Capital Draw

To overcome a lack of capital for a growing number of innovators and entrepreneurs, Michigan’s investment community is pooling its available resources to drive growth, expand opportunities, and attract new players.
Capital Draw
Lettering by Martin Schmetzer

Venture capital investment, private equity activity, and early stage angel investing all are strong in metro Detroit and throughout the state of Michigan, but leaders in the field say there isn’t enough capital to support so many entrepreneurs.

Michigan-based venture capital firms had $2.2 billion in capital under management in 2018 (latest data available), while another $1.5 billion came from national firms with a presence in Michigan, according to the Michigan Venture Capital Association’s 2019 Annual Research Report. The high-water mark for in-state investing — $2.4 billion — came in 2016, and the peak for both local and national investment was $5.3 billion, which came in 2015.

In 2019, Detroit-based private equity firm Huron Capital completed 25 acquisitions, making it one of the busiest years in the company’s history.

“We expect 2020 to be another solid year for M&A,” says Gretchen Perkins, partner in charge of business development at Huron Capital. “In our opinion, the capital markets continue to be liquid at all levels of the capital stack, from senior debt on down to equity, but one can expect conditions to moderate a bit, in line with the consensus (regarding the) U.S. economic outlook.

“According to The Conference Board, the economic outlook for the U.S. will be more of the same (approximately 2 percent GDP growth), with the anticipation that the situation may moderate just a bit by year-end 2020,” she adds. “We believe there will continue to be business owners who come to market in 2020, in advance of the future recession, to maximize their sale proceeds in a good economic environment, thus producing acquisition opportunities for private equity in 2020.”

Ara Topouzian, executive director of the Michigan Venture Capital Association in Novi, says venture capital activity is strong in Michigan, as well.

“I think we’re seeing that certainly Michigan is an attractor for out-of-state investment,” Topouzian says. “We’re seeing about $8 coming in from out-of-state (investors) for every $1 invested in-state.”

Charlie Rothstein, founder and senior managing director of Beringea, a venture capital firm in Farmington Hills, says demand for capital is more intense in the state due to its manufacturing roots.

“We’ve been telling the rest of the world for a long time that Michigan isn’t a fly-over state when it comes to investing in growing businesses,” he says. “The venture capital business in the state of Michigan has grown quite a bit over the last 10 years, thanks in part to the success of the region. Success kind of  builds on itself.”

While venture capital invested in Michigan ranged between $3.7 billion and $5.3 billion over the last five years, during the same period the number of entrepreneurs in need of financial support continued to increase. The MVCA says there were 140 active venture-backed startups in Michigan in 2018, a 37 percent increase over the past five years.

The MVCA estimates that $964 million in additional venture capital will be required in the next two years to adequately fund the growth of Michigan’s existing venture-backed startups, not including funds for new startups. Only $334 million is said to be available.

“There’s a significant amount of R&D that goes on in the state,” Rothstein says. “When you compare that to the amount of capital available for innovation, the ratio of available capital is way out of whack. We’re very low. The state and the Midwest region are capital-starved.”

Last year, venture capital firms with a presence in Michigan raised 47 percent less than they targeted, making it difficult for startup companies to obtain the capital they need to grow and hire in Michigan.

Angelic Assistance
Angel funds like Grand Angels in Grand Rapids and Woodward Angels in Detroit provide capital to business startups in the early phases of their existence. // Spot illustrations by Brian Britigan

“We definitely need more capabilities for VC activity in the state,” Topouzian says. “There’s no shortage of entrepreneurs. We can’t be compared to the West and the East coasts. We definitely need more fundraising capabilities. We need incentives. Years back, the state had incentives for the venture capital community, and that translates to the entrepreneur community. We haven’t had anything like that in a few years.”

Investors, venture capitalists, and angel investors alike try to make up for the lack of available capital by collaborating and pooling assets from different sources. The goal is to help more Michigan innovators and entrepreneurs not only get their dreams off the ground, but to expand.

