Laws of attraction

Several US states are striving to build their own Silicon Valleys with a mix of tax incentives and grants. This article surveys the ways seven states are trying to attract venture capital dollars.

What US state wouldn’t want a Silicon Valley? The California venture hot spot is an easy place for other states to envy, with its rich tax base, job growth and headline-grabbing technology.

Many states have not content to wait for local Silicon Valley to form organically, instead cultivating a Valley of their own with special tax incentives, grants, and financing their own venture funds to foster high tech industries.

?Most states are realized that attracting one huge employer to your state may or may not work with tax incentives, because, quite frankly that one employer can leave, taking all those new jobs with it,? explains Mark Heesen, president of the National Venture Capital Association (NVCA).

However, it may take years for these states to see any tangible results from their efforts. The success of California and Massachusetts shows that such initiatives may be worth the wait. Those two locales are all too aware that others are looking to emulate their success and have been moving quickly with their own initiatives focused on clean tech and life sciences to maintain their place at the front of the pack.

?Most states have realized that attracting one huge employer to your state may or may not work with tax incentives, because, quite frankly that one employer can leave, taking all those new jobs with it.?

What follows is a rundown of some of the more aggressive initiatives underway to create new VC hot spots, and followed by reports on California and Massachusetts to illustrate what today’s leaders are doing to stay on the leading edge of innovation.

A state-funded jumpstart
From rising unemployment to census figures indicating a second consecutive year of population decline, Michigan appears to be the land the New Economy left behind. However, in January of 2007, the state of Michigan responded by launching two separate state supported fund of funds vehicles: the $109 million 21st Century Investment Fund and the $95 million Venture Michigan Fund (VMF). The two funds differ widely in their requirements and their sources of financing, but by and large, they are both meant to increase the amount of private capital, managed both by in-state and out of state firms, in the hope of generating profits to finance sequel funds of both initiatives. Credit Suisse manages the pair, as they do for similar state-sponsored funds in Ohio, Oregon and Indiana.

The 21st Century Investment Fund was financed by tobacco settlement cash and requires recipients of their commitments to either open an instate office or enter a partnership with an existing in-state entity. So far, the fund has made several investments including a $10 million award to Madison, WI-based Venture Investors LLC which opened an office in Ann Arbor; and another $10 million award to San Francisco-based Nth Power, a VC firm that entered into a partnership with Detroit-based NextEnergy to jointly source and invest in energy-related companies.

The Venture Michigan Fund (VMF) was financed by a $200 million loan from Deutsche Bank. While it does not have a requirement for the funds it backs to reinvest in Michigan, it does require a ?best efforts? approach to that end. Ned Staebler, the director of the capital markets for the Michigan Economic Development Corp., explained to Crain’s Detroit Business that the VMF is dedicated to venture capital funds focused on very early stage investing while 21st Century will invest in those entities but also in later-stage venture funds and in private equity firms.

The Michigan Economic Development Corporation also made a $2.1 million grant to the Michigan Venture Capital Association (MVCA) to help its efforts to build the state’s VC industry.

The first of three initiatives was to finance $150,000 Fund Development Awards to help new funds with their own start-up costs. ?That grant can help pay for the numerous costs incurred in establishing funds, including legal fees, publishing PPMs, traveling to meet investors and the like,? says Mary Campbell, the president of the MVCA. The MVCA has already bestowed two of the four planned awards to a pair of Ann Arbor-based funds, MacBeedon Partners and Plymouth Ventures.

The second is a research initiative. ?We are funding a systematic research effort to gather data on resident Michigan funds to create a onestop shop of accurate information on the funds that make up the state’s VC industry as well as on activities in Michigan that are financed by out-of-state firms,? says Campbell. The third and last initiative is an entrepreneur-in-residence program, directed at venture funds seeking either expert counsel, or seeking assistance in recruiting or paying first-year salaries of qualified CEOs.

