Recently, Houston Exponential announced plans to create a venture capital Fund of Funds (VC FOF) to support the local entrepreneurship ecosystem. This strategy has been used by other cities and regions, such as Michigan and Cincinnati, to spur local startup growth. Private firms also offer VC Fund of Funds. What does this type of fund look like, and how has it played out in other locations?
The Basics
FOFs are funds that invest in multiple smaller funds. The increased diversification that they offer investors makes them attractive. However, there is a risk of overlap with FOFs; the many funds that make up the FOF may invest in the same entities. FOFs also may carry additional fees over a traditional fund because the the investor also has to pay the fees for the funds that constitute the larger FOF.
A VC FOF specifically invests in multiple venture capital funds. These venture capital funds then invest in local startups, entrepreneurs, and small businesses investment. FOFs diversify investors’ portfolios by ensuring investment in a wide variety of companies. Many venture capital funds make up VC FOFs, so their success depends on what investments the constituent VC funds make. In the private sector, the advertised appeal of VC FOFs is diversification, early liquidity, and enhanced fund returns.
FOFs can also exist through firms that typically invest in mature companies and buy all of each company’s equity, known as “Buyout FOFs.” The Chicago Booth Review claims that VC FOFs offer more diversification than Buyout FOFs, with an average of 7 more individual funds in each VC FOF. The research also indicates that VC FOFs are “more likely, through fund selection and/or access, to overcome their additional layer of fees” than buyout FOFs. This suggests that VC FOFs may bring investors higher value than buyout FOFs.
Impact on Cities
The trend towards creating VC FOFs to boost local innovation began about a decade ago. In 2008, Michigan created the Renaissance Venture Capital Fund. The premise behind the fund was simple: “Venture capital is important for economic growth and [Michigan is] underserved in the amount of venture capital available to fund exciting new ideas and technologies.” By investing specifically in VC funds that are active in Michigan, the Renaissance VC Fund provides the necessary capital for Michigan startups to grow and thrive.
Currently, the fund claims to receive a 21:1 return on every dollar they invest. With this success, they have grown; the fund has offices in both Ann Arbor and Detroit. Figure 1 shows the spike in investment and deals following the introduction of the Renaissance Fund. However, investment and deals seemed to have tapered off in recent years. Nonetheless, the new plateau does seem to be slightly higher than the average values before the fund was introduced.
Figure 1: Michigan saw large increases in investment in 2010 and 2011. Deals then peaked in 2013. Michigan introduced the Renaissance Fund in 2008.
In 2012, Cincinnati created a fund modeled on Michigan’s Renaissance Fund. Cincinnati-based corporations, like Kroger and Proctor & Gamble, created the Cintrifuse Early Stage Capital Fund I, LLC, which exclusively makes seed and early-stage investments in local startups.
According to Cintrifuse, the fund has resulted in a net increase of $24 million in value to the city. Figure 2 shows the spike in deals in both 2012 and 2014. Investment also peaked in 2014, relatively soon after the fund’s introduction. Nonetheless, the introduction of this program seemed to have no noticeable impact on Cincinnati’s overall GDP in 2012 and afterwards. The number of deals and amount invested have also declined substantially since 2014.
Figure 2: Cincinnati’s VC deals spiked in 2012 and 2014. The city created Centrifuse in 2012.
What Will This Mean for Houston?
VC Fund of Funds seem to carry benefits for both investors and local VC/startup culture. However, no plan to boost growth is a guaranteed success. Michigan and Cincinnati have demonstrated that it is difficult to maintain momentum with these funds. These cities’ experiences teach us that the fund needs to place a sustained emphasis on providing capital to the local region. McNair Center research indicates there are about 50 VC firms in Houston. This means that there are firms for which the FOF can provide capital. These VC firms can then disburse funds to local businesses.
