to prove that this program works, and we are able to utilize larger dollars, then we’ll be able to open it up to all kinds of emerging technologies, which would possibly include the biotechs,” he said.

Bryan Renk, executive director of BioForward, an industry association that represents Wisconsin life and bioscience firms, supported the bill because a number of BioForward industries — agriculture, food, energy, health care, and medical devices — would qualify for investments. “The industry definitions in the bill would probably cover 40% of the industries in our association,” he noted. “Even though we felt the bill was far from perfect, we still felt it was a win.”

Renk said that in future state budget deliberations, the association would lobby to include biotechs in the program. He noted the life sciences and biosciences are strong industry sectors for Wisconsin, not just Madison, and that is illustrated by their ability to withstand the recession of 2008-09. “During the recessionary period, that total sector grew 5% from a job-growth standpoint,” he stated. “The entire state economy lost 6.5% from a jobs perspective, so we think this sector should be supported, and we’re going to push to get it supported in the future.”

Exit strategy

Lyons said there are ample protections, which he described as “firewalls,” written into the law to prevent politics from influencing investments. The five-member body that selects the fund manager will consist of three members from the State of Wisconsin Investment Board and two from the investment capital arm of the Department of Administration.

With the Wisconsin Economic Development Corp.’s hiccups in tracking state development loans, the task of tracking investments will be handed to SWIB and DOA, and it will be the subject of annual audits. In addition, none of the recipient funds could receive more than $10 million of the $25 million allocated.

Wisconsin might have been late in terms of developing sources of capital for its high-growth, early-stage companies, but Still believes the state now can take fuller advantage of entrepreneurial assets like better-than-average investment in research and development, solid patent production, a skilled workforce, and a robust network of angel capital groups.

As the fund-of-funds program develops, public acceptance might depend on educating Wisconsinites about how venture funds work. Investors know they will have some failures in their respective portfolios, but they expect to come out ahead if there are more winners than losers, or if the winners pay off enough to offset any losses. 

Without this perspective, news of a big loss could impact public support. 

“On the public side, not everyone is going to understand how it works, and that is to be expected,” Still said. “One thing I can tell you for sure is there will be companies that fail that are invested in through this fund. That is the same for any private fund, and it’s the same for just about any investment class you could name. Banks have loans that don’t work out. The Small Business Administration has loans that don’t work out, and this is a sector that is no different in that respect.

“However, angel and venture capital tends to be very efficient over time,” Still said. “They do help create more stable companies and companies that are more likely to grow. While there will be some individual failures, on balance this program should work very well.”

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