Deal with it: 2013 was good for VC – but no 2012

Michigan deal volume was up 39 percent from 2012 to 2013, while dollars invested were down 57 percent, according to the MoneyTree report from the NVCA and PricewaterhouseCoopers.

Nationally, numbers moved back to their 2011 levels, with volume up 3.5 percent and dollars invested up 7.7 percent.

That contrasts with 2012, when Michigan’s VC activity spiked as investors from outside the state said they were drawn to Michigan’s lower costs and valuations, state initiatives to support entrepreneurs and investment, and an available talent pool of educated, experienced people, as well as entrepreneurs with a Midwestern work ethic.

Michigan’s dollars invested nearly tripled to $239 million in 2012 from $83 million the previous year, while national dollars invested dropped 8 percent to $27.3 billion.

Michigan’s strong 2012 had a lot to do with timing, industry insiders said.

Funds had pent-up money that needed to be deployed — many of them fueled with state government funds intended to spur the economy. And the state’s economy, which was on weak footing well before the real estate-driven meltdown, was coming back a beat earlier than other parts of the country.

“We saw a lot of activity in 2011 and 2012, and a lot of that was that Michigan was so far behind in terms of where the economy was,” said Peter Roth, partner at Grand Rapids-based law firm Varnum LLP, whose practice covers venture capital.

“We had an uptick, and maybe it’s normalized now.”

Michigan’s VC world was less frenzied than that of Silicon Valley’s, and its firms skew toward health care and life sciences, as opposed to software and IT.

“Valuations here tend to be lower. There’s not as much capital chasing the deals that are here,” said David Parsigian, head of the venture capital practice at Honigman Miller Schwartz and Cohn LLP in Detroit.

The rise in the national numbers last year was largely driven by investment in software and Internet businesses, with biotech also a leading sector of activity last year, said Mark McCaffrey, global software leader in the San Francisco office of PricewaterhouseCoopers.

Businesses associated with buzzwords like “cloud,” “big data” and “disruptive technologies” began to catch the attention of VCs as the value of these companies’ innovative technologies became clear, he said. Declining uncertainty over the national economy helped, too.

McCaffrey said companies doing things like using analytics to offer insights into clients’ customer bases or developing mobile technologies were examples of innovations coming out of the software sphere.

Consumer products and social media were part of the mix: Pinterest and Uber garnered some of the biggest national investments in 2013, according to the MoneyTree report.

Software innovations are affecting a broad range of industries, as has been widely reported, and the companies behind them finally started to pick up investment steam last year as investors saw strong returns on investment and valuations coming from that sector.

Investors’ move last year toward software companies in the center of the big data, cloud and mobile computing movements will continue not just in 2014, but in the years to follow, said Tony Grover, managing director at Ann Arbor-based RPM Ventures, which invests in these kinds of companies in areas such as B2B services, cloud infrastructure, online marketplaces and automotive IT.

“We’re very bullish that the trends we saw come together in 2013, we’ll see in the next decade,” Grover said.

Michigan could become an interesting place to see these trends spread into automotive IT, a specialty area of Grover’s firm, with all the buzz around the “connected car” these days.

“There’s pent-up demand and interest,” he said. “I do expect to see, this year and the next couple of years, there’s going to be a lot of investment in this area.”

Michigan’s 2014 probably will be steady as it was last year but doesn’t appear to have any single major event on the calendar, like the IPO of Plymouth Township-based pharmaceutical company Esperion Therapeutics Inc. last year that raised $73 million, Grover said.

“There’s nothing I know of that might pop and create a big up or down,” he said.

He expects his firm to have an active year of investing but does not have a set number of deals it plans to make.

The numbers are probably understated, as some firms have yet to report deals made at the end of the year, said Carrie Jones, executive director of the Michigan Venture Capital Association in Ann Arbor, which will publish its annual report with comparable data in May.

A lot of deals were rushed before the end of 2012 to avoid capital gains tax increases expected to kick in last year, said Charles Rothstein, senior managing director at Farmington Hills-based Beringea LLC, the state’s largest venture capital firm, with $550 million under management.

It took some time for the investment world to digest those deals before jumping back into new deals.