On the other side of the equation, Houston will need local entrepreneurs and startups in which VC can invest. According to McNair Center research, there are approximately 20 startups active within the 610 loop. However, looking outside the loop to the greater Houston area, there is an abundance of startups. Nonetheless, the industries in which these startups focus may not be as desirable for investors as others. Houston’s startups do not tend to focus on one specific industry, although medicine and energy are popular. Since tech is one of the most desirable fields for investment right now, Houston’s tech startup scene may need to develop further if a VC FOF is to succeed.
Both sides of this equation need to be present in order for VC FOF to successfully boost the city’s innovation scene. If this is the case, there is hope that a VC FOF could provide a welcome boost to Houston’s ecosystem.
Athgothon 5 brought budding entrepreneurs and students from over 50 universities in 35 countries to the World Bank headquarters in Washington D.C. in 2013.
Photo courtesy of Athgo.
Dr. Armen Orujyan Photo courtesy of Athgo
Dr. Armen Orujyan is the founder and chairman of Athgo, an entrepreneurship platform that is in consultative status with the United Nations Economic and Social Council, U.N. Department of Public Information and the World Intellectual Property Organization. Athgo advances innovation ecosystems in Europe and Africa and has established recurring global innovation forums at the U.N. and World Bank. Orujyan earned his bachelor’s degree from the University of California, Los Angeles in 2000 and his doctorate degree from Claremont Graduate University in 2007. In 2017, Orujyan joined the Baker Institute’s Board of Advisors.
The McNair Center’s Diana Carranza recently interviewed Orujyan about his experience in social entrepreneurship.
What is your definition of Social Entrepreneurship?
I would characterize, albeit no longer classify, social entrepreneurship as building enterprises that create both financial wealth and communal value. The approach advances the idea that “doing good” and “doing well” can and should coexist. I just call it constructive entrepreneurship. Constructive entrepreneurs create short-term value through the provision of products and services, and long-term value through enterprise operations. Their activities incorporate two characteristics: positive net income (wealth creation) and positive net value (communal value creation). To be successful, constructive entrepreneurs expand performance criteria to measure and communicate both net income and net value.
How did you get involved in Social Entrepreneurship?
While in college after doing advisory work for U.S. political campaigns, including Vice President Gore’s Presidential run in 2000, I led a human rights movement that brought over 40,000 young people and concerned citizens onto the streets of Los Angeles. Leveraging the power of social media and the convening power of youth, the movement has since turned into an annual observance, attracting in effect of 160,000 people.
The experience of passionately following a vision and watching tens of thousands of people from all walks of life join to pursue a common objective was humbling and at the same time powerful and enlightening. I began seeing that with a slight push, direction and a compelling story, not only I, but also all individuals on the margins, especially young people, can realize their potential.
The success of the movement was emotionally gratifying and intellectually fulfilling, and it paved the way for my next phase in life. I wanted to do well in life by empowering young adults avoid many of my own past challenges and encourage and aid those with great ideas.
Athgothon 5 brought budding entrepreneurs and students from over 50 universities in 35 countries to the World Bank headquarters in Washington D.C. in 2013. Photo courtesy of Athgo.
There are three ways of living: 1. Live aimlessly, 2. Live for a purpose and 3. Purposefully live. I went with number 3 and founded Athgo as a nonprofit that provided a stage for young people pursuing common objectives but lacking direction, access or means.
We launched with a small program at UCLA with 20 students, but Athgo quickly evolved into a global entrepreneurial platform powered by a proprietary quantitative behavioral framework and with recurring Innovation Forums at the United Nations and the World Bank headquarters as well as in Europe and Africa.
Over the years, the Organization, has provided intellectual, networking and financial opportunities to over 10,000 young adults from over 600 universities in 80 countries while building support from Fortune 100 firms and cultivating partnerships with leading academic institutions and the United Nations system.
What are the current misconceptions about Social Entrepreneurship? For example, there is a general association of the term social with not-for-profit startups. This is one of the reasons why I stopped using ‘social’ and instead use ‘constructive’ to classify our work. Constructive enterprises produce both positive net-income and positive net-value, whereas nonprofits are not structured to be profitable, essentially relying on donors’ buy-in to be successful.
