IEDC shelves proposal to copy Ohio initiative: Program matches promising startups with capital

August 28, 2006

An Ohio program launched in 2003 to urge development of extremely earlystage companies has already spurred investments worth $239 million in 68 Buckeye startups.

Venture capitalists would like to duplicate the program here. But their proposal has been languishing at the Indiana Economic Development Corp. for a month.

"We have the application. We haven't done anything with it," said IEDC Director of Small Business and Entrepreneurship Bruce Kidd. "This is a classic steeple chase. You've got lots of hurdles to get over. First and foremost is, where does the money come from?"

To stimulate high-tech job creation there, Ohio formed the Third Frontier Initiative in February 2002. It's a 10-year project that aims to direct a total of $1.6 billion in state money toward promising areas like fuel cells or life sciences.

Hoosier venture capitalists would like to replicate Ohio's Validation Funds program, the most successful component of Third Frontier so far. Through the funds, Ohio makes grants directly to venture capitalists who promise to funnel the money to embryonic firms there.

The Validation Funds name stems from the idea that it encourages professional venture capitalists to invest in startups so unproven they'd otherwise balk.

Ohio Department of Development spokesman Merle Madrid said a 2002 study by the Columbus, Ohio-based Battelle Memorial Institute identified a clear lack of available capital for pre-seed and seed investments in nascent Ohio startups. The same study found 85 percent of startups stay wherever they first put down roots.

So far, Ohio has committed $17 million to the Validation Funds program, Madrid said; $6 million has been distributed to 12 venture capital firms. That outlay has leveraged another $239 million in private investment from venture capitalists in 68 startups.

To qualify for the Ohio program, the venture capital firms must have at least $20 million under management. They receive Validation Funds money at a 2-for-1 match. Ohio contributes up to $2 million toward each validation fund. In turn, the venture capital firm kicks in up to $1 million of its own.

Investing in early-stage companies is among the riskiest forms of business speculation. As an extra incentive, the Ohio venture capitalists are allowed to keep any money they earn until their validation fund breaks even. After that, profits are split, with one-third going to venture capitalists and two-thirds to local economic development organizations.

"We created a program that essentially puts some state money to the effort of getting venture capitalists to take a calculated risk with their money," Madrid said. "We recognize that government can't single-handedly create jobs. That's not what we're trying to do. We're trying to spur private industry to do that."

Cincinnati-based Blue Chip Venture Co. is among the Ohio venture capital firms that manage a validation fund. Blue Chip Managing Director John McIlwraith said the program allows venture capitalists to speculate in small sums on truly unproven technologies-areas traditionally too risky even for them.

"Now when we have these young companies come to us with really interesting plans, we can say, 'Hey, let's take a look.'" he said.

In conjunction with Carmel-based venture capital company Gazelle TechVentures, Blue Chip wrote an application in July to form a pilot project mimicking Ohio's Validation Funds in Indiana, said Gazelle Managing Director Don Aquilano.

"The landscape is very similar in Indiana to Ohio," Aquilano said. "There shouldn't be any reason why it wouldn't have the same impact here as it has in Ohio."

Even Ohio has no reservations about seeing Indiana duplicate its program.

"It's not like it's a Hoosier/Buckeye game on the hardwood," Madrid said. "Growth for the region is good for all states in the region."

Even so, it will likely be some time before IEDC responds. Kidd said there is no readily available source of money for the program. The Indiana 21st Century Research & Technology Fund, for example, is legally set up to make grants for university technology transfer, not to fund venture capital partnerships.

What's more, there are questions of administration. Who would oversee the program? Who would be responsible for rolling it out across the state? Who would vet the venture capital firms that apply?

And Kidd said IEDC already has a full plate.

"The concept is certainly interesting. It's not that we've said no, but it's a challenge to figure out how to make it work," he said. "And there's plenty on my table right now to get done over the next quarter."
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