With a Good Story, A Young Firm Targeting the Midwest and Texas Thrives

Blair Garrou is unassuming, but he’s as ambitious a venture capitalist as you’re likely to meet, as evidenced in part by his co-founding Houston-based DFJ Mercury at just 32 years of age. He was young, but having worked as a principal at the Houston-based private equity firm Genesis Park, and as the CEO of Intermat, a decades-old portfolio company of Genesis that Garrou helped sell to a public company, he decided he was ready anyway.

That Garrou helped convince investors of the same is more impressive. Indeed, the firm, formed in 2005, managed to collect $30 million to invest between $100,000 and $5 million into nascent companies — particularly those created out of tech transfer programs in Texas, Illinois, Colorado and Michigan. This spring, despite what’s long been an inhospitable fundraising climate and just one exit, DFJ Mercury closed on a second fund more than twice the size at $70 million.

Earlier this week, I asked Garrou how his team pulled it off.

Fundraising is way down. Alan Patricof recently detailed how arduous it was for Greycroft to close its newest fund. What was your experience like?

Greycroft’s name came up a lot on the fundraising trail. As our small fund size and approach was being looked at, it was almost in lockstep [with Greylock]. They had Patricof, of course, but other advantages they had is that their fund hails from area of country where there’s a lot of venture investing and that they are sector specific, focusing on software and digital media.

Telling people we focus on the middle of the country, it was hard to get a conversation started. Also, we’re not strictly IT focused but we also invest in advanced materials and biosciences. So we had to get potential LPs over the hump. To do that, we had to reach out early and let them see us over subsequent quarters and see our companies improving quarter to quarter. Basically, what we told them would happen came to fruition, but without that, because of where and how we invest and that we’re an emerging manager, things might not have worked out so well.

It also helped that we could talk about Phurnace [the one company in DFJ’s portfolio that exited, via a sale to BMC Software for an undisclosed amount]. That exit was just around a 6x for our fund and returned just 35 percent of our first fund, and in this environment, that gave a lot of people comfort.

I’ve seen a lot written about the commercialization gap that you’re targeting. Can you elaborate?

Sure, we’re kind of puzzled why more people haven’t picked up on this, but if you look at various states and R&D spend versus venture capital spend, you see very interesting activity. Obviously, Massachusetts and California cover their R&D opportunities with venture capital, but in the middle of the country, massive gaps exist.

We started with a hunch, but if you look at states’ individual R&D spend, both academic and commercial, and compare that to venture investment activity — we tend to analyze gaps with a lag of two to three years; for example, R&D spend in 2005 and venture investment in 2008 — the data is surprising, especially for states with $100 million or more of VC spend. In Michigan, for example, the ratio of R&D to VC spend is 72 to 1. In Illinois, it’s 26 to 1. In Texas, it’s 12 to 1. Meanwhile, in California, it’s 4 to 1.

To us, especially taking into account the active tech transfer programs at places like the University of Michigan and the University of Illinois at Urbana-Champaign, the Midwest stands out as a place with great opportunity.

Is it challenging to keep startups born in the Midwest to remain there?

We want to keep companies where innovation occurs, but we know if you don’t have a presence in Northern and Southern California [your potential is sometimes hampered]. In enterprise software, we don’t feel like our startups have to move; those investments have pretty much stayed put. But in consumer Web, it’s hard to find analogs of success in the Midwest or Southwest other than Feedburner or Groupon or HomeAway. In fact, to a T, every single one of our Web companies has a presence on West Coast. Thankfully, most don’t have issue with half of their workforce picking up and moving.