Call it a Goldilocks dilemma: When it comes to venture capital,
how much is too much, too little or just right?
That depends on whom you ask. Last year, for instance, Minnesota
saw a record amount of venture capital$877 milliongo
to young entrepreneurial companies. Some might think that's a lot
of porridge, but manyeven in the Twin Cities, where most of
Minnesota's venture capital landsbelieve the state's helping
of venture capital is downright meager.
In some ways, they're right. Despite solid growth in venture capital
financing in the last half-decade, the state is not keeping pace
with the rest of the country. The situation is even more dire in
the rest of the district, where entrepreneurs have to look long
and hard for venture capital. This worries policymakers and business
leaders alike, who see venture capital as an important nutrient
for fast-growing, entrepreneurial companies that could turn into
the next Microsoft or 3M. The absence and apparent shortage of venture
capital, by extension, is seen as a predictor of economic doom,
or at least stagnation.
But it's not clear whether such cause-effect exists. Part of the
problem lies in the fact that there is virtually no quantifiable
measure of either supply or demand when it comes to venture capital.
On the surface, venture capital supply can be easily defined, even
by the various seed-to-expansion stages of investment that a young
company goes through. Capital is difficult to box in from a geographical
sense, however, and the narrow focus on institutional venture capital
overlooks substantial investment capital in the hands of private
individuals and corporations. The demand side is even trickier because
it involves an entrepreneur's subjective "need" for someone
Without a clear measure of capital supply and demand, the discussion
often falls to anecdotes of cash-strapped entrepreneurs. But financial
difficulty itself does not represent market failure, as entrepreneurs
have historically struggled to find money to seed and grow their
endeavors. And there is little evidence that the market is systematically
overlooking good ideas in the district.
What's more, economic theory would suggest that the venture capital
industryformally organized, high-risk investment of other
people's moneyis developing much as it should. Typically,
it pools in areas offering the highest rate of return, usually in
regions with highly visible investment opportunities and an inlaid
support system to nurture good but immature concepts or products.
Exceptions do exist where good ideas go hungry, both in the district
and elsewhere, and efforts are under way to improve the availability
of regional capital and connect it with local entrepreneurs.
Buddy, can you spare a few million?
By many measures, venture capitalcommonly referred to as
VCis playing a significant role in today's economy. A study
by WEFA, an economics consulting firm, found that venture capital-backed
companies are responsible for 3.3 percent of the nation's jobs and
7.4 percent of gross domestic productall for about 1 percent
of the nation's investment.
Venture capital is particularly prevalent in high-tech areas and
with so-called gazelles (young companies that experience 20 percent
annual growth), both of which have a weighty impact on the national
economy. For example, despite making up just 5 percent of all U.S.
firms, gazelles were responsible for about two-thirds of all new
jobs from 1993 to 1996, according to a report by the Progressive
There are many factors behind the growth of venture capital. For
example, wealth and disposable investment income have increased
tremendously; at the same time, securities and other investment
regulations have been loosened, opening the door to a plethora of
investment outlets, including high-risk ventures. Development of
the Internet and telecommunications industries has exponentially
accelerated the information exchange necessary for high-risk investments
to take place, and, along the way, these industries have become
the poster children for the feast-or-famine nature of venture capital.
Today's fast-paced economy is also demanding larger financial
investments in earlier stages of a company's development, particularly
for those in high-tech fieldsa gap increasingly filled by
equity funding. A May survey of more than 100 high-tech start-ups
(roughly half in Wisconsin and the other half from eight other states)
by the Wisconsin Technology Council found that only six had traditional
bank debt as a primary source of first-round capital.
Venture capital investments are typically segmented by phases:
start-up (or seed), when an idea or product is being developed;
early, when the idea goes into initial production and sales; and
expansion, when the idea is ready for full-scale rollout and production.
