The Michigan Economic Development Corp. plans to put $3 million into a capital fund that will invest in early-stage technology companies.
The Michigan State University Foundation will match the state money with $2.5 million of its own, for $5.5 million total, and manage the Pre-Seed Fund III, which will operate similarly to two prior capital funds formed by the state.
As well, the MSU Foundation will provide coaching and mentorship in areas such as finance, marketing tactics and strategy to entrepreneurs behind the startups the fund backs, said Jeff Wesley, executive director of Red Cedar Ventures, the organization’s venture capital subsidiary.
Red Cedar Ventures operates an “active fund” that “is there to provide guidance and coaching in every aspect with their business,” Wesley said. The MSU Foundation also has an established professional network that includes prospective investors who could participate in follow-up investments as a startup company progresses, he said.
“When you’re dealing with pre-seed companies, you’re pretty hands-on. So, we’re there every day, working with them on all aspects of the business,” Wesley said. “We see the challenges of the startups and we’ve worked with many over the last few years. We just can’t get these funds fast enough to help these entrepreneurs that work so hard and get their businesses commercialized.”
The Michigan Strategic Fund board chose Red Cedar Ventures to manage Pre-Seed Fund III over Invest Michigan and Ann Arbor SPARK, each of which operated prior pre-seed funds. Proposals from all three firms scored highly in an evaluation, with the MSU Foundation edging out Invest Michigan and Ann Arbor SPARK in final scoring.
Red Cedar Ventures, created in 2014, presently has 50 active startups that it backs. Those startups have collectively received about $5 million from Red Cedar Ventures and have gone on to secure $200 million in follow-on investments, Wesley said. Managing Pre-Seed Fund III extends the reach of Red Cedar Ventures, which has focused primarily on innovations spinning out of the university.
“We think we can have a huge impact going forward for these companies through the unique infrastructure that we have and our ability to coach them to success, and we’re just looking forward to the opportunity,” Wesley said. “We’re looking at taking all of the lessons learned, and all of the experience we have and the ecosystem we have, and bring that to the rest of the state.”
‘Right thing to do’
Pre-Seed Fund III follows two prior funds that since 2011 have collectively provided $20.5 million in early-stage capital to 125 tech startups, which went on to leverage the investments to attract nearly $560 million in additional capital.
Given the success of the earlier pre-seed funds, the MEDC decided to proceed with Fund III to try to address a persistent gap in the access to capital for young startups. That gap has widened over the years as angel and venture capital investors moved upstream to take on less risk with companies that have progressed beyond their earliest stages.
“That’s just become the norm now,” said Fred Molnar, vice president of entrepreneurship and innovation at the MEDC.
“Some very good companies would come out of the university system or out of a SmartZone and they would have great ideas and rely on their self-funding — friends, family, etc. — and then after that, there was a gap,” Molnar said. “That’s where the state stepped in and we thought we could best help.”
The MEDC hopes the funding can help to move early-stage startups to where they can attract funding from other angel and venture capital investors, Molnar said.
Filling the gap in the capital continuum is “elementally crucial to the ecosystem,” said Dale Grogan, a managing director at Grand Rapids-based Charter Capital Partners. He served on a committee that evaluated proposals to manage Pre-Seed Fund III.
“It is absolutely the right thing to do and I wish there was more of it,” Grogan said. “I can’t stress how important this is for economic gardening and building the ecosystem.”
‘Best support possible’
The MEDC was planning the Pre-Seed III Fund prior to the COVID-19 pandemic that spread into Michigan in March. The fund is separate from other efforts to aid small businesses and startups hit by the pandemic.
Still, a MEDC staff memo this month to the Michigan Strategic Fund board noted that formation of the fund “is especially critical at this time, considering the impact of (the) COVID-19 pandemic on Michigan technology early stage companies.”
“Now more than ever, the goal is to get (the) best support possible to early stage technology companies, putting them on a path to survive the current economic crisis and scale when the downturn subsides,” MEDC staff wrote in the memo.
“When it’s impacting major companies, you can only imagine the stress smaller companies have as they try to power through it,” Wesley said.
The MEDC’s first pre-seed fund of $10.2 million, formed in 2011 and administered by Ann Arbor SPARK, made 86 microloans and investments in 74 companies over five years. Those companies went on to attract $283.2 million in follow-on investments, created or retained 509 jobs, secured 109 patents and generated $25.1 million in new sales, according to the state.
The $10.3 million Pre-Seed Fund II, run by Invest Michigan, made 108 investments in 51 tech startups that later attracted $275.5 million in private capital, created or retained 2,248 jobs, were issued 95 patents, and collectively generated $130.2 million in new sales, according to the MEDC.
The state’s $3 million allocation for the third pre-seed fund was based on what was available in this year’s MEDC budget, Molnar said. The MEDC plans to return to the Michigan Strategic Fund board in subsequent years for further allocations for the fund, he said.