Turning up the Heat: How Venture Capital Can Help Fuel the Economic Transformation of the Great Lakes Region

Battered for decades by the loss of manufacturing, the outmigration of talented workers, and a sluggish entrepreneurial spirit, the states and metropolitan areas of the Great Lakes region have long struggled to remake the area’s once powerful economy. Efforts to grow new industries and jobs in the region are today more urgent than ever, as the global financial crisis, bankruptcy of two of Detroit’s Big Three, and ripple effects through the supply-base are churning the economic and physical landscape on which many of its communities were built, and once thrived.

Its deep problems not withstanding, the Great Lakes region has formidable assets that will necessarily provide the foundation for future economic growth, including substantial research and development capacities, a strong existing industrial base, and growing prowess in key economic sectors and technologies. But this isn’t enough: The region still lacks the venture capital investments needed to help translate the huge amount of innovation these assets generate into the high value firms, products, and services that, as the Great Recession recedes, will define the next economy.

The dearth of venture capital has not gone unnoticed, and over the years several states in the region have undertaken initiatives designed to encourage innovative start-up companies, entrepreneurship, and venture capital formation. Historically, the goal of such efforts was to spur state economic development and job creation by providing entrepreneurs with incubator facilities, social networking, and other services. But there has since been some movement away from this public service model toward the creation of business-driven organizations that focus on achieving investor returns by facilitating aggressive growth of innovative firms. These publicly and philanthropically-supported “catalytic enterprises” perform valued services for venture investors that need not be paid for by venture fund management fees, helping spur investment in activities that, given current trends in venture capital investing nationwide, might otherwise be overlooked.

Despite these efforts, a number of challenges have continued to hamper the growth of venture capital investing in the Great Lakes region. First, not enough “investable” deals are created from the vast array of new ideas and projects produced by the region’s many universities and other institutions. Second, the high costs of early stage venture investing, while an issue in all communities, is exacerbated in the Great Lakes region by an inadequate critical mass of deals, and by the dispersion of its assets across a wide region. Finally, and in large part due to the first two challenges, the Great Lakes region does not have the capacity to provide lead investments throughout the course of young companies’ growth, increasing the likelihood that they will move elsewhere to access needed capital.

This paper presents investors, community leaders, and governmental officials with a venture capital strategy aimed at helping the Great Lakes region successfully overcome these challenges. It is based on the premise that Great Lakes region has several of the key prerequisites for successful venture investing—including the capacity to create innovative products and services that can become investable deals, a knowledgeable investor community, and a growing support structure that can help lower investor risks and costs—but that concerted, collaborative actions by a range of stakeholders are needed to create and sustain a virtuous cycle of venture investment, entrepreneurship, and firm growth in the region.

This study offers two recommendations:

• The core recommendation is to create a Great Lakes 21st Century Fund, a $1 billion to $2 billion fund of funds that would invest in early stage venture capital funds operating in and focused on the Great Lakes region.1 Such a fund would have three major objectives:

    o To invest in early-stage venture capital funds with a presence in the region that focus on investing in operating companies in the region.

    o To co-invest in selected operating companies that are in the portfolios of the venture capital funds in which it invests and to co-invest in these companies through successive financing rounds.

    o To co-invest with large national and international venture firms that create offices in the Great Lakes region.

    • The key complementary recommendation is that a variety of private and public stakeholders—including federal, state, and local government leaders, research institutions, the philanthropic sector, and catalytic enterprises—work in parallel with the investor community to create a vigorous support system for venture investment. These actors should not only play a direct role in growing and sustaining venture investment, but also in supporting the research and development, talent generation, and entrepreneurial activities needed to create profitable deals.

    The two-pronged strategy proposed here is designed to allow public funding to complement private investing in ways that ultimately yield both financial returns for investors—essential if venture investment is to be sustained—as well as long-term economic benefits for the Great Lakes region at large. Will it alone turn the Great Lakes economy around? Not by a long-shot. But it will help leverage the region’s substantial resources and promising opportunities for venture capital investing, and in turn help the region grow, and retain, the new businesses and jobs it needs to ensure a more prosperous and secure future.