Originally published in Twin Cities Business Magazine on 9/25/23.
For the last four months, I’ve been haunted by a statement made by one of our panelists at the most recent Angel Fest:
“If you could look into where the total dollars were invested by the area’s local family and community foundations, you’d find that there’s more money going to Russia than what is being invested within this community.”
That can’t be true… could it?
Crunching the numbers, I could see how a large, diversified, global portfolio could easily, and possibly accidentally, support that theory. But there are so many incredible investing opportunities in Minnesota; are the gears connecting the area’s largest capital allocators to the local private equity market simply not aligned?
There’s no better person to answer this question than Shannon O’Leary, chief investment officer of the Saint Paul & Minnesota Foundation.
For context, the Saint Paul & Minnesota Foundation (and a partner organization, the F. R. Bigelow Foundation) has established itself as one of the most engaged foundations with the local venture scene. Along with the Bush Foundation, both organizations openly seek to invest ($1M to $3M) in emerging venture funds, including Groove Capital, Tundra Ventures, Bread & Butter Ventures, Matchstick Ventures, and others whose thesis includes a commitment to investing in Minnesota’s brightest entrepreneurs.
Having completed the diligence process and received an investment for our most recent venture fund, I can say two things about the Foundation’s process: 1) It was not easy; they run a professional diligence practice and 2) the way they think as an organization is different.
To elaborate on what makes them so unique, I want to share a few snippets from a conversation I recently had with Shannon, where we discussed their approach to investing locally and the intentionality it takes for large foundations to work with emerging investments firms.
Reed Robinson: Shannon, the way that you look at investing locally is unique; how did you get to a place with your organization where you could have the flexibility to invest in that way?
Shannon O’Leary: We’re unique compared to many other foundations, most of which remain highly dependent on large national consultants for investment sourcing and diligence. We have a dedicated CIO, with a staff of seven additional folks on the investment team. Our team looks for mission-alignment with each and every manager or deal we screen, and I suspect that more consultant-driven entities are less able to take this approach.
We manage about $1.7 billion in multi-asset portfolios that are designed to support a 5% spending policy, while offsetting inflation, and our timeframe is very long-term. So, we have to be very growth-oriented. One of the most important things we’ve done along the way is intentionally looked at the assets that we’re holding in these various portfolios and asked ourselves “is there anything in here that is in conflict with the work that we do in the community?”
In foundation and endowment land, I think there can be a “front-of-the-house” versus “back-of-the-house” thing that happens. Everybody likes to talk about the grants — the front-of-the-house — but start to fall asleep when you talk about the finance and investments at the back of the house. Yet that back of the house acts as a mission-critical engine that generates the cash flow to pay the grants. My throughline with committees, boards, and staff is to say, hey, if we’re investing in things in the back-of-the-house that are functionally cancelling out the grants that we’re making into the community, then what are we accomplishing?
Grant amounts are relatively small compared to our investable assets. Our average manager commitment is usually in the $10 million to $20 million range. If I’m investing in something at that size and scale, and the investment dollars create negative externalities that exacerbate, say, the lack of affordable housing in the Twin Cities, a $50,000 grant into the community for housing is totally overwhelmed. We’ve missed the mark.
So, we invest for both a financial return and for positive social impact in the Twin Cities, and Greater Minnesota more broadly. Our work really puts us out there, and it makes us a lot more informed than the typical investment office might be. We want to look for interesting investment opportunities that the community needs and we will pursue these ideas even if there isn’t a vehicle through which to invest.
RR: Like the work that you put into helping Tundra Ventures get started? That’s a good setup for the following. But it doesn’t seem realistic to me to expect a lot of foundations to take that level of involvement to create something new. What feels like a more natural next step for many may simply be flexing their investment criteria to be more open to working with smaller, less established funds. As you’re aware, Groove has had some success with institutional investors, but I want to share some of the objections that we’ve either experienced or heard from other local emerging managers:
- “Your fund is too small.”
- “I can’t write a check that small, and I can’t be a large of a percentage in your fund.”
- “We don’t work with first-time funds or emerging managers.”
Where do these objections come from?
SO: Okay, there are a number of topics there. In general, having been an allocator for my entire career, I’m incentivized to always look for a reason to say no. My team and I receive about 500 incoming emails a day, most of which are cold intros to managers. It’s just not realistic for our team to even open all of these! Most allocators develop a prioritization checklist, and include hurdles that make it easy to just eliminate 75% of the incoming calls.