What are the current main areas of focus and challenges for social ventures? The challenge becomes incorporating both of these features, net-income and positive net-value, into project and management performance measures. While each constructive enterprise must create financial success and communal value, there are varying definitions and varying degrees.
In the case of not-for-profit ventures, how can success be measured?
The nonprofits predominately focus on producing social impact at all costs, as long as it is within the allocated budget. The concern with this is that the budget allocations for many of these initiatives are done subjectively rather than based on deep market analysis. The question has been whether the efforts of the nonprofits are established based on a ‘need’ or a ‘desire’ of the organization to produce the value.
How can ecosystems address the need of social entrepreneurs?
In order to successfully execute constructive enterprises, there must be an effective management reward structure that incorporates both communal value and financial success. Without clear definitions of how performance will be measured, management will be conflicted between competing goals.
Existing performance measures do not always support this enterprise type. Attempting to create a management reward system based on blended return without performance measures can lead to conflicting goals, which will threaten viability and undermine long-term stability.
These performance measure limitations lead some enterprises to produce superior revenue accentuation and some entities superior value accentuation. Ecosystems should have a system in place that promotes and rewards a pre-established balance between revenue and communal value. It ought to establish for companies both financial hurdles and communal value hurdles. Managers then will look to achieve a pre-established balance between revenue and communal value.
Are there niche entrepreneurship ecosystems for social ventures?
We are what we observe ourselves to be – a rock star or a rock under a star – our choice. It really does not matter where you are geographically. Companies such as Tesla, Facebook and ERI are successfully operating as constructive enterprises away from federal and state capitals. Yet, if we want to promote more rock stars, the ecosystems would need to implement favorable legal frameworks, which will reward the constructive approach. For the time being, this is still a dream.
MassChallenge was located at One Marina Park Drive until 2014.
Corporations and startups are moving toward early stage interactions. MassChallenge, a highly successful nonprofit accelerator, has been connecting corporations and startups since its 2010 launch in Boston. MC has several US and international locations, which accelerated 372 startups in 2016.
MC delivers positive results and has been listed among the Best Startup Accelerators by the Seed Accelerator Rankings Project, led by Baker Institute Rice faculty scholar Yael Hochberg. There are over 1,000 MC alumni, who have collectively raised more than $1.8B in outside funding, generated $700M in revenue and created over 60,000 jobs. According to a 2016 MIT study, MC startups are 2.5 times more likely than non-MC startups to hire at least 15 employees and three times more likely to raise $500,000 in funding.
With seven years of history, notable MC alumni includes Ginkgo Bioworks, which designs custom microbes to produce chemicals, ingredients and industrial enzymes. As a startup, Gingko Bioworks raised $154M in funding and signed a deal for 700 million base pairs of designed DNA — the largest such agreement ever made — with Twist Bioscience. Other remarkable graduates of the program include Ksplice, Turo, Sproxil and LiquiGlide.
An Attractive Alternative for Startups
MC is similar to other startup institutions such as Techstars and Y-Combinator. However, the nonprofit differentiates itself by not taking equity. Entrants to the accelerator must be early stage startups, defined as companies with no more than $500K of investment and $1M in annual revenue. As part of the four-month program, selected startups receive mentoring, co-working space, access to a network of corporate partners, tailored workshops and the chance to win a portion of $2M in zero-equity funding. Additional prizes are provided by partners such as The Center for the Advancement of Science in Space (CASIS) and Microsoft’s New England Research and Development Center.
For entrepreneurs in regions with mature ecosystems like Silicon Valley and Boston, MC is one option among an array of accelerators and informal networks. This density of resources is called agglomeration, a geographic concentration of interconnected entities increases interactions and the productivity. The MIT study suggests MC acts as a complement to the prior advantages of startups in established ecosystems by providing key resources and access to social capital and also found evidence that startups founded in regions with higher access to early stage investors had on average higher quality ideas, but that their chances of success were not higher conditional on the quality of their idea.