With each passing phase, capital demands grow. For example, start-up
funding typically ranges from $300,000 to $3 million; early stage,
$3 million to $20 million; and the expansion phase, $20 million
to $100 million, possibly more. (Outside major venture capital markets,
however, each funding phase is usually much smaller.) The expansion
phase is expected to culminate in either an initial public offering
of company stock or a buyout from an established firm, at which
point venture capitalists cash outoften with eye-popping returnsand
reinvest in other opportunities.
The color of acorns
Venture capital is on the rise in the district, particularly in
the Twin Cities. Since 1995, the number of venture capital deals
in Minnesota has risen by about 70 percent, and total capital investment
has risen by 500 percent. But that level pales in comparison to
national trends. During the same period, the number of nationwide
VC deals has quadrupled, and total capital invested in these deals
has exploded more than 14-fold to $88 billion.
As a result, Minnesota has seen its share of national venture
capital slide from 2.6 percent in 1995 to 1 percent last year, according
to a PricewaterhouseCoopers and VentureOne MoneyTree survey. That
falloff in national share meant there were "30 to 40 companies
that didn't get financed, and those that do get less," said
Jay Hare, partner of the technology industry group at PricewaterhouseCoopers.
This represented a lost opportunity, something Hare likened to the
seeding of an oak tree. "If that acorn doesn't grow, what's
the consequence? That depends on the type of tree" it would
have grown into, Hare said, "and how many [new] acorns drop
from the tree."
Historical evidence suggests, however, that 1995used by
many as the VC benchmark for Minnesotamight be more of an
anomaly than a standard, a blip in the data, if you will. PricewaterhouseCoopers
data go back only to 1995 but show the state's VC share dropped
to 1.1 percent the following year and has averaged less than 1.3
percent over the last five years. Venture Economics, which uses
a different data methodology, shows three years with about a 3 percent
state share for Minnesota (1990, 1995 and 1998). But in the remaining
eight years since 1990, the state share was 1.5 percent or less;
six years were 1.1 percent or less.
Nonetheless, it remains that the majority of acorns fall disproportionately
on a few coastal regions. Silicon Valley and northern California
grab almost a third of all venture capital investments in the United
States. Add on southern California, and the state attracts $4 of
every $10 of venture capital, according to Venture Economics, a
Thomson Financial company specializing in private equity information.
U.S. Venture Capital
Total vs. New Funds
||Number of Funds
(Billions of $)
|Number of New Funds
With Route 128 and the Big Apple, the New England and greater New
York regions together attract a little better than one-quarter of
all venture investments. After that, venture capital tends to be
isolated in small regional pools, like Austin-Richardson, Seattle,
Raleigh, Denver, Chicago, Atlanta, and the Twin Cities, each garnering
between 1 percent and 4 percent of the national pie.
VC (envy): Enough to go around
When it comes to venture capital in the Ninth District, there's
the Twin Cities and then everywhere else. Even in mid-size cities
like Duluth or Sioux Falls, entrepreneurs have traditionally had
very little local venture capital to tap into.
In the first quarter of this year, for example, 100 percent of
$159 million in VC deals made in Minnesota were with Twin Cities
companies, according to the most recent MoneyTree survey. Wisconsin
is seeing strong growth from a percentage standpoint, but virtually
all of it is occurring in the Madison-Milwaukee corridor (which
is part of the Chicago Fed's Seventh District), and only last year
cracked the $100 million annual mark. There have been no VC deals
in the Dakotas since 1995, according to PricewaterhouseCoopers;
Montana has had a total of seven deals worth about $55 million in
the last six years.
(Oft-cited venture capital data from the National Venture Capital
Association show both more deals and higher VC levels in all Ninth
District states, particularly Minnesota and Wisconsin. This results
mainly from the use of different criteria in tracking venture capital.
But trends in NVCA data generally mirror those of PricewaterhouseCoopers.)
By such measures, not to mention numerous anecdotes and popular
opinion, venture capital in the district appears hard to come by,
particularly in comparison to other regions. "I think there
is a shortage of venture capital" in Minnesota, said Roger
Weingarth, president and chief operations officer of Optical Solutions,
a fiber optics firm in Minneapolis. "If you're looking for
money, California is the place."
