Ideas for fixing the Midwest VC ecosystem imbalance

The Midwest and Great Lakes region continues to fall behind at a time when venture capital is funding fewer firms with larger exits, said John Austin, senior fellow with the Brookings Institution, a Washington, D.C.-based research group.

Austin visited Milwaukee last month to share findings of his most recent report, entitled, “As the venture capital game gets bigger, the Midwest keeps missing out,” with members of the Rotary Club of Milwaukee.

The Midwest is home to a third of U.S. Fortune 500 companies and 20 of the world’s top research universities, which is more than any region in the U.S., according to the report. However, the Great Lakes region continues to export wealth to coastal economies despite producing more than a quarter of the nation’s research and development, new patents and top talent, the report said.

At Rotary Club, Austin discussed the imbalance in the region’s VC ecosystem and also provided a solution based on a recent analysis sponsored by the Brookings Institution and the Chicago Council of Global Affairs, and conducted by a team of University of Michigan executive MBA candidates.

“We’ve been challenged for years in the Midwest with this phenomenon of having a sort of innovation horsepower that’s sort of unrivaled, but we’re not translating that into a lot of new startups in the region and places like Milwaukee,” Austin said.

Institutional investors, pension funds and university endowments in the Midwest produce at least half of the money invested into VC throughout the country, Austin said. However, only 5% of that money finds its way back to the region, with only 12% of the nation’s VC being invested in the region, he added.

According to PitchBook, the Midwest and GLR invested a total of $6.5 billion in VC with 1,062 total deals in 2019. The rest of the country, including New England and the Mid-Atlantic region, as well as the West Coast, invested $113.2 billion in VC with a total of 7,410 deals in 2019.

The disparity in VC funds exists in part because venture capitalists are concentrated on the coasts. Another factor holding the Midwest region back is that coastal venture capitalists aren’t made aware of the innovative technologies coming out of Midwestern universities and, in turn, those universities don’t have enough capital partners to funnel their ideas to coastal venture capitalists, Austin said.

To help remedy the imbalance in the Midwest VC ecosystem, Austin proposed a regional fund of funds, which would serve as a vehicle for in-region and out-of-region investors to put their dollars to work with investments in VC firms.

However, the concept of a Great Lakes regional VC fund is not new. Frank Samuel, the architect of Ohio’s Third Frontier state investment fund, first proposed the idea in a 2010 Brookings paper.

“Such a fund would facilitate much-needed growth in the size and scale of the venture capital network in the Great Lakes/Midwest, allowing it to be competitive in today’s larger and later rounds of funding,” Austin stated in his report.

Austin also shared the success story of an Ann Arbor, Michigan-based company’s exit and the impact it had on the city’s identity and economy. Cybersecurity company Duo Security was acquired by Cisco in 2018 in a $2.35 billion cash and stock deal. As a result of the sale, several more millionaires now walk the streets of Ann Arbor, not only with the cash to reinvest in Michigan’s startup ecosystem, but also the knowledge of a successful exit to then build new tech companies.

If an exit of this caliber occurred in Milwaukee, Austin said it could change the city’s reputation from being a beer, brats and motorcycle hub to being known for, as an example, a water technology hub or a leader in another industry.

“That’s the kind of dynamic that big venture capital and new technology and startups can facilitate to change the storyline about the region’s economy,” Austin said. “When you do that at scale, it really changes the narrative about the community.”

However, Ken Johnson, partner at Wisconsin-based Sun Mountain Kegonsa, which manages the Badger Fund of Funds, posed an alternative solution to propel the state and Milwaukee’s VC ecosystem forward. He said the next step for Wisconsin and Milwaukee is getting more corporations involved.

Johnsonville Ventures, The Capital Times, MGE Energy Inc. and Inventure Capital, all of which are Wisconsin-based, recently committed an undisclosed amount of funds to the Winnow Fund, an approximately $8 million pooled investment fund designed to invest in startups incubated in Wisconsin universities.

Having these Wisconsin-based corporations supporting the BFOF, Wisconsin’s state-backed venture capital program, is a key element to advancing the VC ecosystem in the state, Johnson said. When these corporations invest in BFOF funds, they relinquish control as limited partners, placing their faith in a funding vehicle focused on backing Wisconsin startups, which boosts the state’s economy, he added.

“I was very surprised that the Winnow Fund got four (corporate investors) and we’re still out raising capital,” Johnson said. “To me that’s a change in the atmosphere. We’ve got to get corporations involved, especially in Milwaukee.”

Johnsonville Ventures, one of two VC Funds operated by Sheboygan-based Johnsonville Sausage LLC, was established earlier this year to fund startups in the food and beverage space.

The VC fund chose to invest in the Winnow Fund because it’s Wisconsin-based and supports students, said Kevin Ladwig, president of MSAB Capital, one of two Johnsonville VC funds.

“Johnsonville is a learning company so the fact that we’re looking at universities for new ideas and allowing students to come forward and give them some support just appealed to us,” Ladwig said.

Having been in Wisconsin for 75 years, Johnsonville believes Wisconsin generates a lot of talent and innovative ideas, which is why the company chose to get involved in the state’s VC ecosystem, Ladwig said. However, the company also believes the ecosystem is missing involvement from companies like Johnsonville that have the experience to help young entrepreneurs get their idea to market.

“I think that’s where we see the ecosystem lacking,” Ladwig said. “Johnsonville is a great operating company; we want to help these startups because we think we have something to offer beyond just money. We want to be advisors and we want to help as best we can.”