Rothstein said 2013 was a normal year of deals done at all stages nationally and in Michigan, and he expects Michigan’s rebounding economy to be good for young, venture-backed companies. “At times of expansion,” he said, “all companies look better.”

The year ahead could see more exits, pending conditions. “If interest rates stay low and the stock markets continues to perform well, it makes for a good exit environment,” Rothstein said.

One thing Michigan had in common with the rest of the country was a lean toward early-stage investments. In a breakdown of companies by stage — seed, early, expansion and later — $49.9 million of the $102.5 million committed last year went toward early-stage companies. Companies in the expansion and later stages drew the bulk of the rest of the money.

That was a marked change from 2012 in Michigan, when later-stage companies attracted about half of the money — $116.4 million out of a total $238.9 million — and companies in the early and expansion stages took most of the remainder.

By deal volume, numbers were similar in both years. The lion’s share — 44 out of 68 deals — went to early-stage companies last year in Michigan. Expansion-stage companies drew 12 more.

Of note: 16 deals came from Grand Rapids-based Start Garden, with investments ranging from $10,000 to $30,000.

“That trend is consistent with what we see on a national basis. Venture capitalists were trying to get in earlier than what they had historically. Competition around these investments is starting to increase,” McCaffrey said.

The increase in deal count shows the ecosystem is growing, Jones said.

The slide toward earlier stages signals a refilling of the pipeline, and that means the next three to five years should see more growth-stage investments as these early-stage companies seek larger rounds, Grover said.

“That’s a very encouraging statistic,” Grover said. “This is such a long-term business, you have to look at bigger trend lines.”

Since investment numbers can bounce a lot from year to year, it’s important to remember where Michigan was 10 years ago compared to 2013, Grover said. New “fund-of-funds” vehicles have come into being, outside VC firms have opened offices, and seed-stage funds have appeared in Michigan since 2003, he said.

In 2003, Michigan saw $95 million invested in 18 deals. Eleven firms were based here and no outside firms had offices in the state, compared to 21 based here now and 11 outside firms with offices here, including the recently announced arrival of Draper Triangle Ventures, an arm of influential Silicon Valley venture capital firm Draper Fisher Jurvetson.

The arrival of Draper Triangle Ventures will make things more interesting in Michigan this year, Parsigian said. The firm plans to open offices in Detroit and Ann Arbor, and has raised $75 million for a new fund it hopes will reach $100 million, Crain’s reported in January. The fund will target early-stage IT companies.

It’s still too early to see where things are headed in Michigan in 2014, Parsigian said, but no major shifts are in sight.

“There’s no reason to see it depressed or particularly robust,” Parsigian said. “I’d be surprised if the outcome is dramatically different from 2013.”

Jones at the MVCA said anecdotally she’s hearing that VCs will be busy making investments this year at a similar pace as last year.

The two leading sectors for VC money in Michigan in 2012 — the most recent year the association has tallied — were life sciences, which picked up 40 percent of investments, and IT, which grabbed 36 percent, and that doesn’t look likely to change much, she said.

“We’ll probably see IT grow a little, but the breakout will probably be similar to 2013,” Jones said.

The MoneyTree report pegs software firms at picking up the most investment money last year, at $35.6 million of the $102.5 million total. The related areas of biotechnology and medical devices together picked up $47.8 million.

Health care is ripe for IT investments and could be a hot sector this year, given the changing regulatory pressures in the industry.

“There’s so much buzz around the health care market … there are huge problems begging for solutions,” Parsigian said. “There’s going to be substantial buyers for those solutions. Whether that will pop this year or next is hard to know.”

The health care industry has been slow to join the digital age, but now that it’s beginning to, it is a sector to watch, said Grover at RPM, which has one health care IT play in its portfolio with Ann Arbor-based ArborMetrix Inc.

In addition to health care and life sciences, Roth said new technologies in manufacturing could get funding this year, as well. It is Michigan, after all.

Last year was a return to a normal level of investment for Michigan, he said. Judging from conversations with venture capitalists, the late part of this year should see exits developing out of the investment activity of 2011 and 2012, and that should continue in 2015, Roth said.

“A year from now, looking back and seeing the number of exits up significantly will be one of the things we see this year,” he said.