For startups in nascent ecosystems the resources provided by MC can become the only option to pitch their ideas to investors and advance their company at no cost other than the time invested on the program. Of equal value is the endorsement received as a MC graduate inferring the quality of the startup venture.
A Model Built on Strategic Partnerships
As a nonprofit, MC depends on the support of a network of public, private and philanthropic partners, with the vast majority of their funding coming from corporations. Governments and philanthropic foundations fund MC with the goal to foster regional economic growth. Founders John Harthorne and Akhil Nigam, former consultants at Bain & Company, garnered early support from the Commonwealth of Massachusetts, successful entrepreneurs and large corporations such as Blackstone, Microsoft and the nonprofit Kauffman Foundation.
MC could have faced financial challenges by providing accelerator programs at no cost and with no equity commitment. However, MC was able to become a bridge between large companies’ need for innovation and startups’ need for capital. Large companies have the scale of resources, customer information and market experience, but may lag in innovation. Startups, on the other hand, lack the resources but innovate with sometimes disruptive and successful ventures, frequently taking incumbents by surprise (Airbnb, Uber).
MC serves as a channel between startups and established companies to meet the need for fast-paced innovation. Companies like Bühler and PTC partner with MC to source high-potential startups for the development of advanced technology. Companies can also source tailored programs or tracks for specific needs.
A study done jointly by MC and innovation firm Imaginatik looked at how startups and corporations interact in new collaborative ways. The research team surveyed 112 corporations and 233 startups from various industries. 82 percent of the corporations considered startup interactions important, and 23% stated that these interactions are “mission critical.” Startups have a high interest in working with corporations with 99% stating it is important for them to interact with potential corporate customers, marketing channels and strategic partners.
Expansion
MassChallenge was located at One Marina Park Drive until 2014.
MC communicates its impact and vision to donors by demonstrating the cost-effectiveness of alliances between startups and corporations. A solid accelerator program, global vision, robust network and a sustainable funding strategy have set up MC for success. As stated in the MC Impact Report 2016, the accelerator is committed to running 12 locations annually by 2020, including at least one on each populated continent.
Before establishing an MC accelerator, the metropolitan area is evaluated for the quality of its research universities, urban setting, level of entrepreneurship opportunity and investment capability. As government and private stakeholders partner, a sense of shared ownership becomes crucial to consolidating efforts. This engagement guarantees that the resulting ecosystems are seen as a shared legacy.
The next MC sites are yet to be announced. Currently in five locations with global impact, MC’s 2020 vision is on a path to become a tangible reality.
The author and editor would like to thank Tay Jacobe for assistance with researching and drafting this post.
When you think of an emerging entrepreneurial ecosystem, you probably think of Austin, Texas or Boulder, Colorado, not a moderately sized city deep in the heart of the Midwest. But Cincinnati’s entrepreneurship ecosystem is positioning itself as a good place to start a high-growth, high-technology startup firm.
The Fortunate 500 companies that call Cincinnati home, such as Kroger, P&G and Macy’s, have been investing in their local ecosystem through a nonprofit organization. The resulting increase in resources and capital in Cincinnati’s entrepreneurship scene has led industry commentators, including TechInsurance and Entrepreneur.com to enthusiastically expound the city’s positive trajectory. In this blog post, I explore the driving forces behind Cincinnati’s transformation and ask whether it is real.
History of Entrepreneurship
Local and state governments have historically helped maintain the Cincinnati ecosystem. Individual grant programs provided the Cincinnati Children’s Hospital Medical Center, University of Cincinnati and the Cincinnati Regional Chamber with funding for high-tech projects. However, until recently, the Fortune 500 companies have been largely absent from Cincinnati’s entrepreneurship ecosystem, and there was no depth to the ecosystem’s support and service organizations. For example, less than a decade ago, there was not a single startup accelerator anywhere in the region.
Accelerators in Cincinnati
The past few years have seen an emergence of a spate of entrepreneurial resources available in and around Cincinnati. Accelerators – 12 to 16 week entrepreneurship boot-camp programs for startups that typically end with a pitch day – now span the tristate area of Ohio, Kentucky and Indiana.
