A gap in financial
markets has left
Minnesota companies
vulnerable to biotech
by venture capital firms
on the coasts.
Fortuantely, there's
a simple cure.
Originally published
as the StarTribune BUSINESS FORUM
July 8, 2002 

By Harlan Jacobs

    Seed capital traditionally has been the rocket fuel for propelling technology visionaries off their launch pads. It is in scarce supply today in Minnesota. This shortage largely is a private-sector problem, yet it has serious implications for both the public and private sectors.

    While the pendulum has begun to swing back from the excesses of the dot-com mania to traditional areas of investment, such as medical devices, a serious problem continues to exist in the realm of biotechnology.

     A comprehensive understanding of the present dysfunctional system must be gained by the citizens and taxpayers before it is too late to act.

    For example, when Perry Hackett, a professor of genetics and cell biology at the University of Minnesota's College of Biological Sciences, wanted to secure $5 million of funding to develop his technology, he had plenty of offers from venture capitalists on the East and West coasts. These fund managers were ready to invest with only one little requirement: They wanted to be within a one hour drive of their investee companies and insisted that Perry move out of Minnesota.

    To his credit, he stood his ground (a rather curious virtue for a native of Palo Alto, Calif., during a cold and bleak Minnesota winter). Hackett wanted to stay and build his business here, and yet he was frustrated that no local venture capital firm had any interest in investing in a biotech company with a five-year research-and-development program that then would be followed by a commercialization program of comparable length. Ten years was just too long for the local fund managers.

    Fortunately for Hackett, and for Minnesota taxpayers, he found a strategic investor in the form of a local company that manufactures reagents and diagnostic kits. The company made $3 million private placement investment. That investment, combined with a $1.5 million grant from the Irvine, Calif., Beckman Foundation, saved the day and kept Hackett (and the jobs) here.

    Consider the irony of what could have happened. Minnesota taxpayers provide generous funding to the University of Minnesota so that it can develop world-class programs such as what Dean Bob Elde has done at the College of Biological Sciences. Top flight students and faculty flock here from around the globe.

    When they're finally ready to commercialize the technology — which should in turn lead to the creation of a good number of high-wage jobs and an enhancement of the property tax base — a Boston or Silicon Valley venture capitalist, as a matter of personal convenience or policy, insists that the firm move out of Minnesota.

    The possible net result: Minnesota taxpayers pay for the development of new technologies, and Boston and Silicon Valley end up with the high-paying jobs, a highly educated workforce and an enhanced tax base.

The next Medtronic
    Again, this is a private sector problem. While business angels can help get the next Medtronic started, venture capitalists must come forward early on to help with the several millions of dollars that are needed to launch a biotech company. Sadly, I am aware of no venture capital fund that's located in Minnesota today that has in its charter the stated mission and the resources to invest $5 million to $10 million in the first round of funding, called Series A, for several biotech companies annually over a multipleyear period.

    All Minnesotans stand to lose from this problem. Until one or more venture capital funds hang out their respective shingles indicating that they will invest in biotech companies and do so early on with regularity, Minnesota stands to lose jobs and enhanced tax base to states on the coasts where biotech venture capital funds with very deep pockets are ready to take calculated risks.

    When the nature of this problem was shared with thoughtful listeners at the Legislature, a solution seemed obvious: Just follow the plan known as Technology 21 that Pennsylvania Gov. Tom Ridge (now President Bush's director of Homeland Security) developed to solve some of the same problems caused when Boston venture capitalists were moving companies (spawned at taxpayer expense) out of Pennsylvania.

    Rather than following this free and proven program, local politics prevailed in Minnesota. The result was the formation of the Biomedical Innovation and Commercialization Initiative.

    Instead of following a successful recipe, too many cooks spoiled the broth. The private sector didn't respond favorably within the time frame set by the legislature and the state took back the $10 million that had been appropriated, thus leaving Minnesota biotech companies in a prolonged drought.

    Little if anything was noted in the news media when biomedical initiative bit the dust. A postmortem might prove useful in order to understand what went wrong and how it could or should have been fixed.

Pennsylvania's lead
    But now what's needed in Minnesota is to follow Pennsylvania's example: Ridge issued an executive order requiring the state's pension fund managers to invest $20 million in a Pennsylvania fund that is managed by professional Pennsylvania fund managers, which in turn match the state pension fund's $20 million with $30 million of their own investment capital. This fund invests the $50 million fund only in qualified biotech companies that are based in Pennsylvania and intend to build their business in there.

    (Those concerned about the wisdom of pension funds making venture capital investments should note that pension funds routinely put about 5 percent of their assets in venture funds. So what Ridge was doing, in effect, was making sure that at least a portion of that seed money was being planted in Pennsylvania.)

    The Pennsylvania fund managers manage the entire $50 million with the same degree of care that they apply to their own $30 million. No unneeded intermediary functions, no new overhead and bureaucratic salaries are needed — just the private sector managing its own clients' funds, as venture capital funds have been managed in the last fifty years, earning the normal 2 percent annual mangement fees plus 20 percent of the long term profits. (Yes, the compensation programs for venture capital fund managers are indeed attractive).

    Minnesota can still follow Pennsylvania's lead. That $50 million could help get 10 Perry Hacketts funded and growing right here in Minnesota.

    Until the problem is fixed, I'm buying lottery tickets twice a week. If I strike it rich, I'll fund a venture capital program that would be dedicated to investing in life-science companies, especially in the realm of biotechnology, here in Minnesota.

    Here's another idea to consider: How about establishing a lottery that is dedicated to investing in Minnesota biotech companies — taking risk dollars and aggregating them for a specific economic development program with tremendous upside for the citizens and taxpayers of Minnesota?

    Perhaps this is how the biotech version of Minnesota's next Medtronic will get funded.


Copyright 2002 Harlan T. Jacobs, all rights reserved.