By John C. Austin
Since Rust Belt voters tipped the results of the 2016 election, interest in effective strategies for supporting new business and job growth in this important region has intensified.
Such interest recognizes that the states of the upper Midwest share more than their swing state status. A unique economic and social development storyline unites the industrial heartland, extending across all or part of 12 states from Minnesota and Missouri in the West, through the Great Lakes and up the Ohio River Valley to Western New York, and to Pennsylvania and West Virginia in the East. The region has many economic challenges, but also boasts important economic strengths, perhaps none as important as the tremendous innovation and talent emerging from its companies and universities.
Yet a lack of risk capital in the Rust Belt has held back the region’s capacity to translate its formidable innovation and talent assets into new businesses and jobs. That’s beginning to change, but public policies could do much more to accelerate the development of a robust innovation infrastructure equal to the Midwest’s potential.
The Midwest’s significant innovation assets are gaining more attention
Home to more than 200 of the nation’s Fortune 500 companies and 20 of the world’s top 200 research universities, the upper Midwest generates 26 percent of the nation’s corporate and university patents and 31 percent of its university-based research and development. The latter includes more than one-third of the nation’s highly competitive National Institutes of Health (NIH) research funding, key to the creation of new drugs and medical technologies.
The region’s formidable network of colleges and universities means it also punches above its weight in generating talent. With 31 percent of the nation’s population, schools in Rust Belt states produce 35 percent of the nation’s total bachelor’s degree holders, 33 percent of its STEM graduates, and 32 percent of all higher education degrees awarded in the United States.
The power of these assets to drive local technology-based economic development, and contribute to a modern, post-Rust Belt economic reality and storyline, is increasingly evident across the region. According to commercial real estate services firm CBRE, three of the top 10 fastest-growing Tech Talent Markets in North America in 2018 were Madison, Wisc. (#3), Pittsburgh (#5), and Cleveland (#8). Similarly, innovation guru Ian Hathaway’s latest report on startup communities notes Columbus, Ohio and Indianapolis among those continuing to expand, with Pittsburgh, Madison, and Ann Arbor, Mich. among those rising faster than national peers. The presence of top-flight research institutions and universities in these same markets (e.g., University of Wisconsin, Carnegie Mellon, Ohio State University, University of Michigan, and Cleveland Clinic) is no coincidence. PitchBook finds that the presence of highly ranked research universities and top-tier colleges is one factor behind Michigan and Pennsylvania’s strong performance on talent retention.
These positive trends reflect the increasing return to the region of capital and talent that once fled to the coasts for opportunity. Entrepreneurs and investors, including coastal venture capitalists and wealthy regional “ex-pats,” are discovering and investing in the talent, ideas, and technologies generated in the region. Techstars’ Ted Serbinski, who operates out of Detroit, tells Crain’s Detroit, “This is arguably one of the most talented regions in America, churning out the most real, revenue generating businesses. None of these social networks that will ‘figure it out later.’” Serial Silicon Valley entrepreneur Steve Blank notes, “Silicon Valley is out of A players. Don’t start your company here. Start it in Ann Arbor. You won’t find the talent you need here. It’s in Ann Arbor.” And Ohio Innovation Fund manager and Silicon Valley refugee Bill Baumel writes in Venture Beat, “I see more ‘Silicon Valley-quality’ companies [here] in medical technology, cybersecurity, data science, and advanced manufacturing that have grown over 100 percent annually to tens of million in revenue with sights on $100 million, and have more prominent customers including a majority of the Fortune 500 and leading universities.”
Some investors are giving the Midwest a closer look for reasons beyond the region’s strong fundamentals. The results of the 2016 election prompted many to see how they could contribute to the economic, cultural, and political transformation of the Rust Belt. This theme helps animate Steve Case and JD Vance’s Rise of the Rest Fund, as well as former Microsoft CEO Steve Ballmer’s significant new investments in Detroit. These investors and others also worry that tech giants who are trapped in the Silicon Valley bubble are isolated from large swaths of the nation’s people and politics, and risk blame for its woes. As the Dallas Morning News argues:
By locating in emerging tech hubs outside Silicon Valley, leading venture capitalists could gain a measure of protection against changing politics. In an earlier era, the military and its industrial complex mitigated political risk by opening bases and plants in congressional districts across the country. Moving could also serve as a form of patriotic economic development if it meant investing in “comeback cities” of the Heartland such as Detroit, St. Louis, or Youngstown, Ohio.
This interest is translating into new multimillion dollar funds closing across the Midwest, with participation by significant coastal investors. The region is also seeing some attention-grabbing “Silicon Valley-like” exits. Ann Arbor-Detroit’s Duo Security, which recently went public as one of the region’s few billion dollar “unicorns,” just sold to Cisco Systems for $2.3 billion, minting new local millionaires and promising further new technology development ripple effects.
The region still isn’t living up to its innovation potential
Despite all this interest and activity, the Midwest’s innovation assets still aren’t translating into new businesses and jobs at the rates one might expect. Ohio Third Frontier architect Frank Samuel first detailed some of the factors behind this gap in his 2010 Brookings report, Turning Up the Heat: How Venture Capital Can Help Fuel The Economic Transformation of the Great Lakes Region. Among the dynamics he noted at the time, several remain salient:
Investable ideas and technologies often languish at big companies and universities or aren’t “found” by coastal money and VCs. While the upper Midwest generates between one-quarter and one-third of the nation’s new ideas, technologies, and talent, it attracts less than 5 percent of the nation’s total venture capital investment, which peaked at $84 billion in 2017.