Cincinnati now boasts The Brandery, UpTech, OCEAN, First Batch, Founder Institute, a minority business accelerator housed in the Cincinnati chamber of commerce, and two university affiliated accelerators. There are also several incubators in the local area.
The Brandery
The Brandery, located in Cincinnati and founded in 2010, was inspired by successful accelerators such as Austin’s Capital Factory and Boulder’s TechStars. The Brandery offers a three-month program for seed-stage companies that use Cincinnati’s existing strengths: branding, marketing and design. Companies receive $50,000 in seed funding, office space, branding identity, legal support and more in return for 6% equity stake in the startup.
The Brandery has a portfolio of twenty-nine startups. Notably, the Brandery accelerated FlightCar, “a marketplace that allows owners flying out of an airport to rent out their cars to arriving travelers” that was acquired by Mercedes Benz and Skip, “a mobile checkout solution that allows you to scan items as you go through the store and skip the checkout line.” The Brandery has been ranked a top-ten U.S. accelerator.
UpTech and Ocean Accelerator
Launched in 2012, UpTech is a Greater Cincinnati tech accelerator program for data-driven startups. Located across the river from Cincinnati in Covington, Kentucky, UpTech was established as an effort by Northern Kentucky University College of Informatics and the Greater Cincinnati community. Up to ten startups per cohort participate in a six-month accelerator program and receive up to $50,000. UpTech differs from traditional accelerators in that it draws its hundreds of support staff from community volunteers and interns from Northern Kentucky University. Successful UpTech startups include online walking-tourism planning platform, Touritz, and software and data management company, Liquid.
The third and newest accelerator in Cincinnati is three-year-old, faith-based OCEAN Accelerator. Ocean runs a five-month program that provides mentorship, monetary support in the form of a $50,000 note, branding and legal advice. OCEAN claims to be the the only faith-based accelerator in the nation, and its curriculum features weekly bible studies. Alumni of Ocean include Casamatic, a real estate technology company that increases buyer engagement, and Cerkl, a startup that provides personalized email campaigns.
University Resources
The University of Cincinnati and Xavier University both have academic accelerator programs. The University of Cincinnati’s Technology Accelerator for Commercialization provides full-time faculty and staff with the opportunity to develop intellectual property at the University of Cincinnati. In order to be eligible for the TAC program, the technology must be developed at the University of Cincinnati and have a focus on commercialization. Start-up companies are not eligible for the TAC program.
Xavier University offers a business program aimed to boost the Greater Cincinnati economy. Called X-LAB (short for Xavier Launch A Business), the seven-year old competition provides want-to-be entrepreneurs – particularly including students – opportunities to launch a business. The Williams College of Business supports the winners by providing the business expertise of its professors, executive mentors and MBA students.
Seed-Stage Funding
Cincinnati has had stable seed-stage investors for some time. These include CincyTech and Queen City Angels, as well as some early stage venture capitalists and some nonprofits that provide grants to startups. In recent years, CincyTech and Queen City Angels appear to have had some successes and grown considerably, which bodes well for the future of the ecosystem.
CincyTech
CincyTech, a public-private partnership focused on seed stage investments, was the first effort by the local government to jump-start entrepreneurship. Established in 2001, CincyTech’s mission has been to strengthen the regional economy through the creation and expansion of technology companies in Southwest Ohio. CincyTech is now investing out of its fourth and largest fund, a $30.75 million seed-stage fund, which is bigger than its first three funds combined.
CincyTech garnered considerable national attention after providing Lisnr, a company that has invented an ultrasonic technology for transmitting data through sound, with Stage A capital. Lisnr came to fruition aboard the 2012 StartupBus, a competition where participants launch a company in 72 hours on a bus headed to Austin for the South by Southwest Festival. Since Lisnr’s establishment, they have received $10 million in Series B funding from Intel Capital and garnered accolades from CNBC’s Disruptor 50 list, Cannes Lions International Festival for Creativity and Fast Company’s Innovation by Design Awards.
