Flexing VC Muscle in Minnesota

In December, Eden Prairie-based Itiliti Health announced a $2 million round of seed funding. It was one of 175 venture capital deals in Minnesota in 2021, and certainly not one of the biggest. But in a sense, the Itiliti round may represent the future of startup funding in the state. 

Developed by Blue Cross Blue Shield MN alumni Michael Lunzer and Kurt Hulander, Itiliti’s technology helps health plans and care providers reduce the cost and time to process medical prior authorizations. Co-leading the round was Minneapolis-based Bread & Butter Ventures and Houston-based Altitude Ventures. Also participating was Minneapolis-based Groove Capital and two firms from outside Minnesota, M25 (Chicago) and SpringTime Ventures (Denver). 

The Itiliti deal “was a great example of collaboration during the pandemic,” says Bread & Butter co-founder and managing partner Mary Grove. Itiliti was able to attract investors from all across the country—something she expects will become more and more common for Minnesota startups.

Bread & Butter and Groove are two of the dozen or so VC “startups” that have sprouted in Minnesota in recent years. Along with numerous incubators, accelerators, coalitions, advocacy groups, and the state’s Department of Employment and Economic Development (DEED), these firms have powered the state’s startup ecosystem to record numbers. In October, Gov. Tim Walz introduced the JoinUsMn.com website and platform to attract even more startups. Early-stage founders here have more resources for networking and education than ever.

But what about money? In 2021, Minnesota companies attracted $1.34 billion in venture capital investment. That’s just a fraction of the record $329 billion invested nationally, and a much smaller share than the scale of the state’s economy would justify, but a figure that nearly doubled 2020’s tally, according to data from Seattle-based PitchBook and the National Venture Capital Association. 

“We have a great startup ecosystem, and we have a lot of capital formation happening,” says Rob Weber, a managing partner at Great North Ventures, the St. Cloud-based VC firm he cofounded with his brother, Ryan. “But it’s not happening at as fast a pace” as it could; compared to other states and cities, including those in the Midwest, he notes, “I’m afraid that Minnesota and the Twin Cities specifically are falling behind.” 

Could the state do more to capitalize on its opportunities—and help startups attract more funding?

Growing—but growing enough? 

Bread & Butter typifies the newer VC firms that have arisen in Minnesota in the past 10 years with a focus on early-stage investments. It has about 50 companies in its portfolio across three funds, including its most recent $28 million fund. About 25% of these companies are Minnesota-based. 

Mary Grove knows the startup landscape well. Before she moved to Minnesota four years ago with husband Steve, now DEED’s commissioner, she worked in Silicon Valley and New York City, a career that includes seven years directing Google’s entrepreneur-support program. Two years as an investment partner at Rise of the Rest, the between-the-coasts seed fund run by Washington, D.C.-based Revolution, “honed my love and appreciation for markets outside of Silicon Valley,” she says. 

Grove’s take on her adopted home state: “We’re sitting on an unbelievably untapped resource here in Minnesota. We’re at the global epicenter of multi-trillion-dollar global industries,” including Fortune 500s. “We should be harnessing that for new starts and scaling new companies.” She’s seen increased interest in Minnesota from VC firms across the country, interest driven not only by the state’s burgeoning ecosystem but also because the pandemic has inspired these firms to look beyond their nearby surroundings to startups they can “visit” via videoconferencing. 

Capital formation for Minnesota startups over the past two years presents a mixed picture. Data gathered by PitchBook and the National Venture Capital Association shows Minnesota companies earning $1.34 billion in VC investment last year, down from 2020’s record $1.54 billion (though still ahead of 2019’s
$1.2 billion). Still, according to a DEED analysis of PitchBook data, the number of investors in Minnesota startups increased 15% from 2020 to 2021, while the number of startups involved in deals was up 33%, and the number of deals jumped from 128 to 175. The decline in dollars in 2021 appears to be due to several large rounds in 2020. 

The state of Minnesota has introduced programs intended to help startups connect with capital. Launch Minnesota was founded in 2019 to bring together public and private organizations to provide access to capital and expertise. “An important aspect of having the ecosystem for startups to thrive is access to capital,” says Neela Mollgaard, Launch MN’s executive director since its founding. “And we’re trying to address that in multiple ways.” 

Before Launch, the state’s most notable effort was the angel tax credit, enacted in 2010. “The angel tax credit has incentivized quite a bit of investment,” Mollgaard says. In 2021, the state awarded $10 million in credits, with investment going to companies that collectively raised over $40 million of private capital. Mollgaard adds that historically, 40 percent of  these credits have been awarded outside of Minnesota. Since the program’s inception, $498 million of private capital has been invested in more than 530 startups. 

Launch Minnesota itself provides capital “innovation grants.” As of mid-February, Mollgaard says, the program has provided about $4.7 million to 144 startups. Grantees tracked by PitchBook “collectively have raised $35 million from other investors,” she adds. 

Among the industry-driven organizations that have helped boost Minnesota’s ecosystem is BETA, founded in 2013 to provide networking and education to state startups. In June 2020, BETA co-founder Reed Robinson launched Groove Capital, whose goal is to provide seed-level support to more than 50 Minnesota-based companies by the end of this year.  

“There’s a wave of talent wanting to do something meaningful,” Robinson says. The ecosystem is also being nourished by a diversified corporate community with access to global scale. And, Robinson notes, a “good run of exits,” including SportsEngine, Jamf, and Bright Health Group, has shined a brighter light on Minnesota as a promising greenhouse for startups. 

But more is needed to help the ecosystem fulfill its potential, Robinson believes. For one thing, “we need more angels in the game,” he says. “They are the primary source of concept-stage capital.” Robinson is leading a group within Forge North, a coalition of business and community leaders under the aegis of Greater MSP that’s conducting a statewide “angel activation campaign” to lure new angels into the pool.  

