Round two: Early-stage survivors hungry for second-stage investing

As more venture money has been invested in Michigan companies and deals have skewed toward early-stage companies, the next chapter in the state’s venture capital industry is to see whether these companies grab growth capital — and eventually bring about profitable exits.

“In three to four years, we’re going to see a bunch of early-stage companies that have seen early-stage success ready for the next round of funding — long-term, viable companies,” said Jeff Barry, partner at Plymouth Management Co. in Ann Arbor, which targets Great Lakes region growth-stage companies with between $1 million and $10 million in revenue.

Paul Brown, vice president in charge of capital markets at the Michigan Economic Development Corp., said more players are coming back into the market across the funding spectrum from senior debt and equity to mezzanine and venture debt. But for young growth companies, “there’s really a gap there. We’ve seen Beringea and Credit Suisse play in that space … but there’s still a big need in the state,” he said.

For companies in need of heftier follow-on investments to fuel growth, certain eternal truths haven’t changed. They usually don’t have the track record of business needed to elicit senior debt such as bank loans. And the investments needed are larger than the startup investments, making it harder to get venture funding. These companies struggle even in the best of environments to get growth capital.

Investors are sure to point out that any given company with a truly strong case will never fail to find the money it needs. But they also say Michigan does have a gap in covering this area.

“This probably remains the biggest challenge area. It’s here where companies are looking for a bigger piece of capital, but their profile is still pretty high-risk,” said Michael Kell, principal with Credit Suisse’s Customized Fund Investment Group. “That’s more specific to Michigan. If you go to the coasts, you’re going to find pockets of that capital available. In Silicon Valley, it’s easier for these venture capital firms to form syndicates.”

Another challenge for young Michigan growth companies is that many of them are in more traditional sectors like manufacturing. Even when it’s technology to make advanced manufacturing improvements, that might not be enough to draw the attention of outside investors looking for the next big “game-changing” thing, said Sean O’Donnell, a vice president of the Credit Suisse Customized Fund Investment Group.

Mark Horne, CEO of Plymouth Management, said there are plenty of mezzanine and private equity dollars available, but those investments are usually targeted at companies with sales of $20 million and up. “It is tougher for B rounds to find capital,” said Horne, who is betting that his firm will have more regional second-stage companies to invest in as they grow from their angel and startup phases.

For Beringea LLC in Farmington Hills, the largest venture firm in Michigan based on funds under management — $490 million — this is a good problem to have. The flood of startups in need of investments on the order of $3 million to $10 million will need a local firm to fill the gap.

“That’s a core thesis of the existence of our funds,” said Managing Director Jeff Bocan. “We’re tracking all the early-year venture-backed companies. There are more on our dashboard than ever before.”

Bocan said the pipeline of companies is growing. Beringea, along with the Credit Suisse Customized Fund Investment Group, is managing a new attempt to close this gap. They announced in January the launch of a $180 million Michigan Growth Capital Partners II LP fund to invest in Michigan growth companies.

Beringea and Credit Suisse also co-manage the $185 million Michigan Growth Capital Funds, part of the InvestMichigan series of funds. Before the launch of Michigan Growth Capital Funds in 2008, there were no Michigan-based funds that could serve this segment, Bocan said.

For more established companies with a proven revenue track record, now is a good time to find growth capital. Banks are back in the game on the senior-level debt, mezzanine funds are brimming and private equity funds have had a couple of good years, drawing increased interest in more deals.

“I wouldn’t say (private equity firms) are booming, but they’re doing quite well,” said O’Donnell at Credit Suisse.

March 10, 2013 | Crain’s Detroit Business – New Michigan Deal Supplement