The state’s universities are doing their share as well, with Michigan State University launching its own tech commercialization program, and Wayne State University (WSU) planning a $10 million seed fund to assist spin-off companies so they may better appeal to angel and VC investors. In November of 2006, the University of Michigan and WSU created the University Research Corridor, a program to coordinate research and spinoff efforts between the two institutions.

Despite the promise of these efforts, their impact has not been felt just yet. Statistics gathered by the National Venture Capital Association on third quarter VC commitments in 2007 report that just two companies in the state received a total of $4.4 million. This drops the state’s ranking from 20th in the second quarter, to 35th in the third. The NVCA’s report on the fourth quarter was not published prior to this going to print.

Madison sets the standard
There appears to be two Wisconsins these days, personified by two cities. There’s Milwaukee, a stalwart manufacturing town clinging to the memory of its post-World War II boom years, and Madison, now known as the birthplace of stem cell research due to the pioneering work of the University of Wisconsin-Madison. According to a set of government data on GDP released in September of 2007, Madison’s economy grew at 15 percent in the period from 2001 to 2007, while Milwaukee only grew at 5 percent. Most observers credit the university’s top-ranking research facility for the city’s growth, but the state’s CAPCO (Certified Capital Company) program might warrant some applause as well.

A CAPCO program is a state economic development tool that allows insurance companies to invest in venture capital companies that qualify for that status through local presence in that particular state. States attract those insurance companies with tax credits for investments backing those qualified VC funds. The first known example of a CAPCO program was back in 1983, when Louisiana sought to encourage VC financings of local small businesses. However, CAPCOs face real restrictions on their investment activities, balancing their market-based preferences with the priorities of the state lawmakers conferring CAPCO status.

?In most cases, CAPCOs are a one-time implementation with several funds,? explains Ryan Brennan of St. Louis-based Advantage Capital Partners. He should know, as his firm’s focus is investing in underserved markets, often using the CAPCO program as a means to accomplish this goal. Advantage develops local expertise and establishes a local presence, and then uses CAPCO-driven commitments or other partnerships to become the seed money for that new fund. Advantage has since opened offices in Missouri, Louisiana, New York, Texas, Florida and Washington, DC, with affiliated offices in Alabama, Colorado and Wisconsin.

According to a recent white paper study from KPMG analyzing CAPCOs, the tax credits have been restricted to insurance companies due to ?numerous legal and practical reasons? including the fact that often insurance companies are subject to ?premium tax, or a tax on receipts from premium received in lieu of income taxes.? CAPCOs offer a rare break to these companies who normally don’t qualify for income-based tax credits.

?Madison created a pool of $50 million credits back in 1999,? explains Brennan. The tax credits are spread out over years so that the $50 million CAPCO credit program is spread out over ten years, with a ceiling of $5 million a year. The tax credits are applied to the investors’ premium taxes, not any returns they may receive from the firm themselves. Brennan explains that CAPCOs have become popular as way to leverage the expertise of professional venture capitalists rather than forcing state programs to pick individual winners themselves. ?CAPCOs allow for a lead investor to really ?kick the tires? on a potential investment,? says Brennan. He stresses the value of creating such magnets: ?We raise and attract roughly $12 for every CAPCO dollar invested in a portfolio company.?

?We raise and attract roughly $12 for every CAPCO dollar invested in a portfolio company.?

However, even Brennan admits that Madison offered some real advantages well beyond the CAPCO program, including a robust industry of service providers. With over eighty registered patent lawyers in Madison alone, there’s plenty of counsel for the venture funds and the businesses they back. Some local attorneys credit the presence of such resources with the founding of the University Research Park back in 1984, financed by both the university and state government. The Park acts as a commercialization center for the technology developed at the University of Wisconsin. The Park reports launching over 70 companies so far, and isn’t the only such incubator facility in the city. The Madison Area Technical College has its commercialization center and the Fitchburg Technology Campus, in the suburbs of Madison, has reserved 90,000 square feet for emerging tech companies, with a priority on nanotechnology offerings.

