Show Me The Money: VC In MI

Photoshop is equal parts relief and frustration in Michigan. Relief because it was genius born and bred in Metro Detroit that invented the program that revolutionized the world of pictures and graphics. Frustration because the thousands of valuable high-tech jobs it spawned are mainly based on the West Coast in Washington and Northern California.

Thomas Knoll first created Photoshop in Ann Arbor "for fun" while working on his PhD at the University of Michigan in 1987. At the urging of his brother John, Knoll developed the software into a viable commercial product while his sibling pitched it in Silicon Valley. After a few demonstrations, Adobe scooped up Photoshop and turned it into its flagship product.

"That's where the industry was at the time," says Knoll, a lifelong Ann Arbor resident who serves as a consultant with Adobe. "I debated moving out to California but decided not to because I like living here."

Almost 20 years later, high-tech entrepreneurs still travel a similar path in Michigan. Think Google and how Michigander Larry Page co-invented the search engine that was developed and is now based in Northern California's Silicon Valley. But that's changing as more and more home-based venture capitalists and angel investors are tapping into the state's deep talent pools.

"We're not interested in small businesses. We're interested in businesses that are temporarily small," says Thomas Kinnear, director of the Institute for Entrepreneurial Studies at University of Michigan's School of Business. He is also the managing director of UofM's Wolverine Venture Fund, an investment pool run by MBA students, and president of the investment board of the Venture Michigan Fund.

Our state of venture capital

Michigan is ranked 20^th in the amount of venture capital, the mother's milk of high-tech innovation, invested in states in the second quarter of this year, according to the National Venture Capital Association. That's up eight spots since the first quarter. Not too shabby for an area where innovation has historically taken place on factory floors.

However, the reality is that the Wolverine state's $54 million in venture capital investment this quarter is a drop in the bucket compared to the $3.5-billion-with-a-b in venture capital invested in California, about half of all venture capital investment, in the same the time. Much of that is invested in Silicon Valley, which is awash in money, expertise and the wherewithal to take risk that creates venture capital's perfect storm.

California's dominance of seed money doesn't mean everyone else should tuck tail and hide. Michigan has more than its fair share of entrepreneurs with good ideas. The state's university system keeps the talent pools deep and despite the conventional wisdom otherwise, lots of Michiganders prefer to stay here.

Many of the state's best known companies, GM and Dow, got their start thanks to angel investors, wealthy individuals who provide capital to start-ups in exchange for equity stakes. That tradition continues today where local firms like Pleasant Ridge-based ePrize, Detroit's Asterand and QuatRx of Ann Arbor are really starting to flex their profit-making and job-creating muscles for the first time thanks to local venture capital and angel investors.

"The infrastructure is here and the venture capitalist history here goes back 150 years," says Ron Reed of Seneca Partners, a Birmingham-based venture capitalists firm.

Although the major venture capital firms are on the coasts, a smattering of local firms, about 14, are taking root here. Add in the entities like the Venture Michigan Fund, Michigan 21^st Century Investment Fund and the Wolverine Venture Fund and there is more than enough to build on. The problem is finding a way to channel more of our money into turning the state's brawn-based economy into a brain-based one.

"There might be enough fire power (about $500 million) to start 50 companies, which is not a lot," says Mary Lincoln Campbell, managing director of EDF Ventures, an Ann Arbor-based venture capital firm. "We need more capital and more choices for entrepreneurs."

Show me the money

The lack of available, local capital is the chief challenge to developing the companies today that will create the tomorrow's jobs in Michigan. Out of 200 ideas submitted to a local venture capital firm, it may invest in two. Maybe. That creates a fierce competition among startups and a prominent position for angel investors.

Rand Mueller, 57, has been following that string of money for years. Pontiac-based Guidepoint Systems, which the Waterford resident founded a few years ago, is his 13^th startup. The company uses GPS technology to track vehicles. It serves as an alternative to Lojack and OnStar.

Mueller raised $2 million from angel investing in 2003 and another $5 million last year, fundraising that has taken him across America. He points out that starting capital is paramount to weathering the sure-to-come storms that sink many new ventures.

"Always go and raise money when you don’t need it," Mueller says. "Always, always, always, underscore always, raise a lot more than you think you’ll ever need."

He describes Michigan's venture capital environment as "a distant third, fourth or fifth" compared to the rest of the country, to put it nicely. He sees signs of improvement, but it lacks the sophistication of other states that are enjoying hundreds of millions of dollars in venture capital investment.

"Our state needs to decide where to go from here," Mueller says. "Mainly I find lacking is 'What’s the strategy?' There are plenty of VC guys in southeast Michigan that are working hard and trying to attract people here. There are deals getting done here. But it’s far easier in Northern California."

It's not all about the money. A sudden infusion of billions of dollars would not solve the problem. Venture capitalists and angel investors usually bring much more to the table than cash. Their experience, expertise and other intangibles prove invaluable to startups, especially the ones run by new entrepreneurs.

Many of these businesspeople have earned their stripes, watching numerous businesses sink and boatloads of cash with them. Half of the businesses Mueller has started have failed, a fact he's proud of.

"I’m not embarrassed about that," Mueller says. "You learn something each time."

Those who give the seed money also tend to own, or have major stakes in, established businesses in the market. Those startups often end up selling to those companies, which is what Mueller hopes to do with Guidepoint, before moving forward with their next big idea.

This business climate is exactly why Silicon Valley is the Mecca for venture capital and startups. The same holds true for car centric technology in Michigan, because the state is loaded with that expertise. But the fact that most people can name the state's major technology firms and count them on one hand means the state still has a long way to go to grow more investment.

"If you invented Photoshop software today, what company would you take it to to sell it?" says Tom Meloche, an Ann Arbor resident and president of Studytag.com. There is a silence on the line. "That is the answer I get most of the time."

The 20-minute rule

A common sentiment among local entrepreneurs is that Michigan shouldn't pretend to be Silicon Valley. The state should play to and build on its strengths. That doesn't mean it shouldn't crib some of the ideas of venture capital hotspots, such as Northern California or Massachusetts (No. 2 in venture capital investment).

Institutions like Ann Arbor Spark help entrepreneurs get their feet under them and their ideas organized so they are prepared when they make that 15-minute speech to potential investors. Groups such as Web 2.0 facilitate meetings between local tech entrepreneurs. Events like the Michigan Growth Capital Symposium puts large numbers of local companies and venture capital firms in the same room together, helping make the connections and synergies that can launch these companies. And of course, the state's university system continues to produce top-notch talent.

"The cool thing is you can still invent personal software in Michigan," Meloche says.

"The endgame is the companies that make them are often sold and the jobs moved out of state."

Or the entrepreneurs leave for greener pastures before the process even starts. If a major venture capital firm in California receives 200 ideas and 190 of them are local, chances are the money will stay instate.

That constitutes the 20-minute rule of venture capital. The investors usually like to invest in companies that are within a 20-minute drive of their home. That's not too outlandish considering these are usually million-dollar investments. And if they find a company they really like outside of their comfort zone, they lean on that company to move closer to them.