At the same time, many investors believe that Minnesota needs to match the level of support that other states provide—notably, a certain state within a day’s driving distance to the southeast. 

When tech startups “are making $10 million to $20 million in revenue, they’ll be able to attract capital from the coasts. But in the early days, they’re often overlooked.”

—Victor Gutwein, M25 founder and managing partner

The Illinois model

In 2021, venture funding in Illinois hit $7 billion—250% higher than the state’s record $2.8 billion tally in 2020. Last year, Chicago spawned 13 new unicorns—privately held startups valued at over $1 billion; unicorns are a frequently cited measure of a startup ecosystem’s health.

M25, one of the non-Minnesota investors in the Itiliti deal, was launched in 2015 to provide capital to early-stage tech companies throughout the Midwest. “Investing in tech startups can be lucrative and exciting, and there’s a lot of potential growth,” founder and managing partner Victor Gutwein says. “But there wasn’t a lot of capital investing in companies in the Midwest region. To me, that was a gap that somebody was going to fill.” When tech startups “are making $10 million to $20 million in revenue, they’ll be able to attract capital from the coasts,” he adds. “But in the early days, they’re often overlooked.” 

M25 has invested in a total of 123 companies in 25 cities. Itiliti is one of its nine portfolio companies headquartered in the North Star State. “Minnesota—the Twin Cities in particular—constantly comes up as a hotbed for sourcing deal flow, where companies are raising big capital rounds, where large exits have occurred, where talent is going,” Gutwein says. 

Like Minnesota, Illinois has an angel tax credit program, which has allocated a modest $10 million in credits for each of the past three fiscal years. But perhaps the biggest driver of early-stage investment in the Land of Lincoln is the Illinois Growth and Innovation Fund (ILGIF). A $220 million fund when it began in 2016, ILGIF has grown to $1 billion, a “fund of funds” that invests in Illinois VCs that provide capital to tech-centric businesses in the state. These VCs need to “generate strong returns,” Gutwein says. “They can’t just be giving away money.” 

ILGIF invested in M25’s third fund, which was raised in 2020. “We would have continued to do well without [ILGIF],” Gutwein says. “However, we have been amplified because of the networks and the professional mentorship and expertise that they can bring to the table, and because they work with so many different venture funds, not just in Illinois but across the nation and even the world.”  

Samara Mejia Hernandez, founding partner and managing director of Chicago-based Chingona Ventures, is unequivocal about ILGIF’s help: “I wouldn’t be here if it weren’t for them.” 

Hernandez founded Chingona in 2019 following stints at Goldman Sachs and Chicago-based MATH Venture Partners. Her goal was to support startups with “untraditional” founders—women, Hispanics, people of color—in sectors including fintech, med-tech, and health and wellness. While focused on Illinois, Chingona invests nationally. “Nothing’s too early for us,” Hernandez says. “We’ve invested pre-product, pre-name, pre-revenue.” 

The relationship-based realm of VC often “doesn’t allow for certain types of founders who may not have a network, may not know the lingo, may not have gone to an Ivy League school,” Hernandez says. “But everything else about them says that they can build a great, scalable, high-growth business.” Companies like these—with great ideas but lacking traditional connections—“need people to write big checks,” she says, so that they can gain traction and a much larger round with larger VCs.

While Hernandez wasn’t new to the VC world when she started Chingona, “historically, institutional investors do not invest in first-time fund managers,” she says. ILGIF, she adds, has helped expand the diversity of fund managers and startup founders. 

“An important aspect of having the ecosystem for startups to thrive is access to capital, and we’re trying to address that in multiple ways.”

—Neela Mollgaard, Launch MN executive director

Bigger opportunities 

Rob Weber is one Minnesota venture investor who would very much like to see an ILGIF-like entity in his home state. While granting the success of the angel tax credit and Launch Minnesota’s efforts, Weber thinks they are much too small. 

He also acknowledges the bumper crop of new early-stage firms in Minnesota, but notes, “in ecosystems with funds of funds, those seed funds are getting bigger faster,” he says, and thus can provide more capital to more startups. 

Launch Minnesota’s Mollgaard says that such a program is a possibility the state is exploring. “We are looking at all options, and we continue to have conversations with our startup community and our investor community,” she says, with the caveat that DEED is not able to make investments into businesses directly and would have to contract with others to do this.

Not all investors agree that Minnesota needs an ILGIF-like funding platform. VC veteran Jeff Hinck, managing director at Rally Ventures, which has offices in Minneapolis and Menlo Park, California, doesn’t think state-run funds of funds and similar state initiatives “have done all that well.” He believes expanding the angel tax credit would be a much more efficient use of state money because it lowers the risk for private investment, particularly for newer angels. 

Minnesota’s angel program is almost universally praised—except that it’s not permanent and needs legislative approval every biennium, and it offers only $5 million in credits in 2022 (down from $10 million in 2021). Walz has proposed $7 million for fiscal 2023 and $10 million in fiscal 2024. Another potential source of state support for startups is the roughly $97 million Minnesota is expected to receive from the federal State Small Business Credit Initiative (SSBCI). 

Meanwhile, some private sector actors are looking to play a bigger role in the ecosystem. One is the Minnesota Investors Network, a Forge North group comprising more than 25 firms, including corporate VCs involved or interested in startup deals. 

In February, Forge North introduced the “Enterprise Playbook,” which encourages Minnesota-based corporations to engage in the state’s startup ecosystem—and offers strategies for this engagement. Says Bread & Butter’s Grove, who co-chairs the network, “There’s a big opportunity to move the needle forward.”