Promising early-stage companies spawned in the region are often acquired or encouraged to relocate close to coastal investors, meaning the jobs they create go elsewhere. Too much of the talent generated in the region in the form of newly minted MBAs and budding investment professionals doesn’t find a home in the region’s thickening but still thin-by-coastal-standards, dispersed network of VCs, private equity firms, angel networks, and financial and investing institutions.
Much of the great wealth amassed over the years by the region’s companies, philanthropies, public and private pension funds, and university endowments serves to subsidize coastal VCs and new business growth elsewhere. Samuel found that 47 percent of pension fund dollars allocated to VCs come from the upper Midwest, while at the time only 12 percent of venture capital dollars were invested there (an upcoming project will update these figures).
Investments from the region’s well-endowed universities tell a similar story. The region is home to seven of the nation’s 25 “richest” universities, which sport multibillion dollar endowments. Endowment managers may not yet see enough responsible, high-return opportunities in the region for the increasing share of endowments invested in venture capital. As a result, too many of these “home-grown” dollars bankroll business and job growth elsewhere. A recent Detroit Free Press story detailed how since 1998, the University of Michigan has invested $220 million with a Pittsburgh-based money manager and $330 with Minneapolis-based hedge funds, but only $40 million with a single Detroit-based fund and no other. Their underinvestment in the region is occurring even as Midwestern state governments increasingly withdraw support for these critical institutions.
One shouldn’t overstate the importance of venture capital to broader economic growth and development. After all, only about 20 percent of public companies are VC-backed, and many successful venture-backed companies might have succeeded without that support. Yet more recent, more research-intensive companies with powerful spillover effects are more likely to have received VC backing. As Ann Arbor’s RPM Ventures Marc Weiser tells me, “Venture capital’s ‘home runs’ create dynamics much more powerful than the ‘singles and doubles’ generated by private equity or other forms of investment—creating new wealth among talented entrepreneurs that compounds and accelerates the local dynamic of continuous new business development.” Venture investing also focuses on the technologies, products, workforces, and companies of the future that can contribute to a new story about any region where these firms emerge, rebranding them as innovative and creative talent centers, rather than industrial backwaters. This is a story the “Rust Belt” very much needs and wants to tell.
New strategies could turn up the heat for venture investment in the upper Midwest
Several states in the Midwest are trying to change the equation. They are creating state-backed funds and seeding regional early-stage capital support organizations to help commercialize more of the region’s innovation locally.
Michigan’s $400 million 21st Century Jobs Fund, which operated under Governor Granholm from 2005 to 2011 (created by securitizing the state’s tobacco settlement money), was credited with spawning dozens of companies and growing the state’s venture capital ecosystem to over $5 billion by 2015.
Illinois’ Technology Development Account operated from 2002 to 2015, with 1 percent of the state Treasurer’s investments dedicated to venture capital firms located in Illinois, eventually supporting over 250 companies across 18 funds. The new Illinois Growth and Innovation Fund created in 2016 will invest $222 million from the state’s investment portfolio in state venture capital firms, and it is projected to create 11,700 new jobs in Illinois and attract more than $400 million in additional private sector investment.
Indiana recently announced that its Next Level Invest Trust Fund, started with $250 million from the $3.8 billion raised from the lease of Indiana’s toll roads, was open for business. The state aims to multiply investment in local venture capital funds and promising startup companies.
Ohio business leaders have called for a re-up of Third Frontier Innovation funding, a successful bond-funded initiative which since 2005 has translated university and private R&D into hundreds of businesses and tens of thousands of new jobs; and for the revival of the Ohio Venture Capital Fund of Funds, first created in 2005.
Another idea whose time may have come is the creation of a Great Lakes-wide fund or fund-of-funds. Samuel first proposed this in Turning up the Heat as a vehicle to raise money from inside and outside the region to invest in smaller, well-run state and local/regional VC funds, and co-invest in promising companies. When the report was published in 2010, investors were interested in making money and spotting more deals, but there was not yet interest in the concomitant social impact of supporting economic transformation and new business and job growth in the Rust Belt.
Today, there is strong political and economic interest in the region. And the venture capital and early stage capital investment ecosystem has matured and grown, with more smart VC managers and others making successful investments, and more entrepreneurs starting promising enterprises. These dynamics make the potential financial success of a regional fund more likely today than earlier in the decade.
I’ll be exploring the potential for such a fund in a new Brookings-Chicago Council on Global Affairs project (with support from a team of Executive MBA students from University of Michigan’s Ross School of Business) over the next several months. We will be facilitating discussions with key informants and interested parties to assess the feasibility and identify practical steps to develop such a fund. It could be a key strategy to catalyze new job and business growth in the upper Midwest, help more of its workers find a place in a changing economy, and modernize the narrative of a region that is truly one of the world’s leading innovation engines.
Read more: webfeeds.brookings.edu