28 Jan For Now, Michigan Can Celebrate $150 Million Entrepreneurial VC Fund
CHICAGO – Michigan has an ancient and proud history of interstate sports rivalries (especially with Ohio, Illinois and other Midwest states). Sometimes, like this past New Year’s Day, the rivalry generates nasty taunts such as: “What do the Michigan Wolverines and marijuana have in common? They both get smoked in bowls.”
Some Midwest states may be fomenting another interstate rivalry. This one is of keen interest to entrepreneurs.
Earlier this month, Michigan’s state government announced a major new initiative aimed at helping entrepreneurs get funded. The express motivation is to overcome a lack of private entrepreneurial investment, keep entrepreneurs from fleeing to other states and generate growth in economic activity, employment and, of course, tax revenues.
The announcement was greeted enthusiastically in Michigan. Reportedly, several other states (including Ohio and Illinois) are considering similar programs. Since it’s premature to actually handicap a contest, though, we’ll have to settle for a scouting report on Michigan, which is the first Midwest team to reach the field.
Major League Versus Minor
The Michigan initiative creates a $150 million VC fund – the Michigan Venture Investment Corporation (MVIC) – to funnel investment to seed and early stage companies based in the state. That’s a sizable number in itself. The intent is for the fund to be perpetual with returns on early investments used to fund later investments. Especially in this era of more modest VC appetites, even a self-liquidating $150 million fund is fairly large.
Rating: big league potential
Pro Talent Versus Amateur
The investing team is composed of all Michigan professional talent.
The state fund will provide financing to Michigan-based venture capital firms that will undertake the actual investing. In investing vernacular, MVIC will be a “fund of funds”. On the positive side, VC professionals will be responsible for picking winners and losers. On the negative side, past data is not publicly available on Michigan VCs to judge their performance.
Not surprisingly, the state association of venture firms (the Michigan Venture Capital Association) strongly supported the initiative. Some cynics observe that getting funds from state coffers is a lot easier than having to raise capital from cold-eyed limited partners.
Rating: promising, but too early to tell
MVIC will be directed by a seven-member board that will include two state employees and four political appointees (selected by the governor, the state Senate and the state House of Representatives) and one from the MVCA.
Unavoidably, that means the MVIC ultimately will be controlled by politicians rather than professional investors. Details don’t seem to be readily available as to how this coaching staff will oversee the investment game plan or select and evaluate the performance of individual VCs.
News reports suggest high enthusiasm for MVIC – at least by the most interested Michigan parties – including entrepreneurs, VC firms and politicians. Enthusiasm is one of those intangibles that can mean the difference between success and failure.
Still, there may be intangibles that are not so favorable. For example, news reports suggest that one way the MVIC will raise capital is by offering investors tax credits to guarantee a certain annual rate of return (perhaps about 6 percent, which kicks in after five years). That is, if MVIC doesn’t meet its guaranteed rate of return, the state must make up the difference in tax credits.
This is a big difference compared to the way financing is raised by private venture funds, which not only don’t guarantee any return but warn limited partners that they could lose their entire investment. Though there seems to be little media analysis of this provision, at least one observer is concerned.
Michael LaFaive, director of fiscal policy at the Mackinac Center for Public Policy in Midland, Mich., was quoted as criticizing the use of a guarantee to lure investors: “What we have here is essentially an unbudgeted liability because we can’t anticipate the losses that could occur,” he said. In other words, it’s an intangible that could turn nastily tangible (especially to Michigan taxpayers).
If the guarantee is as reported, economists would call it a subsidy. Subsidies are notorious for leading to overly risky investment and for eliciting more quantity than objective conditions warrant. This may be exactly the reason for the MVIC, but if so, it’s a risk for Michigan taxpayers and workers and it hasn’t been widely reported.
Rating: reasons for concern
Yes, it’s early in MVIC’s franchise life, but it’s never too early for predictions. At least in the short term, certain interest groups appear to be clear winners:
1. Michigan-based venture funds
2. Michigan-based seed and early stage entrepreneurs
3. MVIC investors
4. Michigan politicians
Other Michigan-based parties may or may not be winners or losers in both the short and long run. It will take at least a few years to find out. In the meantime, less media cheerleading seems appropriate.
Yes, Michigan has taken a major step to promote entrepreneurship and other states seem poised to follow suit, but there are many very good reasons why certain states have an ample supply of entrepreneurial funding while Midwest states seem to go begging. Most of these reasons are the result of private economic decisions, which history shows offer better odds than government programs (including those with private partners).
So go ahead and celebrate, Michigan, but with a certain amount of humility until the scoring begins – you know, humility, like athletes show in end-zone celebrations.
Darrell Dvorak is a partner with Tatum Partners. Formerly, he worked in senior roles at Skokie, Ill.-based Searle (now owned by Pfizer) and Ameritech (now SBC). Dvorak can be reached at firstname.lastname@example.org.
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