Neal St. Anthony: A private sector plan's afoot to help fund Minnesota startups

Local venture capitalists and fund managers have been quietly urging Gov. Mark Dayton's administration to embrace a privately financed and operated equity fund capitalized by large Minnesota financial institutions, foundations and pension funds that would invest mainly in small-but-promising Minnesota companies.

The idea first surfaced in a 2011 task force report to Dayton on ways to accelerate the economic recovery at a time when bank lending to small businesses was still contracting.

The discussion has revived lately as Minnesota witnesses year-over-year declines in venture funding to early-stage companies.

"We need the private sector to lead on this," said Leslie Frecon, whose 13-year-old LFE Capital is known for its Minnesota-dominated portfolio of private investments in small, growing companies and solid returns to initial investors. "There exists a capital scarcity for early-stage companies that need smaller amounts of capital and access to resources, to grow and become successful businesses. We can leverage our history of building partnerships. We know how to do this and we shouldn't wait until we have a crisis — like Michigan did."

The idea would be for flagship Minnesota institutions, such as U.S. Bancorp, Thrivent Financial and Ameriprise, to perhaps pledge several million dollars each, followed by foundations and perhaps affluent individuals. A fund-of-fund manager, operating under agreed-upon guidelines, would disburse the money to Minnesota and other private equity and venture capital managers.

Kathy Tunheim, a Bloomington business owner and volunteer adviser to Dayton on economic development, said she expects the Dayton administration to come together with interested parties and announce an initiative within 90 days.

"I'm thrilled to death on behalf of the governor to have Leslie and the others looking at this," Tunheim said. "Leslie is not asking [the Legislature] to appropriate anything. We've done some things, but the small-business people say there's still too little capital, and the banks are saying they have to do only 'bankable deals.' We'd better figure out what to do or we'll be behind the 8-ball."

Dayton in 2011 streamlined business and environmental regulations and also put about $200 million in state funds into community bank deposits to try and stimulate business expansion.

But a big private fund for direct investment would be a way to inject tens of millions of investor dollars into qualifying Minnesota companies. Unlike a bank, which must prove in its underwriting that a borrower can pay back with interest, equity investors know that their portfolio companies will have different results, but the gains of the big winners will offset the failed and lower-returning companies.

The problem is compounded because a number of small private equity and venture capital funds have quit trying to raise investment capital since the recession, despite a successful passage of a Minnesota "angel" tax credit.

Part of the decline in venture capital dollars is due to the slowdown in funding for medical device start-ups. About two-thirds of venture capital funding in Minnesota has gone to the med-tech sector, which now is under more pressure from regulators and attempts to slow down health care costs.

"A lot of states are starting to do what Leslie Frecon is suggesting," said B. Kristine Johnson, a partner in Affinity Capital, a med-tech investor that targets small companies. "If you think economic development is important, the state could do things to make sure we keep a good amount of local capital invested locally. You manage for good financial returns. But you manage the money patiently."

Michigan's cornerstone corporations and foundations launched a privately managed fund that included some public pension and foundation money in 1998 that has since expanded as a networker for loans and other capital, federal grants and more. The Michigan fund now boasts that private investment in small companies, thanks partly to the initiative, has grown more than $700 million since 2012.

"Michigan's business community got behind this," said Ed Spencer, an Affinity partner and a member of 2011 Dayton task force on capital access. "The data shows venture capital has fallen off in Minnesota. The med-tech falloff is a significant part of this. The funding drop off is really noticeable in the 'seed capital' and early-stage companies. You don't get to 'late stage' funding if don't have early stage. There is a need to do something like this."