The company has gone through three rounds of venture capital financing,
raising a total of $100 million, but only about 30 percent from
investment firms in the Midwest, Weingarth said. Numerous venture
capitalists told him financing would be much easier if the firm
would relocate to a telecom hotbed. For the new entrepreneurs simply
looking for money, "right now I think the pull is either to
the East or West Coast," he said.
While venture capital is very mobile, VC funds tend to be located
in areas where the investments themselves will be made. For example,
close to 60 percent of the VC funds raised and organized in the
fourth quarter of last year were in northern California. This geographic
concentration is not necessarily a problem for Midwest companies
looking for later-stage investments, as Weingarth and other sources
said financing capital is available for proven concepts, even if
they have to go to the coasts. But capital mobility is more restricted
in earlier stages.
"The early stages are where the gaps are," said John
Neis, partner of Venture Investors of Madison, Wis. In early-stage
investments, venture capitalists typically assume a strong role
on a company's board and in general operations. This makes geographic
proximity important and can make financing more difficult for Midwestern
entrepreneurs because capital on the coasts becomes "painfully
difficult, if not impossible to get at," Neis said.
For this reason, Minnesota and virtually all other states not
named California, Massachusetts or New York are pining for venture
capitalists to set up locally based funds. And inroads are being
made in Minnesota, which currently ranks 11th nationally in the
amount of venture capital under management, with over $5 billion
held by 31 private funds in the state. In the fourth quarter of
2000, a total of $1.4 billion in venture capital was raised in Minnesota,
ranking it fourth nationally, according to Venture Economics.
But an increase in state-based funds doesn't mean Minnesota entrepreneurs
are getting funded at a higher rate. Despite a steady climb in VC
firms and total capital under management in the state, most of the
deals and money still go elsewhere. Last year, Minnesota-based VC
funds made 254 deals, but less than one-quarter of those deals went
to in-state entrepreneurs (again, almost all in the Twin Cities),
and that percentage has actually fallen slightly since 1995, according
to estimates from PricewaterhouseCoopers. The percentage of total
dollars allocated within the state has also declined and was just
20 percent last year.
Rather than a VC shortage, some see such an outflow of capital
as a shortage of ideas, or deficiencies in their level of development.
"There is no shortage of venture capital for the right idea,"
said John Taylor, vice president of research for the National Venture
Capital Association. He pointed out that existing venture capital
funds have an excess of $35 billion in capital available for investing.
"That's the powder that's dry."
"It's rare that a smashingly good idea doesn't get funding,"
said Daryl Erdman, senior director of Aavin Venture Capital Partners,
which recently opened an office in Minneapolis. Erdman scouts both
Minnesota and Wisconsin for ideas and works out of his home in the
small town of Shell Lake in northwestern Wisconsin. Erdman acknowledged
that the supply of capital can contract at times, "and then
you have to work a little harder" to get funding. "I'm
not certain that's bad. It never hurts to starve a little before
you get that great big nut."
Evolving from ag finance
Venture capital and equity financing can be a big nut to crack
outside the Twin Cities. A 1999 survey of economic development professionals
throughout Wisconsin identified the lack of equity capital as the
single biggest barrier for start-up companies, with nearly three
of four respondents saying it was a major problem.
North Dakota entrepreneurs face much the same problem, according
to several sources. The state is "stuck in ag finance,"
said Delore Zimmerman, founder and president of CEO Praxis, a community
and enterprise development company in Grand Forks. "We don't
have a culture of local investment. ... Investment [capital] that
is here is outward." Business deals today "are based on
intangibles," Zimmerman said, which are "so different
than normal bank debt financing."
