As Michigan’s venture capital industry made further gains in 2018, it made some progress on one front that’s been the focus of attention the last few years: Diversity.
Statistics tucked into the Michigan Venture Capital Association’s 2019 research report show an uptick over five years in investments into startups companies led by women and minorities.
Sixteen companies led by a CEO from an underrepresented group accounted for $53 million, or 13.7 percent, of the $385 million in venture capital invested in 61 startups in Michigan in 2018. That compares to just 2.8 percent of the $282 million put into 74 startups in 2015, the year after the Ann Arbor-based MVCA began publicly reporting diversity data in its annual report.
MVCA Executive Director Ara Topouzian also points out that 18 of the 140 VC-backed companies operating in Michigan in 2018 were led by a racial minority, an increase of 125 percent from five years earlier when the MVCA first began tracking diversity data.
The 2019 research report indicates some traction in the MVCA’s push to diversify VC investments. Yet despite the gains made over the five-year period, there remains a need for much more progress, Topouzian said.
Diversity among venture capital-backed Michigan startups has “grown substantially” since 2013, “but it’s still low,” he said.
“That’s something that certainly has some room for improvement,” said Topouzian, who joined the Ann Arbor-based MVCA a month ago.
For instance, the percentage last year of VC-backed companies led by female CEOs was the same 10 percent as in 2015. VC-backed companies led by racial minorities did bump up to 13 percent in 2018 from 9 percent in 2015, according to annual MVCA reports.
To further drive diversity, the industry needs to focus on outreach and education to entrepreneurs across all demographics, Topouzian said.
“More people need to realize the opportunities that are out there,” he said.
There’s also very little representation by people who identify as LGBTQ. Just 1 percent of startups backed by venture capital are led by a LGBTQ CEO.
As well, the Michigan VC industry itself has seen little change in recent years in the number of professionals who are racial minorities, female or LGBTQ.
One of the challenges the industry faces in seeking to diversify its ranks is that the number of venture capital firms based in Michigan has been shrinking, said Patti Glaza, managing director of Detroit-based ID Ventures, the venture capital arm of Invest Detroit that manages multiple funds and has $20 million in assets under management.
'Night and day' difference
Twenty-seven venture capital firms were active in Michigan last year, 21 of which are based in the state. That’s down from a peak of 26 Michigan-based firms in 2014.
As the number of firms shrinks, that translates to fewer opportunities for professionals and people who want to get into the field, according to Glaza.
“The ability for us to continue to add more women and minorities is difficult when the number of firms is decreasing,” she said.
Glaza attributes the decline in Michigan-based venture capital firms to a lack of state support. Years ago, the state seeded the formation of new venture capital firms and investments. That effort has since died up and lawmakers in Lansing have been reluctant to consider doing more.
“We’re really beginning to see the impact in the number of startups and the number of funds,” Glaza said. “The long-term impact is something we’re all worried about.”
The MVCA annual research report offers an in-depth look at the venture capital industry in Michigan, including deal flow, and where the money’s coming from and where it’s going.
In 2018, Michigan-based venture capital funds more than doubled the amount they invested in startups, although the money went to fewer companies.
The MVCA report shows 61 startup companies collectively received $385 million in venture capital in 2018, the largest amount ever invested in one year in Michigan. That compares with $179 million invested in 68 startups in 2017.
The amount invested in Michigan last year was more than three times the total from 2013. The number of startups receiving funding grew more than 50 percent during the same period.
The availability of venture capital in Michigan today is “night and day compared to where it’s been,” said Tim Parker, president of Grand Rapids-based Grand Angels, an operator of venture capital funds and an angel investor network.
“We’re seeing some amazing progress,” Parker said.
While overall investment grew last year, so did the gap between the projected demand for follow-on investments and the availability of funds.
The 140 venture capital-backed companies in Michigan require an estimated $967 million in follow-on venture capital investments over the next two years, according to the MVCA’s 2019 research report. Michigan-based funds have about $337 million reserved for follow-on investments, meaning companies will need to attract outside venture capital to satisfy their needs.
Given the growth in venture capital investing in Michigan in recent years and the maturation of venture capital-backed companies, the MVCA’s Topouzian classifies that need as a good problem to have.
“People look at it and say, ‘This is great. We’re investing properly and there’s some interest,’ but it’s also saying that there’s just not enough,” Topouzian said. “We have definite talent in this state and the entrepreneurial community is doing some wonderful things, but they need the capital and that seed money to get going, so it’s kind of a double-edged sword of sorts.”
MVCA data show startups and early-stage companies accounted for 58 percent of investments in 2018, followed by 26 percent invested in companies at the growth and expansion stage, an area where the capital gap is largest.
That gap was noted last week in an annual scorecard on Michigan’s entrepreneurial climate issued by the Small Business Association of Michigan and Michigan Celebrates Small Business.
“Michigan has not been highly successful in attracting expansion/later stage venture capital, placing below the 50-state average. However, it has performed usually near the middle or better among its Midwest peers,” according to the Michigan Entrepreneurial Score Card.
