The most recent MoneyTree compilation of U.S. venture capital investing data, released by PricewaterhouseCoopers LLP and the National Venture Capital Association, shows Michigan deal volume at its lowest point in three years.
Dollars invested, however, show one of the best periods in recent history.
The numbers, drawn from national surveys of venture capital firms, show Michigan with seven deals in the third quarter this year, the slowest since the fourth quarter of 2011 when the same number was reported.
Total deal volume in Michigan came to 32 by the end of the third quarter 2014, compared to 74 for all of last year and on par with 2011’s total of 34.
Michigan’s total dollars invested, however, showed $167 million invested through the third quarter, trouncing last year’s total of $111 million with an increase of 50 percent. The bulk of that, almost $115 million, came from the second quarter, Michigan’s best quarter by dollars invested since the first of 2000, when $143 million was invested.
Venture capital at the national level also had its biggest quarter since 2000, pumping 13.5 billion into companies in the second quarter. That was the highest since the end of 2000, when the fourth quarter’s $22 billion was actually the lowest of any quarter that year. Those were very different times: 2000’s total was $105.1 billion, compared to $29.8 billion last year.
This year is proving stronger, having already beaten last year’s total. Investors spent $33.1 billion through the third quarter. Deal volume, reaching 3,154 by the end of the third quarter, is on pace with recent years.
A flurry of mega-deals north of $100 million have driven the national increase, and software continues to be the hot sector attracting deals, along with biotechnology and media and entertainment.
The big national deal that pushed the second quarter so high was the $1.2 billion that investors poured into Uber Technologies Inc., the company behind the app-driven alternative to taxi cabs. That was the largest single deal since PricewaterhouseCoopers began tracking in 1995.
“The second quarter was just off the charts. We don’t have quarters like that very often,” said Mark McCaffrey, global software industry leader for PricewaterhouseCoopers. “A lot of cash is coming into play, and valuations are reflecting the competitiveness of deals.”
Private equity, corporate venture funds, mutual funds and hedge funds have jumped into venture investing to heat things up this year. Active IPO and M&A markets are encouraging investors as well, McCaffrey said. The third quarter continued the trend, recording 11 mega-deals.
In that light, the Michigan situation looks a little troubling because Michigan’s strong second quarter was because of one large deal.
This year’s 50-percent increase in dollars invested mostly came from the $59.5 million second-quarter investment in Plymouth Township-based biotechnology company ProNAi Therapeutics Inc., likely the largest investment round in state history. (See story.) Vivo Capital of Palo Alto, Calif., led the expansion stage investment and was joined by 11 other firms, most of them based outside Michigan.
The subsequent low number of deals in the third quarter matched its number of dollars invested, at just $14.5 million.
“I’m a little surprised at how low the quarter came in,” McCaffrey said, reserving any speculation as to why it was low until the year wraps up. “If it’s still down, it’ll be interesting for the region going into 2015” and an indicator that cash is going somewhere else.
But “one quarter doesn’t tell the tale,” he said.
Jack Ahrens, general partner at TGap Ventures in Kalamazoo, said his firm made one new deal this year and was disappointed that it couldn’t find more companies to invest in, including ones they checked out in Michigan.
“This year, especially on the west side of Michigan, has been a disappointment, frankly,” he said, but noted his firm specializes in medical device companies that faced new regulatory difficulties.
Jeffrey Van Winkle, a Clark Hill PLC attorney who represents Michigan venture-backed companies, said it’s never easy for them to raise money, but this year has been a notch more difficult. “There’s a sense more money needed to be spent last year than this year,” Van Winkle said.
A year like 2013, which had a high number of deals at a total of 74, “sucks up capacity,” he said. The previous year also was an active one, with almost $246 million invested through 52 deals in 2012.
It’s not surprising for low periods to follow high ones, as companies put the money they received to work, and firms’ reserves are down. Plus, for states like Michigan, whose VC industry has grown significantly but still remains a small player, there are only so many companies to invest in.
“You could have $500 million that you’re willing to invest in Michigan and you’re still not going to invest it all in 2104,” he said. “The number of companies that are ideal candidates for venture capital money is just not there,” Van Winkle said.
A longer timeframe is necessary when judging VC activity, investors say.
Jim Adox, chairman of the Michigan Venture Capital Association and head of the Ann Arbor office for Madison, Wis.-based Venture Investors LLC, said the increase in VC firms has led to two-thirds more venture-backed companies in the state.
Michigan had 16 VC firms based in the state in 2009; that number increased to 23 last year. Out-of-state firms have steadily been coming to Michigan; 10 had opened offices in the state as of the end of last year.
New, smaller funds from firms like Huron River Ventures and Michigan Accelerator Fund are putting early investments into younger companies that set the stage for another cycle of larger investments, Adox said. That sets the stage for another healthy cycle in the coming years.
One thing that could stifle that is a lack of new state-backed fund of funds, which were a “key catalyst” in the cycle that’s now at its end, he said.
The $109 million Michigan 21st Century Investment Fund and $95 million Venture Michigan Fund I are fully committed, as is the $120 million Venture Michigan Fund II.
Michigan’s venture capitalists point to these funds as accelerants that grew the industry by injecting capital and attracting outside investors to the state’s VC dealings.
The fund of funds is managed by Grosvenor Capital Management LP, a Chicago-based firm with $46 billion under management, previously owned by Credit Suisse. Those well-known names made it easier for Michigan venture capitalists to get outside investors to participate here.
“It primes the pump. I can go out to investors and say, “I have $10 million of my $100 million goal already. Do you want to come in? I’ve been vetted by Grosvenor, they’ve checked me out,’ “Adox said.
“Now, there’s no new fund. If that goes on, we’re going to see a noticeable drop in activity.”
The MVCA surveyed state venture-backed companies last year, and they reported a total need of $260 million in the coming years. The association asked state VC firms how much they had reserved for these companies, and the number came to $109 million.
“Some (companies) might not deserve it, but I can easily say the gap is $75 million. That’s a real need for real companies that should get the money,” Adox said.
According to the two most recent annual reports from the Michigan Venture Capital Association, Michigan’s fund of funds provided 13 to 14 percent of the capital in Michigan’s latest venture funds. (Those figures include money from one privately-sourced fund, the Renaissance Venture Capital Fund.)
There is talk at the state level about launching some type of new fund of funds.
The plan is to “put something in front of” the Michigan Strategic Fund‘s board, preferably next year, and then issue a request for proposals, said Paula Sorrell, vice president of entrepreneurship, innovation and venture capital at Michigan Economic Development Corp.But nothing is ready and there is no set timeline.
“I wish I had an answer for that,” Sorrell said.
Coming up with new sources isn’t going to be easy.
The 21st Century fund had tobacco settlement money as its source. The Venture Michigan funds used bank debt. “I’m pessimistic that we’re going to see a replenishment before we see some of the money come back to the existing funds,” Van Winkle said.
There are pros and cons to having a big fund of funds, said Ahrens.
“I’m on the fence. I’d rather see some non-government entity get involved. Whether it’s a bunch of corporations getting together like with Renaissance, venture capital should be separated from the state.”
“But,” he added. “If no one steps up, it should be the state.”