Minnesota investors: Still waiting….after all of these years

If patience is a virtue, then Minnesota venture capitalists have become downright saintly.

Faced with a weak economy that has stifled initial public offerings and mergers and acquisitions, local investors are still looking for exits well after the funds have closed. Throw in tougher regulatory scrutiny for medical devices and drugs and an exit can suddenly stretch into a decade or more.

“It’s kind of like the horror movie when you’re in the hallway with doors and you try to reach for one door but the door knob keeps vanishing,” said Brad Lehrman, a venture attorney and managing general partner for Portage Equity Investments II.

Larger venture funds like Affinity Capital, Thomas & McNerney & Partners, and Split Rock Partners are still making new bets, albeit at a slower pace. But smaller funds like Portage, Sherpa Partners, and Quantris Fund, all founded in 2000 or so, have long stopped writing checks.

The log jam poses serious problems for start-ups seeking early stage financing. Unless funds clear their existing portfolios and earn a return for investors, it’s unlikely existing funds will attract money to finance new deals. It also doesn’t bode too well for new funds trying to raise money like Upwind Medical Partners, Affinity and Triathlon Medical Ventures, and Coordinate Capital.

US venture capital firms raised $3.6 billion in the first quarter of 2010, a 31 percent drop from the same period a year ago and the slowest opening quarter since 1993, according to Thomson Reuters and the National Venture Capital Association (NVCA).

“There is no question that the bar has been raised for venture capital fundraising,” said Mark Heesen, president of the NVCA. “Over the last two years, alternative asset allocations have declined and the exit market has suffered, putting venture firms in the unenviable position of communicating their value in an extremely challenging environment.”

“Many firms have been waiting until the exit market improves before embarking upon their fundraising efforts,” he said. “This wait has been considerably longer than many firms anticipated. Those firms that are successfully raising money today do have both a track record as well as vision for the future. As predicted, the next few years will see the industry consolidate with the strongest firms surviving.”

Normally, it would take a venture fund seven years to exit an investment. Not anymore.

Take Portage Equity’s first fund, which operated between 1997 and 2000. Of the seven companies in the portfolio, one went public, three were acquired, and three stopped operations. Portage launched a second fund, which invested in 13 companies between 2000 and 2003. None have seen an exit.

Lehrman says it’s frustrating but he’s confident in the portfolio, especially companies like Celleration Inc. ($7 million Series B), which makes an ultrasound wound care device, Medisyn Technologies Inc. ($1.25 million bridge financing to Series B), which is developing software to help drug companies develop and test new therapies, and Cima Nanotech Inc. ($1 million bridge to Series B), a maker of nanomaterials for digital ink printing for microcircuits.

Of course, one or two giant exits could make the experience worth the wait. Lehrman noted Cherry Tree Investment’s fourth venture fund lasted a whopping 16 years before it cashed out big with the IPOs of Capella Education and Dolan Media.

Yet medical devices and drugs, which require considerably more capital to fund clinical trials and gain regulatory approval, are a different breed. The longer it takes for these companies to get products to market, any return from an exit will likely shrink as investors spend more money to sustain the company.

So one has to wonder if Portage investors will see a return from Gentra Systems (the fund’s largest bet at $10 million in a Series C round), a provider of DNA and RNA purification products or Excorp Medical ($500,000 bridge to Series C), which is developing  bioartificial liver system? Gentra was founded in 1988; Excorp in 1995.

It’s also unlikely investors will launch additional funds like Portage Equity III if they are still trying to clean out II. Sherpa Partners launched Sherpa Trek I in 2001, implying there would be a Sherpa II. Same thing for Quantris Fund I, which debuted in 2000.

Success, though, makes things easier. Space Center Ventures is still making new bets, thanks to successful investments like SPS Commerce, which raised $50 million from its IPO last week, said CEO and president Paul Knapp.

“The IPO and M&A markets have been non-existent,” Knapp said. “But we still have hope.”