The SBAM report ranked Michigan 18th nationally as of 2017 in seed capital and early-stage venture capital, noting a 152-percent increase from 2014 in financing per $1,000 in state gross domestic product. Meanwhile, Michigan ranked 29th for expansion and later-stage venture capital, with a 2-percent change from 2014 to 2017.
Raising new funds
To help fill some of those capital gaps, the MVCA has a goal to increase the out-of-state capital flowing into Michigan, according to Topouzian.
“We would certainly like to see other investment looking to Michigan, more so than maybe it has been,” he said.
In working to create new funds, venture capital firms that are either based in the state or have a presence in Michigan last year collectively raised $350 million from investors, a little less than half of the $657 million they targeted.
Eleven of the existing firms in Michigan presently aim to raise $722 million in 2019 with a targeted average fund size of a little more than $90 million.
Among those raising money is Grand Angels, which recently closed on the first fundraising round for its third venture capital fund, which is targeted for $15 million to $25 million.
A majority of the investors in Grand Angels Venture Fund III were backers of the firm’s prior venture capital funds or members of the angel investment group in West Michigan, which has affiliates in Kalamazoo and Detroit, Parker said. The fund also attracted outside investors.
“Our reception has been very positive,” said Fund III Managing Director Paul D’Amato. “We’re coming off of two successful funds and raising a third has been received very well.”
D’Amato and Parker declined to say how much Venture Fund III raised in its first round.
Some of the investors who put money into the fund are people who are looking for an alternative investment.
Wall Street volatility and relatively low interest rates have led investors to look for other places to put their money, including venture capital, angel investing and private equity.
“There’s definitely an interest in moving into private equity or alternative investments outside of the public markets. The public market is high, frothy and there are concerns around a number of things, trade issues and otherwise,” Parker said. “We’re seeing good interest in being involved in alternative investments, either from our fund or individual members of our angel network investing directly in local Michigan companies.
“That’s part of their intention, to take some money and put it into investments that are less correlated with the public market.”
Investors interested in alternative places for their money are typically seeking higher returns, said John Cassady, chief investment officer at Grand Rapids-based Red Cedar Investment Management LLC.
Interest in alternative investment has been growing during the last decade, he said.
“People over the last five to seven years have been really seeking out these alternative investments … whether it’s a pension plan that has a target for what they need to earn, or maybe an endowment or a foundation,” Cassady said. “That’s sent a lot of money looking at other places.”
Grand Angels Venture Fund III targets investments in young companies involved in life sciences, advanced manufacturing and software. The fund aims to invest in 15 to 18 companies over three and a half years, with five or six deals expected in 2019, Parker said.
Fund III recently made its first investment by participating in a $54 million capital round for Ann Arbor-based Histosonics Inc., a medical device company that developed an ultrasound therapy to destroy cancer tumors. Grand Angels was a prior investor in Histosonics.
The Series C round was led by Palo Alto, Calif.-based Varian Medical Systems Inc. and New Brunswick, N.J.-based Johnson & Johnson Innovation LLC.
Parker expects fundraising for the third fund to continue into the summer and attract family offices and investors from outside of Michigan.
“We’re not done yet. We still have good investor interest and a number of people who still want to be part of the fund,” Parker said. “We’re confident that we’ll get a good amount. We already have what we consider to be a successful fund and we’re making solid investments out of it. With additional funds we’ll be able to invest in that many more companies in Michigan.
More angel investors
On top of the amount of venture capital invested by Michigan-based funds, angel investors in the state put $52 million into 84 startup companies last year. That compares to more than $41 million they invested into 37 startups in 2017.
The number of angel investors in the state grew to 859 individuals at the end of 2018, up from fewer than 800 a year earlier and more than double the number from five years ago.
At year’s end, Michigan had 11 active angel groups. Since the start of the year, two more angel investment groups formed in the Detroit area: the Grand Angels affiliate Woodward Angels and Birmingham Angels.
Venture capital funds managed by universities and economic development organizations in Michigan also grew last year to $46.8 million, a 19-percent increase from the prior year. During 2018, those funds invested $5 million into 47 startups, with 80 percent of the money invested at the seed capital stage.
Investors in venture capital funds come from a variety of sources, led by individuals and small family offices that are involved in 24 of the 27 venture capital firms based in Michigan or with a presence in the state.
Large family offices back 19 firms, and large corporations and charitable foundations are invested in 14 funds each. Endowments are involved in 13 funds in the state, according to the MVCA.
Despite the year-to-year growth in venture capital invested by Michigan funds, total capital under management declined for the third straight year from $3.88 billion in 2017 to $3.73 billion. Total capital under management in Michigan peaked in 2015 at $5.26 billion.
Since that time, capital under management by venture capital firms based elsewhere but with a presence in Michigan declined from a peak of $3.1 billion in 2014 to $1.53 billion last year. Capital under management by in-state venture capital funds held relatively steady since 2015 to end last year at $2.2 billion.
The decline in capital under management by out-of-state venture capital firms could reflect that they deployed their available capital in Michigan and are no longer actively investing, or recorded exits from their investments, the MVCA’s Topouzian said.
He described the decline over the last few years as “something to keep an eye on, absolutely.”