Early investments in Minnesota firms are at the lowest level on record. Is the state losing its innovative edge?
Adisack Nhouyvanisvong and Corey Thompson of Naiku quickly fixed a student's I.D. in Naiku as teacher Todd Beach gave his A.P. European history class test instructions at Eastview High School in Apple Valley. The test was taken with Naiku software on laptops and netbooks.
Venture capital investments in Minnesota companies are at the lowest level on record. Many of the in-state firms that funded promising technology start-ups have disappeared, and entrepreneurs haven't offset that by raising money elsewhere.
"The trend line we're on is not good," said Jay Hare, who tracks Minnesota venture capital investments for the global consulting firm PwC, formerly PricewaterhouseCoopers.
It wasn't always this way. Fifteen years ago, Fortune Magazine dubbed Minneapolis, "Money-apolis," calling it one of the "few places on the globe where so much cash is chasing so many creative ideas."
Back then, investors in young technology companies could make quick money by taking a company public, a common way for venture capitalists to cash out. In the mid-1990s, as many as a dozen Minnesota companies completed initial public offerings in a given year. Last year, there were two.
That change could have significant implications for the state economy. Entrepreneurs with fewer avenues to raise cash will have a harder time building businesses and hiring people.
The economic turmoil of recent years and accompanying slump in the stock market have been big factors in making it tougher to get those kinds of companies started. Another big issue is that, historically, a lot of the money for start-up companies in Minnesota has gone into the medical device industry.
But that area has lost favor with investors because of concern and uncertainty about the government's process for reviewing new products.
"The cause of the problem is not a lack of capital," said Pete McNerney, a Minneapolis-based partner venture capital firm Thomas, McNerney and Partners, which focuses on health care.
The trends don't bode well for companies like Minneapolis-based Fresh EcoHarvest. The start-up is developing technology to grow produce inside industrial buildings partly by using artificial lights and nutrient-rich mist.
Partner Kristine Sundberg used to be a vice president who headed corporate communications at Supervalu, the Eden Prairie-based grocery giant. New to the start-up culture, she spent the past year talking with state officials and networking with entrepreneurs to find Minnesota investors.
She got important validation at last year's Minnesota Cup, a cash-prize competition for new business ideas. Fresh EcoHarvest was a semifinalist.
But her other efforts to get money sometimes resulted in "wild goose chases." She described the past year as a time when Minnesota investors have been "very skittish about anything resembling risk."
After unsuccessfully trying to raise $5 million to $10 million to build a prototype to show how the technology works, in January Sundberg went all the way to Saudi Arabia to look for money.
In the past, Minnesota has ranked among the top 13 states in the amount of venture capital companies attracted, from in-state sources or not. Last year it ranked 20th, just ahead of Rhode Island.
Venture capital investment in Minnesota companies fell 48 percent in 2010 to $139.5 million, the lowest amount in 15 years of record keeping, according to the MoneyTree Report from the National Venture Capital Association and PwC. Nationwide, venture capital investments rose 19 percent.
For years the state's prowess in medical devices attracted investors trying to follow the success of industry leaders such as Fridley-based Medtronic Inc. But concentration in the area became a liability as investors shied away.
Hare said Minnesota has become a "one-trick pony," with medical device start-ups garnering 64 percent of venture capital last year.
"We've pretty much put all our eggs in the medical device basket, and the medical device basket is hurting," he said.
Entrepreneurs in other areas struggle to get money.
Venture capitalists told Corey Thompson to come back when his business Naiku has increased sales of its Web and mobile testing platform for schools. To make that happen, Thompson needs at least $250,000 for marketing, expansion, and product development. He and two business partners would prefer to find a Minnesota investor, but every so often they receive calls from out-of-state parties.
"I want Naiku to be successful," said Thompson, a co-founder. "If that means I have to take money out of state and they want to build the team closer to them, why would I say no?"
A shrinking industry
As they seek start-up capital, Minnesota's entrepreneurs have fewer places to look. The number of venture capital firms in Minnesota shrunk from 38 in 2000 to just 15 in 2009, according to PwC.
Some that still exist have scaled back. Sherpa Partners, whose $17 million fund invests in early-stage tech companies, tried to raise more money seven years ago but suspended those efforts when it fell short of its goal. Now it is putting money only into the remaining two companies in its portfolio.
"There are fewer people making investment decisions," said Rick Brimacomb, a partner in the firm.
These days, he calls himself a "venture catalyst." He works from a Minneapolis law firm's office and serves as a strategic adviser for emerging companies.
"It's kind of like being a venture capitalist, without a checkbook," Brimacomb said.
Just two firms generate more than half of the venture capital investment that originates from Minnesota, according to PwC.
Michael Gorman, a founding managing director at Split Rock Partners in Eden Prairie, said in-state venture capital firms can help companies meet out-of-state investors.
"We would like to see Minnesota have as robust an entrepreneurial ecosystem as possible," said Gorman, whose firm funds Internet services, software and companies that work in health care. "We would like to see these numbers move in the other direction."
Some say convincing out-of-state venture capitalists to invest in a company based in Minnesota can be tough. The risk is that it might lead a company to move its headquarters closer to investors.
Joe Mandato, a managing director at the Silicon Valley venture firm De Novo Ventures, said a company's location is not a deal breaker. But, he said that if there were two equally great life sciences investments in Minnesota and California and he could choose only one, he would choose the West Coast company.
"There is far more capital around. There is a lot more expertise," Mandato said. "There is a more risk-taking environment."
Attempts at revival
Some groups are trying to boost the amount of investment dedicated to new business ideas.
Triathlon Medical Ventures partnered with Minneapolis-based venture firm Affinity Capital Management to create a $10 million fund to invest in early-stage medical device, biotech and other health businesses. But last fall, Triathlon suspended the effort; it was too difficult to raise the money the group had planned.
Last year Minnesota officials launched the state's first angel tax credit, for wealthy individuals who invest at least $10,000 in Minnesota companies.
Meanwhile, it's possible that sectors of Minnesota's economy such as clean energy may end up attracting more venture capital.
"That isn't something that changes overnight," Gorman said. "It changes over time with success."
Some start-ups wonder how much longer they have to wait.
Orono-based Diabetes Sentry Products Inc. already has approval from the Food and Drug Administration to start selling a device that straps on to diabetes patients' wrists and tells them if their blood sugar level is too low while they are sleeping. There's a wait list of hundreds of orders for the device.
The problem? Diabetes Sentry needs more money to make the product. "Being in the medical device capital of the world, you think you'd have a lot of people beating down our door," said Michael Russin, vice president of sales and marketing.
The company, which wants to raise $300,000 to $500,000, has looked into venture capital but didn't want to give up the kind of big ownership stake that firms wanted in return for an investment.
Now, Russin is taking his quest on the road. Arkansas is paying to fly him in, and South Dakota is wooing him with favorable loan terms and other incentives to move his business there.
Wendy Lee • 612-673-1712