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Renewed life for NM private equity program to help fuel startups

The floodgates are not yet open, but New Mexico may finally be emerging from a six-year venture capital drought thanks to renewed vigor at the State Investment Council to embrace private equity programs.

bizO-RobinsonAvila_Kevin_BizOLast week, the SIC approved the establishment of a new $20 million “fund of funds” to help finance seed and early-stage investments in startups around New Mexico. The money will be channeled into micro funds statewide that, along with matching dollars from private investors, could raise $40 million or more for the growing slate of companies emerging from New Mexico’s business accelerators, incubators and other programs.

The SIC also approved $10 million for Phoenix Capital Partners, a California-based venture firm that will now work to pump at least $10 million into local startups. The Phoenix investment marks only the second time in more than six years that the SIC has committed money to a new, independent venture fund to focus on opportunities in New Mexico.

Those SIC actions reflect a newfound willingness by the 11-member council to rebuild the state’s venture capital infrastructure, which crumbled in the recession. And it’s that renewed state willingness – with real skin in the game – that most investors consider key to reconstructing New Mexico’s venture system.

“The venture capital industry in New Mexico was effectively created by the SIC through its willingness to invest in New Mexico under the state’s Private Equity Investment Program,” said Tom Stephenson, managing partner of the Verge Fund in Albuquerque. “That program has had its challenges, but the SIC’s re-engagement is the critical step in being able to draw out more sources of capital. The SIC’s activities have always been catalysts for other investors to follow their lead to commit to building opportunities here.”

That’s particularly true at the seed and early-stage level, when it’s still too soon for most startups to attract the interest from large, out-of-state venture funds, said David Blivin, managing partner of Santa Fe-based Cottonwood Technology Fund.

“Investors in places like the Silicon Valley or Boston have lots of opportunities to invest right where they are, so why would they come to New Mexico?” Blivin said. “You need the state to take a lead in supporting and building on innovative ideas so startups here can grow to the point that venture capitalists will come from elsewhere to invest.”

Rebuilding from recession

Until 2008, the SIC did maintain an aggressive, leading role in the local venture system, along with the New Mexico Small Business Investment Corp. Under the state’s private equity program, which launched in 1993, the SIC can invest up to 9 percent of the $4.5 billion Severance Tax Permanent Fund in local venture activities. That includes investments in venture funds that operate in New Mexico and direct investments in startup companies.

The SBIC, meanwhile, manages 1 percent of the severance tax fund for job creation, which before the recession included investments in seed and early-stage venture funds to help nascent startups launch and grow.

Robust investment by both entities in local funds helped build a thriving venture industry prior to the recession, with about 15 venture firms operating in the state. Funding for local companies peaked at about $120 million per year in 2007 and 2008.

But the recession crippled the industry as many promising startups crashed and burned. Venture investment plummeted in New Mexico to just $22.2 million in 2009.

In response, the SIC froze funding for the program until 2013 and the SBIC completely withdrew from venture activities to instead focus on debt lending.

New Mexico wasn’t alone. During the recession, venture funding nationwide fell from about $30 billion in 2008 to $20 billion in 2009.

But nationally, the industry has rebounded to beyond its pre-recession levels, reaching $48 billion in 2014. In contrast, New Mexico had just $29 million invested in 2014, the latest statistics available from the New Mexico Venture Capital Association. And only about a half dozen venture firms are now active in the state.

Moreover, most of New Mexico’s venture funding is now “follow-on” money for existing companies to keep growing, rather than for helping new firms establish themselves.

To change that, New Mexico needs a lot more startups achieving some market success to lure later-stage investors, and that means more state help in creating seed and early-stage funds.

“The SBIC did focus on early-stage funds, but it has shifted totally into lending, leaving a real capital gap in New Mexico,” Blivin said. “We need that seed-stage funding to get more companies into the pipeline that can attract later rounds of growth capital.”

The SIC did allocate more money to venture activities in 2013, providing $60 million for direct investment in companies since then. It also earmarked up to $30 million per year for new investments in local venture funds.

But SIC commitments remain at about 5.6 percent of the severance tax fund, well below the 9 percent permitted by statute. And last week’s investment in Phoenix Venture Partners is only the second such investment by the council since 2008.

Changed ecosystem

Requirements that out-of-state funds maintain a full-time investment professional here to qualify for SIC money may be a disincentive for some funds, something the council hopes to change this year. But also, many fund managers might still see too few startup opportunities, according to the SIC.

The council wants to alter that perspective through its new “fund of funds,” especially since the SBIC is unlikely to restart its venture activities anytime soon, said Brian Birk of Sun Mountain Capital, which manages the SIC’s Co-Investment Fund and advises it on investments in funds.

“When earlier policies were put in place, the council let the SBIC invest in smaller, early-stage funds and the SIC generally concentrated on larger funds,” Birk said. “But, with the SBIC pulling back, it changed the ecosystem.”

Investing in small funds, which often commit as little as tens of thousands to startups, is something new for the SIC. The council prefers larger, less risky funds to assure market returns.

But it’s now willing to accept lower returns with investments that generate substantial economic development benefits, something allowed by state statute, said council member Harold Lavender.

“These are not grants, they’re investments in micro funds that are expected to create returns,” Lavender said. “We know full well all the companies that get funded won’t be successful, but we expect enough to succeed to provide a positive return with economic benefits underneath.”

Many factors have influenced that change in SIC position. For one thing, the council has institutionalized strict professional investment practices, with careful vetting of each commitment to a fund or startup through Sun Mountain.

That has helped generate a 4.8 percent overall return from the program since 2004, when the SIC first hired professionals to vet and manage investments, in line with national benchmarks.

Those same standards will be applied to all micro funds that receive SIC money and to the companies that get investments, Lavender said.

In addition, the SIC is committing only $10 million to the $20 million “fund of funds.” Another $5 million will come from the U.S. Treasury and the rest from private investors. And the U.S. Treasury has agreed to the SIC and private funders earning their money back first, before the feds do.

Finally, the SIC and Gov. Susana Martinez’s administration want to shore up the state’s burgeoning startup ecosystem as part of a broader strategy to decrease the economy’s dependence on federal spending, and the oil and gas industry. The governor, who sits on the council, strongly backed the new “fund of funds,” urging its approval.

“Improving access to capital continues to be an important need throughout the state,” Martinez said. “This will help New Mexico continue to build on the momentum we’ve achieved over the last few years in diversifying our economy and growing the private sector.”