So many incubation centers in so little space may seem excessive, but U of W- Madison was ranked the fourth largest academic research institution with $764 million in research spending in 2004, the last year the National Science Foundation compiled such stats. According to the 2006 Greater Madison Area Directory of High?Tech Companies Report the city saw a 15.2 percent increase in the number of high tech jobs in the five years ending in 2005, and 11.8 percent jump in the number of high tech firms.

Such data isn’t lost on the state government. Governor Jim Doyle, in his state of the state speech this year, called for additional credits for angel investors, from $13 million to $23 million over the next two years. He also proposed the Wisconsin Venture Center, to be modeled off of a similar center in Cleveland, Ohio, to help determine what local companies would attract venture capital and help prepare them to secure funding from outside venture firms. Cleveland founded its center in 2002, and reports that area companies have since enjoyed a six fold increase in venture backing over the last three years.

North Carolina
Angels aren’t enough
For many moving in high tech circles, North Carolina’s Research Triangle Park is spoken in the same breath as Silicon Valley and Route 128 in New England as a hot bed for innovation. The area is surrounded by three top tier university research programs: Duke University, University of North Carolina-Chapel Hill, and North Carolina State. As of 2007, there are over 130 R&D facilities in the Park, with more than 39,000 employees working for a total of 157 organizations.

A ranking of states by number of biotech companies released in 2006 by Ernst & Young ranked North Carolina third in the country with 81 companies, behind Massachusetts, with 256, and California, with 374. However, the Raleigh, North Carolina local newspaper, the News & Observer noted the state actually had fewer biotech companies than the year before. Several local industry leaders cite a lack of venture capital as a reason for the statistic.

Last March, the state Senate proposed a bill that would permit the state to borrow up to $100 million dollars from traditional lenders to reinvest in venture funds. The bill did not pass, but will be reintroduced this year, says Monica Doss of the Council for Entrepreneurial Development, an organization spearheading many of the efforts to bolster the state’s venture industry.

?We’re also working on re-introducing a capital gains tax exemption for founder’s shares so that when companies go public, the early supporters keep their tax advantages,? says Doss. She explains that the state has plenty of angel investors but remains in need of more funds for certain industries. ?Plenty of North Carolina natives will come back after they’ve done well on Wall Street and are happy to support local startups,? she says. But she explains that the many young companies in new emerging technologies will need additional resources to shepherd them through the early stages of development. ?Our real priority is to create a mix of professional venture capital so local companies can bloom right here in North Carolina.?

Acting on capital formation
Florida first tried to attract venture capital towards its local early stage businesses back in 1998, through a CAPCO program that invested a total of $100 million in 59 local businesses. Unfortunately, the state ended up losing jobs as many of those businesses were swept away when the tech bubble crashed. By this year, venture commitments in the state fell to $304 million from its all time high of $2.6 billion in 2000. As a result, the state passed the Capital Formation Act which attempts to foster venture capital in three distinct ways.

First, the law launched the Florida Opportunity Fund, a $29.5 million fund of funds to be invested in venture firms in the state. The fund will act to fill in the gap between the state-sponsored research and more mature VC support. Second, the law creates the Institute for the Commercialization for Public Research, a high tech incubator. ?It will serve as a central facility to mentor companies and showcase technologies from publicly financed research, such as those produced by universities or other public research facilities,? explains Louis Laubscher, chief operating officer of Enterprise Florida, the state’s lead economic development arm. ?Essentially the Institute would help win support from outside venture firms.? Finally, the law institutes a grant program that sets aside up to $250,000 for universities to assist their efforts to build companies from the innovations originated in their research labs.

Greenhouses nurture biotech
Beyond the substantial state pension funds backing venture and private equity firms, Pennsylvania’s Department of Community and Economic Development has undertaken several initiatives to foster high tech industries and the venture capital to finance them. One initiative that dates back several decades is the Benjamin Franklin Technology Partners, which offers seed financing and hands-on consulting services to foster the commercialization of new technologies.