But the venture capital scene outside the Twin Cities is evolving,
if slowly. At Sundog Interactive, a web design and software company
in Fargo, N.D., employees were coming up with new ideas that the
company could not afford to pursue, and outside capital was not
available. "We knew there were a lot of ideas out there"
with good potential, said Justin Shardin, Sundog's chief operating
To help grease the entrepreneurial skids, Sundog started Convexity,
an e-business accelerator and small venture fund that received more
than $1 million in start-up grants from the state and Dakota Renaissance
Ventures, a local quasi-public economic development fund. To date,
it has made two venture capital deals and is negotiating a third,
Many sources also acknowledged that investment capital might not
be so much absent as it is inaccessible. For one, there exists in
virtually all regions a number of so-called angel investorsprivate
individuals who make direct investments in young companies. The
Global Entrepreneurship Monitor estimated that angel investors in
the United States contributed about $54 billion in capital to entrepreneurs
last year. The problem for entrepreneurs is finding it. Shardin
acknowledged that "there is definitely money in this state.
It's there, but it's not usable."
Others agreed. "It's not that [entrepreneurs] don't have capital
in rural areas. But that capital isn't organized so you have access"
to it, said Steve Mercil, president and CEO of Minnesota Investment
Corp. (MIN-Corp.). "It's like having a lot of food and not
having a road" to get it to hungry people.
Convexity and MIN-Corp. are two efforts designed to build better
roads between entrepreneurs and investors, and both illustrate a
unique feature to venture capital funds outside the Twin Cities:
Most have been largely capitalized by public or foundation grants.
Usually having $1 million to $10 million in capital, they are very
small compared with funds directed at entrepreneurs in the Twin
Cities. MIN-Corp. is a $10 million venture capital fund targeting
outstate areas of Minnesota and has invested in about 20 companies
in the last decade. The fund was originally capitalized with a state
grant to the quasi-public Minnesota Technology Inc. and was later
spun out as a stand-alone private fund.
But MIN-Corp.'s low rate of deal-making has pushed Mercil to look
for other investment levers to spark entrepreneurial activity in
smaller cities and rural areas. The company has since developed
a template for organizing regional angel investor networks (RAIN),
whereby local private capital is pooled with the hope of surfacing
credible and profitable proposals from local entrepreneurs. MIN-Corp.
hopes to organize 10 such RAIN funds throughout Minnesota, each
with 15 to 25 angel investors and up to $1 million in capital, "to
deliver capital back to a smaller scale," Mercil said.
Currently, there are RAIN funds up and running in Worthington and
Alexandria, each with over $500,000 in capital, and a third is in
the organizing stages. The trick, Mercil said, is to identify a
local person or two who "want to do this for themselves. It's
got to be the local person's group." MIN-Corp. has also licensed
its template to CEO Praxis, which is about to launch the first RAIN
fund in North Dakota, and is in preliminary stages of a second,
according to Zimmerman.
Cliff Grant of Billings, Mont., saw much the same disconnect between
local capital and local entrepreneurs. "Private capital in
Montana is more inaccessible than unavailable. We found that there
are numerous private investors in Montana, but they simply don't
see enough attractive deals to invest in," said Grant, who
is president of LocalFund.com, which he described as "a matchmaker
of entrepreneurs and private investors."
Grant founded the organization last December as "an entrepreneur
who was frustrated with the time and energy that it took to get
a business plan in front of potential investors." Two private
investors helped out because they "were equally frustrated
that there were not more venture opportunities to consider. They
knew the deals were out there, but it was not that easy to see them,"
Grant said. Entrepreneurs pay a small fee to enter their business
plan into a secure Web site, and investors pay to review plans and
are given information to contact entrepreneurs directly.
"It's really a simple solution to a common problem,"
Part of the problem also appears to stem from a lack of awareness
of how equity investments work. When some entrepreneurs find out
they have to relinquish control of the company in exchange for venture
capital, "it comes as sort of a shock," said Erdman, the
Mercil agreed. "People don't understand equity and how it
works. ... I think that's where a lot of frustration is." He
added that high-profile Internet deals have fueled the perception
of a venture capital waterfall. "We've created a culture where
entrepreneurs are naive in what a business idea has to look like"
to get funded.