Queen’s City Angels
Likewise, Queen City Angels is the region’s longest running angel group and is currently investing out of its largest fund of $10 million. Queen City Angels provided the initial stage funding for Assurex Health. Now ten years old, Assurex grew out of research at Cincinnati Children’s Hospital Medical Center and the Mayo Clinic. Its singular product is the GeneSight Test, which analyzes twelve genes that influence mental health and psychoactive drugs that treat a spectrum of mental health disorders. Myriad Genetics purchased Assurex Health in April 2016 for $225 million with another $185 million to come when performance stipulations are met.
Coordinating the Ecosystem
Two organizations provide the glue for Cincinnati’s entrepreneurship scene. StartupCincy is a grassroots organizations that first registered its domain name in 2010. Cintrifuse is an example of a successful municipal government intervention in an entrepreneurship ecosystem.
StartupCincy
StartupCincy describes itself as “the driving force behind [Cincinnati’s] new economy…a rallying cry.” In addition to maintaining a long list of upcoming network, education, accelerator and developer events in the city, Startup Cincy connects venture capitalists and angel investors to startups. StartupCincy is credited by the Cincinnati Business Courier as “one of the most influential groups leading the renaissance of Cincinnati’s startup community.”
Cintrifuse
However, the most important element of Cincinnati’s ecosystem is probably Cintrifuse. Established in 2011 with the goal of creating a sustainable technology driven economy for the Cincinnati metropolitan area, Centrifuse primary manages a fund of funds. This fund of fund has created a network of venture capital funds, including Allos Ventures, Mercury Fund and Sigma Prime Ventures, that invest in Cincinnati startups.
For big companies, like Kroger, USBank, the Greater Cincinnati Foundation and Duke Energy, investment in Centrifuse isn’t just about financial returns. Corporate investors get access to new companies and new ideas, while the startups receive mentorship and connections that help them access potential partners and customers.
Cintrifuse also provides co-working space in Over-the-Rhine, a neighborhood of Cincinnati, and entrepreneur-focused educational programs. More than four hundred companies have gone through Cintrifuse’s programs, and both CincyTech and the Brandery are located in Over-the-Rhine just feet away, providing unique collaboration opportunities.
Cincinnati’s Venture Capital Woes
Author’s calculations based on data from SDC Platinum VentureXpert
Despite all of its great resources, Cincinnati is still not producing enough successful startups to be considered a mature and effective ecosystem. Although there is no consensus among experts, ecosystems that close around thirty to thirty-five deals a year are markedly more stable. Cincinnati falls far below this. While the number of first rounds has been increasing, it appears that the city’s ecosystem may be leveling out at an average of just five first rounds per year.
Author’s calculations based on data from SDC Platinum VentureXpert
The largest barrier to Cincinnati’s emergence as an entrepreneurial ecosystem is probably the quality of its deal flow. Despite the recent increase in startup activity, Cincinnati’s venture capital investment peaked in 2002 at $343 million. The recent maximum was $235 million in 2014, with 2016 reverting to pre-2010 levels. Since the turn of the millennium, the venture capital investment has averaged just $139 million per year. Mature ecosystems, like Austin or Denver, are much bigger.
Untapped Potential
Cincinnati’s entrepreneurship ecosystem is small but does genuinely seem to be growing in an exciting way. From 2000 to 2009, Cincinnati saw an average of around two new venture capital deals each year. From 2010, when the Brandery opened its doors, to the present, the number of Cincinnati based startups receiving venture capital for the first time has more than doubled to almost five each year.
There have been many factors at play: more venture capital, more seed stage investment, more mentorship and engagement with established firms, the arrival of accelerators, a co-working space, and specialist training and professionalization programs, and, just possibly, that the Over-the-Rhine neighborhood has achieved a critical mass of startups in close proximity. These factors appear to be working together to reinforce each other and grow the region’s startup ecosystem and the local economy. Cincinnati is surely a startup city to watch!
CincyTech