“There’s a lot of collaborating that goes on here, as opposed to the coasts,” Topouzian says. “What’s good is the wealth of opportunity and the ability to collaborate. Our members are working with one another to create. The minus is that raising capital is hard.”

Tim Parker, one of the foremost angel investors in the state — he oversees Grand Angels in Grand Rapids, Woodward Angels in Detroit, Kzoo Angels in Kalamazoo, and Flint Angels — is a big proponent of combining forces.

“We’re seeing a lot of collaboration,” Parker says. “There’s not a lot of competition between venture capital firms or between angel groups. Michigan can be a force when we’re networked together. We’re seeing more of that, which is making it a much more attractive climate for businesses when they need capital and capabilities to help them scale.”

Patti Glaza, senior vice president and venture managing director at Invest Detroit, located in the central business district, says collaborative efforts here are unlike any other place in the country. “I can call any investor here in Michigan and they’ll take my call and we can talk about companies,” she says. “It’s not competition for deals; it’s about how we can make companies successful. We have so little that we all help each other out.”

Opportunity in Abundance

With dozens of colleges and universities around the state, a legacy of engineering talent going back more than 100 years, a front seat in the drive for automotive electrification and autonomous vehicles, and a growing entrepreneurial spirit, particularly among younger people, there’s more opportunity for venture capital activities in metro Detroit and Michigan than ever before.

“There’s a significant amount of engineering talent and engineering heritage in the state of Michigan,” says Rothstein, whose firm has been investing for 30 years and has an office in London. “We have great universities that churn out R&D, (as well as) rich intellectual property portfolios that they spin out. All of these forces are coming into play, combining with the manufacturing sector — which, when you look at autonomous technologies, is going to create a lot of opportunities for a lot of different companies.”

Glaza sees mobility as a ripe area for innovation and investment. “We’re seeing more and more mobility here in Michigan, everything from pedestrian detection to airspace mapping and management for drone delivery,” she says. “We’re seeing that spinoff from the universities, and (there’s) organic (growth). We also see a lot of  life sciences and software, like the rest of the state.”

According to the MVCA, 38 percent of the state’s venture capital activity is in the life sciences sector, 35 percent is in information technology, 6 percent is in advanced materials and manufacturing, and 2 percent is in mobility. The other 19 percent is spread out among numerous other industries.

“The high-growth areas within Michigan are definitely the life sciences, any innovation, software development, and IT in general,” Topouzian says.

Parker agrees and adds other areas of interest: “A lot of software and software-related businesses are seeing success,” he says. “Life sciences are a real strength in Michigan, including drug discovery and medical devices. Advanced manufacturing and precision technologies are core competencies in Michigan, with the auto industry and a lot of furniture companies. Fintech is becoming a strong suit, especially on the east side of the state.

“In addition, agriculture is the No. 2 industry in our state and we’re working hard to develop more ag-tech businesses. Space technologies like Orbion Space Technology in Houghton and Atlas Space Operations in Traverse City, and some of that high-tech development, are coming into Michigan.”

Capital Needs
According to the Michigan Venture Capital Association, there isn’t enough available capital in Michigan to adequately fund the growth of venture-backed firms and startups.

Bryan E. Berent, managing partner of Blue River, a boutique investment bank in Bloomfield Hills that also has offices in Pittsburgh and Denver, sees a very busy and prosperous M&A sector here.

“The M&A market has been crazy good for the last three, four, or five years,” Berent says. “Valuations are extremely high. If we represent a company that’s a good, solid, well-run, financially strong company, there’s going to be people from all different worlds bending over backward to see that company. It’s so competitive out there from an acquisition standpoint.”

For all of the talk about advanced manufacturing and autonomous vehicles, Berent still sees traditional manufacturing businesses as the most attractive types of companies to private equity firms, which make their money by acquiring companies and either rehabilitating them, making them grow, or both, and then putting them back on the market.

