State should venture only as limited partner

Super angel investor Tom Shannon meets with the CEO of Somna Therapeutics, a recent spinout from the Medical College of Wisconsin, every Monday morning to go over an activity report. He and CEO Nick Maris look at what got done the previous week, what needs to happen in the coming week and progress against critical milestones as they prepare to bring to market a device for the control of acid reflux.

Tom Schuster, an investor in Somna and a fellow angel investor with me in NexVex, a recent startup out of the Fifth Ward in Milwaukee to create a web marketplace for roofs, has followed suit and is meeting with the NexVex CEO William Bazeley every week on a wide range of startup milestones.

Both startups are holding regular board meetings to make sure their investments stay on track toward a profitable and early exit.

This kind over hands-on oversight by seasoned business people has proven to produce the highest returns for early stage investing of any asset class. It is intimate investing. A study by the Kauffman Foundation put average returns for early stage investing at north of 20%, and it is the personal attention that makes the difference.

Another term for this brand of investing might be called tough love. It’s love for the entrepreneur, but it is also tough-minded oversight. The entrepreneurs accept the help, because they have the biggest interest in a profitable exit from the venture.

They don’t just sign up for the early stage money, known as the A Round; they generally welcome experience, connections and guidance from the seasoned angels.

Shannon, for example, had a highly successful exit from a flu testing company called Prodesse. He knows the ropes for building value in a company.

What angel investors bring to the table, besides their money, is their scar tissue. I often joke that my next book is going to be: “Everything I Learned About Business I learned by Screwing Up.” The lessons were hard earned. Those mistakes don’t need to be repeated by an entrepreneur who has angel guidance. Hence, there’s a higher probability of success.

All of the above is context for the political palaver about the wisdom of putting state matching money into early stage funds. The private investors are putting their own money in first. The do so because they expect to make a profit.

So, if the state goes in as a limited partner, they should expect to make the a profit for the taxpayers. Done properly, the state is not putting in a subsidy; it is making an investment.

Nor are political leaders picking winners and losers, as some opponents of state matching funds assert. Structured properly, the managers of the private funds make the calls on what companies deserve investment, not the politicians.

That the state is an investor, equal to other investors, needs to be a fundamental principle in any venture capital bill going forward in Wisconsin.
Private investors always have reservations about bring in public money. It could be more brain damage than it’s worth. Some choose to turn down the funds, and that has happened recently in Wisconsin. Business decisions, which always carry some degree of risk, don’t lend themselves to public scrutiny. And bureaucratic oversight doesn’t sit well with many investors.

Still, Wisconsin remains in the backwaters of venture investing. Silicon Valley launched high growth 1100 companies last year. Wisconsin launches a couple of dozen per year.

This is not an insignificant matter. Our leaders generally talk the talk on job creation. But they have few reliable ideas about how to get it done. The current job doldrums bear that out.

There are many ideas out there: recruit from other states, cut taxes and regulations, do real estate developments, fill existing openings through better training programs, reform education, offer expansion credits. They all have some merit.

But business creation, which brings job creation, is the one sure path. No economic theorist debates that.

Wisconsin made a bold move in 2005 when the legislature passed Act 255. It offers a 25% tax credit to accredited investors to reduce some of risk of early stage investing. That credit has had a cumulative positive effect on entrepreneurial ecosystem in the state. We have more angel investors than ever before. The deal pace is steadily growing.

This act spreads its benefits across the state, even though Dane County claimed most of the credits in the early years. There are entrepreneurs everywhere, and that is being recognized in the state.

The question before the state now is whether state government should do more. (Disclosure again: I have a dog in the fight as an angel investor.) On balance, with the trade-offs understood, my view is that the state should become an investor. We need another jolt for business creation. And there just aren’t enough accredited investors in Wisconsin to lift the economy.

The foundations in the state could also fill that role. They could invest closer to home with a small part of their portfolios.

Business and job creation are the job of major player in the state.

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