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PART 3: Vanderhoofven reflects on venture capital evolution in the region

(EDITOR’S NOTE: This is the third of three articles from an interview with Grady Vanderhoofven, co-manager of Meritus Ventures and the Southern Appalachian Fund.)

As 2003 came to an end, Grady Vanderhoofven had witnessed the first stage of a regional transformation – going from no local venture monies to creation of the Southern Appalachian Fund (SAF) that was making investments in companies in this region with the hope they remained in the area.

Nine years later, the SAF co-founder and co-manager has seen the amount of venture capital available in the region mushroom. SAF, which was capitalized at $12.5 million, spawned a second fund – Meritus Ventures – that raised $36.5 million. Kentucky Highlands Investment Corporation (KHIC) and Tech 20/20 were instrumental in the establishment of both funds.

Other new funds that have been created and made investments locally include Innovation Valley Partners (a $30 million fund raised in the region), Battelle Ventures (a $220 million national fund), and TNInvestco ($150 million statewide fund).

SAF, however, came at a critical time for the region. The area needed a success story and, more important, it needed investment capital.

“The concept was that it (SAF) was only going to invest in low income areas in Southern Appalachia,” Vanderhoofven said.

Fast forward more than eight years, and Vanderhoofven proudly says that SAF’s “eight portfolio companies have raised $10 for every dollar that we have invested.” Probably its greatest success story is SemiSouth Laboratories, Inc. in Starkville, MS. SAF made its first investment in SemiSouth in 2004, and the silicon carbide semiconductor company has subsequently raised almost $100 million.

Vanderhoofven said that he and partner Ray Moncrief saw a rural business investment opportunity about a year after SAF was created. It took them two years to get the effort approved, but Meritus Ventures was launched in late 2006. Its footprint is companies in central and southern Appalachia.

In addition to the capital the funds invested, the two funds have secured $4 million, mostly through grants from the U.S. Small Business Administration and the U.S. Department of Agriculture, to “support our portfolio companies.” The help is focused on operational needs like legal support, marketing support, and executive recruitment needs.

Of the eight companies in which SAF invested, Vanderhoofven said that five have been sold. Eonstreams, which was located on Market Square in Knoxville when SAF invested, is one of those five.  Eonstreams raised an aggregate total of almost $4 million over a number of years, capped by SAF’s $700K investment in 2005, and ultimately distributed $64 million to its shareholders between 2008 and 2010, following the company’s acquisition by a publicly traded company in 2006.  Another of the five, TiER1 Performance Solutions of Covington, KY, yielded a 400% return on investment for SAF when SAF negotiated its exit from the company in late 2011. The three companies that remain in the SAF portfolio include two in Chattanooga and one in Mississippi.

Locally, Vanderhoofven is very proud of its role in supporting Protein Discovery which recently merged with Expedeon, Ltd. SAF led Protein Discovery’s Series B funding round that raised $5 million beginning in June of 2005.

“I’ve seen a lot of entrepreneurs, and Chuck is different than many young entrepreneurs,” Vanderhoofven said, referencing Protein Discover founder Chuck Witkowski. “He’s going to be very successful. Although he is much more experienced now than he was when he started Protein Discovery, he’s remained exceptionally teachable.”

Vanderhoofven says that SAF is not doing new deals, but has reserved funds to invest in the three companies that remain in its portfolio. On the other hand, Meritus, which has invested in seven companies and seen one exit, is still investing. Local start-up Aldis is one of Vanderhoofven’s favorites in the Meritus portfolio.

So, what’s next? Vanderhoofven unabashedly says that “we need to raise a $100 million expansion-stage equity fund.” Programs like TNInvestco and early stage initiatives in other states in the region have set the stage for a “supply-demand imbalance” if it is not addressed. Vanderhoofven is not critical of these efforts to fund start-ups in their early years, but he worries, as he did a decade ago, if they will survive or stay in the region without growth stage funding.

“I believe in the mantra that good deals will get funded,” he acknowledges while observing that companies will require additional capital if they don’t become self-sustaining or get acquired and pondering what will happen to all of the young companies in the region that don’t achieve either of those milestones.

From his vantage point today, Vanderhoofven sees a significantly changed landscape from his last few years at ORNL when he worried about a different set of challenges. He uses the analogy of the three-legged stool. In the 1990s, the priority was getting technology commercialized. More recently, it has been on securing adequate investment capital. Going forward, Vanderhoofven says its talent.

“We don’t have a wide enough and deep enough pool of people . . . who want to stand in the fire,” he said while citing two role models who have – Witkowski and Will Overstreet of Voices Heard Media.

Vanderhoofven believes the “region is a lot smarter now,” adding that we have a sharper focus, more resources and, most of all, a robust entrepreneurial ecosystem. At the same time, he believes we must be more mindful of a statement that he attributes to former Chattanooga Mayor and current U.S. Senator Bob Corker who once said to him, “If we’re going to have a robust entrepreneurial culture, we cannot punish failure.”

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