Gov. Eric Holcomb preparing to put $250 million into startups

But the mechanics to make that happen still need to be worked out—and many entrepreneurs and venture capitalists have strong feelings about approaches the state should embrace and avoid.

The Next Level Fund, a top priority of Gov. Eric Holcomb in the last legislative session, officially formed July 1. The $500 million fund is the successor to the Next Generation Trust Fund, a decade-old, pool of money originally funded by former Gov. Mitch Daniels’ lease of the Indiana Toll Road.

That fund’s investments had been restricted to low-risk-low-return asset classes, but Holcomb in April signed a law allowing up to half the fund to be invested in high-yield asset classes such as venture capital.

The Next Level Fund stayed mostly under the radar in its first month, as government officials worked to fill out its five-member board and to elicit feedback on the best mechanism for deploying that $250 million.

The fund recently tapped prominent investor Bill Godfrey, the former CEO of marketing software firm Aprimo, and Cindy Lucchese, Hulman & Co.’s chief financial officer, as its two non-governmental board members. They join State Treasurer Kelly Mitchell, Indiana Economic Development Corp. President Elaine Bedel and Indiana Office of Management and Budget Director Micah Vincent. The group was scheduled to hold its first meeting Aug. 4.

Even with a board in place, two big questions loom: How will funds be distributed and by whom?

The board likely will need to name a fund manager, but there’s a debate about whether that person or team should be local. Then there’s the question of whether the money should go directly into Hoosier companies or into venture capital firms that in turn make investments.

The latter mechanism, known as a “fund-of-funds” approach, has the most traction with Next Level officials. But the drawback is that there’s no guarantee the money would ultimately reach Indiana companies. The fund could require that some percentage of its capital be invested into Indiana companies, but placing too many stipulations on cash might render it unattractive to venture firms.

Still, some think that having a requirement for funds to be reinvested in Indiana is a must.

“It doesn’t have to be a large number; it just has to be a non-zero number,” said John McDonald, CEO of Fishers-based ClearObject, an internet of things consultancy. “Because what it does is, it forces those firms to take a look at what’s happening in Indiana.”

The Next Level Fund’s $250 million venture capital allocation has been widely praised by entrepreneurs and venture capitalists, who have sounded the alarm for years about the dearth of venture capital in the state. Hoosier companies drew in about $2.5 million per deal in 2016, according to the PwC/CB Insights MoneyTree report, the 13th-lowest rate in the country. Over the past four quarters, that average has been $2 million.

Oscar Moralez, managing director of the statewide angel investing group VisionTech Partners, said there’s a lack of Indiana-based venture funding in two main areas: very early-stage companies looking for deals in the $25,000-to-$100,000 range, and emerging companies looking to close so-called Series A rounds in the $3 million-to-$10 million range.

Next Level’s structure will largely determine whether it can address those gaps.

“Is it going into strictly funds? More mature funds? Funds that invest in Indiana companies, or is it going to be more of a Midwestern thing?” Moralez said. “So a lot of that stuff remains to be finalized.

The newly named Next Level board will hash out those details. Godfrey, a serial entrepreneur, is managing partner of Carmel-based 4G Ventures. Lucchese joined Hulman, parent of the Indianapolis Motor Speedway, three years ago after serving in a series of high-level posts, including chief financial officer of Hillenbrand Inc. and treasurer of Guidant Corp

While the fund has not announced how it will operate, Vincent told a group of investors and entrepreneurs in June that a substantial portion of Next Level’s assets might take a fund-of-funds approach. He said the final decision would be up to the board.

Vincent didn’t respond to multiple requests for comment for this story.

Observers inside and outside Indiana praised the fund-of-funds approach over direct investments for several reasons.

For one, there’s little interest in having state officials try to build and oversee what effectively would be a venture capital operation. Also, a fund-of-funds approach involves pooling money with other investors, creating the potential for larger infusions into Hoosier startups than the Next Level Fund could achieve alone.

J.J. Thompson, CEO of Carmel-based cybersecurity firm Rook Security, said he initially opposed the fund-of-funds approach because Next Level Indiana funds might not end up in Hoosier companies.

But after talking with fund managers on the West Coast, he said, he changed his mind, in part because the strategy is likely to generate wider awareness among venture capital firms nationally about Indiana investment opportunities.

“If some of the larger funds open offices here, why would you need to go out of state?” he said.

Thompson said an initial concern he had about the Next Level Fund was that the money would flow mostly into marketing tech companies, which the region is known for.

He felt better after relaying those sentiments to state officials. “My understanding is that they’re going to work hard to put some provisions in there to make sure there’s diversification,” he saidMichigan’s experience with venture investing might be instructive for Indiana, said Jeff Barry, a partner at Ann Arbor-based Plymouth Growth Partners, which has invested more than $9 million in Indiana tech companies in recent years.

Barry said his state’s first venture capital fund—Venture Michigan I, which debuted in the mid-2000s—wasn’t particularly impactful. But the second—Venture Michigan II, created around 2011—has had outsized success.

Both took a fund-of-funds approach, but Venture Michigan II required that every dollar invested in a fund result in an equal amount invested in a Michigan-headquartered company.

“What happened was, those firms had to be in Michigan quite a bit if they wanted to deploy capital there,” Barry said. “Most of them I think invested more.”

Barry said the startup ecosystem and venture capital scene is markedly more robust than it was earlier this decade, and “good deals get funded by Michigan firms now.”

Switzerland-based Credit Suisse managed both the first fund and the second fund, he said, before selling that part of its business to Chicago-based GCM Grosvenor.

He said states with similar ambitions should enlist a local company to manage the fund and then hire an investment firm like Grosvenor to advise that manager.

“I just think having a local flavor to it kind of keeps it to the benefit of the local community,” he said.

McDonald said he’s opposed to having fund management handled out of state because he believes that would blunt the impact on Hoosier firms.

His view is shaped in part by the Indiana Public Retirement System’s decision in 2013 to hire the Washington, D.C.-based Carlyle Group LP and Carlyle’s Netherlands-based AlpInvest Partners BV to manage the $150 million Indiana Investment Fund II.

The fund had a dual goal of targeting high returns while nurturing Hoosier entrepreneurs and businesses, officials said at the time. But McDonald said he’s seen “no discernible impact on the Indiana venture economy.”