In terms of the limits on the investment size, there are a few things to unpack. First, diligence takes the same amount of time and effort for any fund new to my team, regardless of how big the fund is. For allocators with limited staff, I can see how the decision to allocate time will drive those folks toward large funds where they can commit larger allocations.
Additionally, there are some specific accounting rules that foundations follow that can limit the total percentage of a fund we can take down. I’m not looking to give my CFO any more heartburn than is already implied for our annual audit.
RR: We see a lot of deals and have our own investing criteria for the same purpose with Groove; I get that. So how does one stand out? Is there anything that we can do to get a foot in the door and perhaps alleviate the burden of the diligence process?
SO: If the objection is based on a lack of experience or track record, you need to focus your framing on the steps you’ve taken to de-risk yourself. When you pitched us, you said, “I spent 15 years preparing to do this work via my startup experience and work with Beta.” You came with relevant experience to a point where we could coach you through how to complete an institutional diligence process. We like to play that role within the community—to find and elevate things that the community needs, while also preparing emerging managers like yourself to go pitch other investors.
The one thing that I’ve run into a lot in speaking with other local investors is that it can be quite easy for an analyst to use the Institutional Limited Partners Association (“ILPA”) due diligence templates as a cudgel against managers. This is particularly negative for first-time funds, and funds run by women and people of color. A number of the ILPA asks make sense if you’re dealing with a billion-dollar fund, but there’s a lot of stuff that simply does not work or apply to a first-time manager or much smaller fund size. For example, asking a $10 million fund to do an annual audit is totally unreasonable. After paying legal, accounting and LP servicing fees, a private fund audit would basically burn the fund’s remaining management fee every year. Do you really want the GP to be too cash strapped to survive for the first 5-6 years? So, yes, process is a part of the problem.
For the foundations with big balance sheets but who don’t have the staff capacity to do the diligence on local and emerging managers, one solution is to participate in co-diligence partnerships with other local impact investors. We’ve done a fair amount of convening with other local impact investors. Casey Schultz from my team gets together regularly with a group from a number of different local foundations, and they share deal flow and best practices.
I think there’s room for more of that type of connective tissue building. We’re more than happy to play the role of “first bird off the wire” and then managers like yourself get to show up with the data room that our diligence process helped you create. And it sure seems like other potential LPs are becoming more willing to engage with these kinds of investing opportunities once they know we’re involved.
RR: I like the collaborative approach and willingness to share deal flow and diligence with your peers. It’s also interesting that there’s a smaller pool set aside to help your organization fulfill its commitment to supporting the local venture (and therefore entrepreneurial) economy.
Outside of adjusting the process, what else have you seen work as it relates to working with smaller funds that others could learn from?
SO: Part of what we need to do is get all the region’s newer venture funds to mature and grow. You’re on Fund II, others are either earlier or later, but we need to see ongoing traction and increased fund size via successful track records and fundraising efforts. As successive funds grow towards that $100 million dollar fund size, most of the concerns about fund and commitment sizing fall away. Our hope is that eventually, you all graduate out of our impact pool and into our larger multi-asset portfolio. Even though you’re not at that capacity now, we like having the opportunity to partner with you, and others, in hopes that we can participate in a bigger way over time and continue to foster economic development and growth locally.
Also, Reed, don’t forget the data shows that the limited partners make the most money on funds one, two, and three. Emerging managers, particularly women and people of color, are acutely aware of the signal that their failure might send to the investing community. It’s a real high-wire act to try to ensure preservation of capital and strong returns over the life of the first or second time fund. The stakes are so high.
RR: I feel that. Failure is not an option.
So, it’s like a farm system, where you’re bringing in Groove, and other like us, to see the inner workings, in hopes that we turn into a larger, more traditional investment? We appreciate that long term view; it’s completely aligned with how venture works.
Shannon, thank you so much for the conversation, but before we wrap, I need to know… is that statement true? Is there more money going to Russia than what is being invested here?
SO: Not in the portfolios I oversee, but you’re probably right on a global level. Let’s make sure it doesn’t stay that way – there’s plenty of local opportunity and I’m always delighted to share our experiences with potential new investors in Minnesota.