“We’re a manufacturing-based economy in Michigan, and manufacturing is still a strong sector and performing well,” Berent says. “There’s more money focused on manufacturing and distribution than any other sector. A lot of other sectors get more press — the tech sector and the software companies — though the valuations are sky-high. But if you look at where private equity wants to spend their money, it’s going to be with hard-core manufacturing businesses. They know them; there’s a history. They know if they buy this manufacturing company, it’s still going to be there five years from now, and the valuations are pretty straightforward.”

Improving the Climate

Diversifying the state’s economy, increasing the incentive for investors, and improving education are proposals put on the table to boost the climate for investment in the Great Lakes State.

“We’ve been talking about diversifying the state economy for years,” Topouzian says. “The reality is we’re automotive. I think it’s always good to diversify a little bit more, but let’s speak to our strengths, too. The mobility factors for automotive are important. The Midwest, in general, has a wealth of startup opportunities that are in the mobility space, and I think there’s more that can come from it.”

Blue River’s Berent is a diversification proponent. “It’s still hard to keep engineers and technical people in Michigan, even though we have great schools,” he says. “The only way to do that is to build up some of these other industries.”

He points to Pittsburgh, which remade itself as a health care and technology center after the steel industry faded away, and Cleveland, which is transforming itself into a center for block chain technology — the foundation of cryptocurrency. “The state of Ohio is the first state in the nation to allow people to pay taxes with cryptocurrency,” Berent states. “There’s got to be something that we can put in place like Pittsburgh and Cleveland did.”

Invest Detroit’s Glaza, like Parker, points to fintech as evidence of diversification. “A growing trend here in Michigan is fintech,” Glaza says. “There’s a lot of activity there.”

Rothstein says Michigan should try to make itself an even better place in which to live than it already is. “You want to make this place super livable, the place where people want to live and work,” he says. “That means fix the damn roads. It means improve the schools in the city. Make it the place where young people want to be, where young businesses that are bringing great jobs and young families back to our state want to be.

“Let’s take advantage of what Michigan has, which is a beautiful setting, an amazing cost of living relative to what people in other regions deal with, and then we’ve got this deep intellectual pool.”

The ongoing rejuvenation of Detroit’s central business district and its neighboring enclaves like Midtown and Corktown, along with new attractions and streetscapes in urban suburban downtown districts across the state, bode well for the future. As new urban residences and loft office spaces come online, they’re being filled with tenants.

Demand for more urban development is one reason Ford Motor Co. is spending $740 million to transform the shuttered Michigan Central Station at Michigan Avenue and 14th Street in Corktown into a mobility mecca of R&D labs, offices, autonomous test sites, and mixed-use development. It’s scheduled to open in 2022.

Digital Diversification
The state of Ohio has diversified by becoming a center of digital currency. Some experts believe mobility is providing the innovation boost Michigan needs.

The project is joined by the redevelopment of the neighboring Roosevelt Warehouse and the recent transformation of a long-ago hosiery business at Michigan and Rosa Parks Boulevard (12th Street) into The Factory, where Ford now has more than 220 employees as part of its Project Edison team and electrification programs. Overall, Michigan Central Station and the neighboring projects will be home to some 5,000 tech workers and software engineers focused on self-driving vehicles and ancillary technologies and services. The automaker says half of the workforce will be represented by innovative companies from outside the company.

Another factor that will help draw capital and talent to the state is a robust high-speed fiber network and data warehousing market that’s largely owned and operated by local companies. For example, in February, 123Net — a large data center services provider in Southfield — announced it had partnered with Telia Carrier, a Stockholm-based telecommunications company and owner and operator of a large high-speed fiber network, to provide additional service to the Michigan market.

123Net’s fiber footprint throughout the state includes 4,000 route miles of high-speed fiber in more than 106 communities. The two networks will connect geographic reach and broadband capacity for both. Other local players like Rocket Fiber in Detroit, along with large providers like AT&T, Comcast, and Verizon, are adding high-speed data services across the state.

In turn, enterprises such as ManagedWay Co., a cloud services provider in Troy, and its contemporaries like Barracuda Networks and 123Net, have made their homes in southeast Michigan because the area is consistently rated as one of the safest places in North America — relatively free of natural disasters such as hurricanes, tsunamis, earthquakes, tornadoes, and volcanoes.