?The Ben Franklin Technology Partners has been active in early stage investing for more than twenty years, and has survived numerous administrations, both Democrat and Republican,? says Brenda Gavin of Pennsylvania-based venture firm Quaker Bioventures. The Technology Partners offer seed financing in three general areas: technology, physical science and life sciences. ?Often times, the fund provides the first money any of these ideas get,? says Gavin.

Pennsylvania also used $100 million of its tobacco settlement allocation to create life science ?greenhouses? in Pittsburgh, Harrisburg, and Philadelphia. These greenhouses fund life science companies across the state, often in collaboration with the Ben Franklin Technology Partners. ?Together, these two funding groups can provide firm foundations to early stage life science companies,? says Gavin. These initiatives appear to be paying off as the state regularly ranks in the top ten for the number of biotech firms in the state, according Ernst & Young’s rankings.

The billion dollar bet
New England is often paired with the Bay area as the dominant regions for venture capital in the US, but the state government in Massachusetts isn’t taking that ranking for granted. This past year, Governor Patrick announced a ten year, $1 billion life sciences initiative to make the state the nation’s leader in that sector.

?There has been some historic complacency along Rte. 128 given the prior successes,? admits Michael Greeley of Boston-based IDG Ventures and president of the New England VC Association. ?But plenty of us also know how hard other states are working to build comparable venture markets.?

In an op-ed in the Boston Globe arguing for his initiative, the governor wrote, ?[W]e cannot afford to rest on our laurels. Competitor states and foreign nations are investing billions to attract our researchers, institutions, and industries. The University of Wisconsin-Madison outspends both Harvard and MIT in research and development.?

The Massachusetts Life Science Initiative involves three key programs: the Stem Cell Bank, Innovation Centers and a series of commercialization grants. The Stem Cell Bank aims to hold the largest collection of stem cell lines in the world and make that catalog widely available to researchers. Innovation Centers are tech labs dedicated to advancing stem cell research without the legislative constraints that exist in other states. Massachusetts will help provide cutting edge equipment for the Centers and place them throughout the state to spread the jobs they create. The last initiative will be grants to help translate research accomplishments into viable enterprises.

In terms of spending, over the next ten years the state would issue $500 million in bonds to pay for capital investments at academic institutions and other facilities. The state would also spend $250 million on both research grants and tax credits to biotech companies that establish jobs in the state, and finally Massachusetts would spend $250 million on matching grants from biotech companies for fellowships and research.

As ambitious as that may be, Greeley warns that it fails to address a real problem for the venture industry in the state. ?Our local universities attract and train some of the best minds in the world, who then leave the state to start companies elsewhere,? he explains. ?Perhaps we should offer real incentives like subsidized housing for any students who stay in state? Unless we start granting some meaningful incentives for our students to stay here after they graduate, we won’t reap the rewards our schools sow.?

How green can the Valley get?
Silicon Valley is maintaining its ample lead in the US in terms of the number of venture firms and high tech companies, but the state of California is now providing financing for environmentally friendly innovations, otherwise known as ?green tech? or ?clean tech.? In 2006, California passed legislation to cut its greenhouse gases by 25 percent and reduce usage of carbon in fuels by 10 percent by 2020.

This past October, Governor Schwarzenegger signed the Alternative Fuels and Vehicle Technologies Assembly Bill into law. This bill would provide grants and revolving loans to state agencies, California-based businesses and projects, public-private partnerships, vehicle and technology consortia, fleet owners, consumers, and academic institutions towards the development of alternative fuel and vehicle technologies to help attain the state’s climate change goals. The bill is funded by fees on vehicle registrations for a term of seven years and is expected to yield about $205 million per year in new funding for R& D into clean transportation technologies, as well other clean air initiatives.

As for the state’s broader venture and tech industry, California will clearly continue to dominate. ?Plenty of states look with envy on California,? says Heesen. The president of the NVCA stresses that states can make a real difference with targeted policies, so long as they keep their expectations realistic. ?They have to realize that fostering their own venture ecosystem is a long term proposition, and the fact is, there may be only one Silicon Valley.?