$200 million later, was TNInvestco worth the risk?

Christopher Parks launched Change Healthcare in 2007 to bring more transparency to health care, building the company with $1 million he raised from local investors.

In 2010, a year after the state's TNInvestco program was created with the mission of supporting entrepreneurship and job creation by funding early-stage companies, Parks landed $5.5 million, $1.5 million of that coming from TNInvestco. His company has since raised $25 million more from local and national investors, allowing it to grow its staff to more than 70 employees with nearly 7 million people on the health care platform nationally.

Change Healthcare is one of 157 companies that have received funding from TNInvestco, now in its fifth year. More than 80 percent of the funds raised through $200 million in tax credits has been allocated, and investors say that while it's too early to measure the program's overall effectiveness, signs of success are abundant.

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They point to the role the program has played in building the entrepreneurial ecosystem, the ability for TNInvestco companies to lure employees from outside Tennessee and the amount of funding the companies have been able to attract from private investors after receiving TNInvestco capital.

"It's energized the venture capital community in this state and facilitated the building of a network of relationships within the state and outside the state," said Townes Duncan, managing partner of Nashville investment firm Solidus Co.

As of 2013, 10 TNInvestco funds have allocated $111.2 million to Tennessee companies, which have received about $191 million in "follow-on" dollars, or additional, private investment, according to the funds. As of 2012, TNInvestco companies were supporting 577 new jobs, the majority in Tennessee, and nearly 1,400 jobs in full.

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The reports detailing the number of jobs as of 2013 are being audited and are not available, according to the Tennessee Department of Economic and Community Development, which oversees the program.

Need for transparency

In 2009, the program was touted as a way to bring new jobs to Tennessee and support startups when capital was especially tight.

With millions spent on luring corporate headquarters to Tennessee, legislators and economic development staff pointed to the program as a way to build jobs from the ground up. Funds would invest in companies and split returns with the state in a liquidity event, such as a company sale or an initial public offering. Six funds were chosen to participate in 2009, and four more were added in 2010.

From its inception, the program has stirred controversy.

A venture fund not chosen to participate in 2009 filed a lawsuit concerning how the funds were selected, and some legislators questioned using tax dollars to finance companies. Others said the terms were too generous and more returns should go to the state.

In 2012, an audit found "serious and pervasive problems" with the program and said TNInvestco lacked safeguards to ensure companies receiving funding were eligible.

Legislation passed this year addresses how the state can eventually recoup returns in companies through means such as selling ownership stakes to a third party. It also gives funds more time to address noncompliance issues and increases fines for such noncompliance.

The bill stemmed from an interest to add "more transparency and greater accountability" to TNInvestco, and the liquidation rules were an oversight in the original legislation, said Sen. Doug Overbey, a sponsor.

"When you are starting a new and innovative program, you try to to look at it from all angles and anticipate a scenario, but that was one that wasn't covered," he said of the amendment. "I'm glad we could come back and cover it."

Last week, Economic and Community Development informed the state comptroller that it had learned follow-on investment numbers (additional money from new investors) reported by funds had been inflated through 2012, with funds co-investing in companies both calculating the same investments in their follow-on estimates. The funds have been aware of the annual reports' inaccuracy for 18 months, according to a letter sent to the comptroller by Ted Townsend, assistant commissioner of strategy for ECD.

The funds, which report individually, became aware of the discrepancy this week as they responded to media queries and "immediately" reported it to Economic and Community Development, according to a statement sent by Duncan. It said the error was the result of how the department aggregated reports.

Sen. Randy McNally said that although he initially voted for TNInvestco, he has concerns about the program. "Anytime (money) gets out of state control and into private control, we need to make sure we can follow the money," he said. "The bill that was passed this year is certainly a step in the right direction. There probably needs to be a lot more transparency."

Gauging success

Job creation and venture capital spending were cited as the program's benefits when it was approved in 2009, but TNInvestco investors argue that at this point in the program's life span, the follow-on capital is the most accurate gauge of success, as jobs typically come after a company has proved its value.