“That’s a great selling point for us; plus, in metro Detroit we’re within 500 miles of nearly 110 million people in the U.S.,” says Robert Sanders, president and CEO of ManagedWay Co. “By comparison, Chicago is (close to) 85 million people. More and more, you’re seeing data centers locate in our region, which is good for our economy and good for us.”

To propel further investment capital in Michigan, Rothstein and Parker agree that industry and government entities can do more to streamline the process entrepreneurs go through to receive VC investments.

“Making it simpler to obtain capital would help,” Parker says. “I do feel like, as a nation even, the venture capital system is a little bit broken. We ask entrepreneurs to move fast and make quick decisions and focus on their business, but when a venture capital firm or a private equity firm comes in, it’s not uncommon for us to slow them down while we get our act together. We’re doing a pretty decent job, but there are always things we can do better.”

As for future growth, Topouzian is optimistic. “I think the future is bright because of the type of entrepreneurs we have here,” he says. “I challenge anyone to go anywhere else and find the kind of entrepreneurial talent we have.

“Next year (2020) is going to be a pivotal year,” he continues. “The legislators and the state government are interested in putting some kind of incentive together so that we can be a little bit more competitive, and make things easier for all involved.”

After three decades in the venture capital business, Rothstein still is impressed by what he sees.

“It’s a really inspiring business to have,” Rothstein says. “All of us get so inspired every day when we get to meet these young companies that are doing something different. They’re bringing a solution to some business problem, and someone is creating a company around that. It’s really energizing.”

In fact, Glaza doesn’t see an end to the innovation coming from metro Detroit and Michigan. “There are always ways to do things differently or better,” she says. “We’re going through a huge shift in how we think about getting from place to place, and I don’t see that slowing down.”

Strong and Active

Andrew W. MacLeodAndrew W. MacLeod, a member of the Dickinson Wright law firm in Detroit and the newly elected president of ACG Detroit, a nonprofit business organization of private equity firms, corporations, and lenders, assesses the current M&A market and the investment climate in metro Detroit and Michigan.

DB: How would you rate the current M&A market in Michigan?

AM: In general, the M&A market remains active and strong, both in terms of valuations and deal volume. Anecdotally, I’ve heard concerns regarding elevated valuations and a slight easing of transaction volume, especially during the second quarter of 2019, but I haven’t seen that in my practice. However, the M&A market has been strong for a number of years, and some slight easing wouldn’t surprise me. 

DB: Can you assess the current venture capital market?

AM: Similar to the general M&A market, in 2018 the venture capital market experienced a record year with respect to venture capital investments. This active pace continued in 2019, (and at the end of the year) venture capital investments were anticipated to be on pace to be second only to 2018’s record total. As a result, although venture capital investment is down from its peak, at this time the venture capital market remains healthy and active.

DB: How can the investment markets be improved in metro Detroit and Michigan?

AM: At ACG Detroit, we’re focused on growth, and growing and facilitating investment in middle-market companies. Middle-market companies represent a significant portion of the U.S. economy, employing nearly 50 million people, and are vital to a healthy economy. However, in terms of business and legislative initiatives, middle-market companies are often overlooked. They’re too large to benefit from small-business initiatives, and too small for the unique opportunities typically accorded to larger business. Without addressing specifics, broad-based initiatives that foster business investment and efficient dealings with government tend to have the greatest impact on middle-market companies, and we’re supportive of such initiatives.

DB: What are your priorities for your two-year term as president?

AM: In recent years, ACG Detroit has been recognized twice by ACG Global as the Chapter of the Year, in large part due to the innovative and unique network and program offerings it’s able to provide to its members and the business community. ACG’s membership is comprised of professionals, financial advisers, capital providers, business owners, and private equity firms that are leaders in M&A and the business community. However, ACG Detroit is still, in some ways, a best-kept secret. My first priority is to build on the efforts of prior leadership to spread the word about ACG, and the benefits it provides, to the business community.

Go to accompanying 2020 Michigan Investment Organizations list