Recent changes to the state-backed venture capital program Badger Fund of Funds aim to make it easier for fund managers to grow their respective firms and attract outside funding.
In February, Gov. Tony Evers signed Legislation into law that not only implemented several key changes to the Badger Fund of Funds program, but also allocated $25 million in additional funding from the state budget.
“My expectation is that every 10 years, we’ll be able to double (that initial $25 million),” said Ken Johnson, partner of the Badger Fund of Funds and managing director of Madison-based Kegonsa Capital Partners LLC. “In the next 10 years, it should be $50 million. In 20 years, it’ll be $100 million.”
In 2011, KCP partnered with Sun Mountain Capital to form Sun Mountain Kegonsa, which was selected to manage the Badger Fund of Funds. The Badger Fund is the lead investor in five Wisconsin-based portfolio funds managed by first-time managers.
In 2012, the state approved awarding the Badger Fund of Funds its first $25 million. The fund then raised another $10 million from the private sector. From there, the Badger Fund created five more venture capital funds across the state, including Gateway Capital Fund, the Winnow Fund, Rock River Capital Partners, the Idea Fund of La Crosse and the Winnebago Seed Fund.
The original Badger Fund law said that for every $1 of state money awarded to each portfolio fund, $2 had to be reinvested in Wisconsin by each portfolio fund. The new legislation clarifies the investment requirements of portfolio funds. It allows the Badger Fund to meet the private capital matching requirements across its entire portfolio, rather than requiring each fund to do so individually.
The state still gets the same minimum match, but the clarified language allows some funds to be less than 2-to-1 as long as the Badger Fund as a whole meets the 2-to-1 requirement.
To help the individual funds grow and stand on their own, they will need to look both regionally and nationally for deals. The original language regarding the 2-to-1 match likely would have restricted that ability.
Even with clarified investment requirements, some professionals in the world of venture capital believe the 2-to-1 match still makes it impractical for the smaller portfolio funds to invest heavily outside Wisconsin.
“There are some (investments) we’ve decided not to pursue in other states that are more restrictive (with their programs), including the Badger Fund,” said Victor Gutwein, founder and managing partner of Chicago-based venture capital firm M25. “The Badger Fund has created funds that, in practice, can only invest in Wisconsin companies.”
M25 is currently operating out of its fourth fund and has more than $80 million under management. The firm considers itself a pre-seed and seed fund focused primarily on software and digital companies.
M25 invests throughout the Midwest, including here in Wisconsin. Some of its investments include Milwaukee-based Scanalytics and Madison-based EnsoData.
Gutwein also questioned why some Badger Fund managers have invested in common equity rounds instead of preferred equity. Preferred equity comes with special privileges like liquidation preferences that reduce investor risk.
“That’s something that makes it really hard to syndicate with non-Badger Fund (firms) and get outside money into the state,” said Gutwein.
Additional changes
Another barrier for outside investment found under the original Badger Fund guidelines was a rule that required any company that received an investment using Badger Fund money to have 51% of its workforce in Wisconsin.
“That 51% can suddenly become a barrier for growth for larger companies,” said Johnson. “There’s no way a venture capital firm coming from outside the state is going to agree to have 51% of its employees in Wisconsin.”
Under the new law, that workforce requirement sunsets after three years.
Perhaps one of the biggest changes to the Badger Fund program was making the program’s funding evergreen. This means the Badger Fund no longer needs to send a portion of its returns to the state’s general fund but can instead reinvest it.
Evers vetoed the old program requirements on reinvestment, citing concern that the provisions “may undermine efforts to attract additional co-investors in the fund of funds program,” allowing those additional funds to be reinvested, according to an announcement from his office.
Making the state funding evergreen, coupled with the additional $25 million in funding allocated to the Badger Fund, shows that the program is working, said Jonathan Horne, managing director of the Idea Fund of La Crosse.
The Idea Fund was the first portfolio fund to receive an investment from the Badger Fund of Funds.
“The program is working, (so they’re saying) let’s double down on it,” said Horne.
Earlier this month, the Idea Fund announced it had closed its second fund worth $31 million.
When the first iteration of the Badger Fund program was announced, there was skepticism surrounding the portfolio programs and whether they would be able to raise their own additional capital and go on to make investments, said Horne.
“It’s a completely unique program,” he said. “There’s nothing like this in the entire country. Everyone said the proof is in the pudding. We’ll give the Badger Fund a chance, but they have to go out and deliver.”
The Idea Fund’s second funding round, raised from non-Badger Fund investors, is proof that the Badger Fund program is doing exactly what it is meant to do, said Horne.
While some people might think the Badger Fund remains highly involved in the day-to-day operations of its portfolio funds, Horne said they have much more autonomy.
“(The Badger Fund) was 40% of fund one. With my second fund, they’re less than 10%. They’re a normal investor,” he said. “We are completely at this point an ordinary-course, national-standard venture capital fund.”