"Jobs follow business success," Duncan said. "If they precede business success, they stop business success. If you hire a bunch of people and you're paying a bunch of people too far ahead of your revenues, you violate the fundamental rule of a startup business: Don't run out of money."

Since Change Healthcare received three rounds of TNInvestco capital through Solidus' TNInvestco fund, it has attracted capital from prominent venture capital firms including Mitsui Global Investment in New York, Sandbox Industries in Chicago, and HLM Venture Partners in Boston and San Francisco.

"The TNInvestco money has absolutely been a big part of bridging us from where we were as an early-stage company to ... where we have brought in other investors, both locally and outside of Nashville," said Doug Ghertner, CEO of Change Healthcare. "You don't get to that point unless you have structures or vehicles like TNInvestco to get you there."

Once larger firms with bigger purse strings begin looking to Tennessee for investment opportunities, that benefits all Tennessee startups, not just those receiving TNInvestco funds, said Sid Chambless, executive director of the Nashville Capital Network, which includes TNInvestco's Tennessee Angel Fund.

Sandbox Industries, for example, invested in Nashville health care company InvivoLink before turning to Change Healthcare and Nashville-based naviHealth. It also helped launch Healthbox, a health care accelerator at the Nashville Entrepreneur Center. While these deals don't show up in the TNInvestco annual report, they are a result of the program and will have a lasting impact on the state's economic development efforts, Chambless said.

"The proof is in the follow-on capital going to these companies," he said. "It suggests we are investing in really great companies that will scale."

Five TNInvestco companies have attracted buyers, including NeighborMD in Nashville, bought by HCA's TriStar Health System and CareSpot, and ExtraOrtho in Memphis, with the funds reinvesting their share of returns. The program also has prompted a handful of firms to move to Tennessee from other states. Health care company Shareable Ink moved to Nashville from Boston, cooling fan-maker Auramist relocated from Arkansas, and Molecular Sensing came from California.

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"People are willing to move to town from outside the state if we'll write a check," said Joe Cook III of Mountain Group Capital, which runs TNInvestco's Limestone Fund. "That never happened four years ago."

Not every company has seen the same levels of growth, measured in jobs and follow-on capital. At least five companies have closed since receiving TNInvestco funds. Knoxville-based TrakLok closed after receiving $1 million, and The Smart Image, a Nashville online coupon company, closed after receiving $450,000.

Other companies have not stayed here. Krush Inc., a fashion shopping app, moved to Newport, Calif., after garnering $2 million in TNInvestco money. While Krush no longer employs Tennessee workers, the state and TNInvestco fund Tennessee Community Ventures will have access to returns, said fund manager Eric Satz.

Filling the gaps

The investors also point to the inception of programs, including Launch Tennessee and Jumpstart Foundry, as one of the side benefits of TNInvestco. Companies that go through Jumpstart receive $15,000 from Solidus' TNInvestco fund, which supports them as they go through the startup accelerator program and helps them develop their product or service. Several of those, including InvisionHeart and Evermind, have gone on to receive larger rounds from other TNInvestco funds or private investors.

As TNInvestco winds down with no plans for a second round, there could be a loss of momentum in early-stage funding, especially in the $2 million to $3 million investment rounds, Chambless said. Local investors are hopeful that private money, and money from the state's federally funded Incite Co-Investment fund, helps fill the early-stage funding gaps TNInvestco has helped address in recent years. The Nashville Capital Network, Limestone Fund and TriStar Technology Ventures, each with TNInvestco funds, have launched new funds with private investors that will be directed to early capital rounds.

"TNInvestco just started the ball rolling and scratched the surface in terms of the early-stage capital needs here," Chambless said. "There are more and more companies that are coming out of (Tennessee accelerator programs) that are seeking capital. ... What keeps me up at night is the access to capital and the ability for these great companies … to be able to capitalize their business."

Reach Jamie McGee at 615-259-8071 and on Twitter @JamieMcGee_.

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