SPECIAL REPORT: 2nd stage firms transform Michigan economy

BY RICK HAGLUND

Maestro eLearning, a Kalamazoo company that offers online training services to corporations nationwide, was founded in 2007 in a room above founder Josh Little’s garage.

But in just three years, Maestro has grown into a multimillion-dollar enterprise that employs 15 and expects to double its sales growth this year from 2009.

A company that has so far sidestepped Michigan’s brutal economic downturn, Maestro also was named one of this year’s Michigan 50 Companies to Watch by the Edward Lowe Foundation in Cassopolis.

Those companies will be honored tonight at the annual Michigan Celebrates Small Business event in Lansing. This sixth annual class of companies had an average annual revenue growth rate of 20 percent.

“We are so busy. We’re all running. It’s really, really fun,” said Maestro President Jennifer Randall, who left a career at health care products giant Johnson & Johnson to help start the company.

Maestro and thousands of other so-called second-stage companies are increasingly being viewed by state leaders as critically important in leading Michigan into a new, more entrepreneurial economic era.

Second-stage companies are those that have grown beyond the startup stage, have annual revenues of between $1 million and $50 million, and employ between 10 and 100 workers with the capacity for further growth, according to the Lowe Foundation, which specializes in conducting educational programs aimed at these businesses.

The Lowe Foundation was established by the late Edward Lowe, who invented and manufactured Kitty Litter.

Growing Our Own

Over the past 30 years, state economic development policy has focused largely on recruiting new companies to Michigan in an attempt to replace the hundreds of thousands of jobs shed by automakers and other manufacturers.

But state officials and other experts say turning around Michigan’s troubled economy depends on small businesses that are already here growing into large employers.

“We’re not going to be able to recruit our way out of this,” said Greg Main, president of the Michigan Economic Development Corp. “We have to grow our way out of this.”

But that will require an enormous cultural change in a state that has long depended on Fortune 500 corporations, such as General Motors Co., Kellogg Co. and Dow Chemical Co., for its economic prosperity.

“We have a large-company mentality,” said Mark Lange, executive director of the Lowe Foundation. “We don’t have a second-stage company mentality.”

Lange said many business-assistance and financial-incentive programs in Michigan are aimed at startup firms and large companies.

“In the middle, where we have most of our jobs, we kind of forget about those companies,” he said.

Bucking the Economic Trend

Second-stage companies employed 1.3 million workers in the state in 2007, the last year for which figures were available, and comprised Michigan’s largest employment segment.

There are about 57,000 second-stage firms in the state, up from about 51,000 in 1993.

Second-stage businesses added 137,249 jobs between 1993 and 2007, according to Lowe Foundation figures. That was the most of any business category.

By contrast, fourth-stage companies employing more than 500 workers shed 257,585 jobs in the 15-year period between 1993 and 2007.

And the number of fourth-stage companies in Michigan fell from 544 in 1993 to 459 in 2007.

Those statistics demand that the state’s economic development policy be much more skewed toward helping existing businesses in the state grow, said Rob Fowler, president of the Small Business Association of Michigan.

Fowler said the state must develop a sophisticated “economic gardening” strategy that identifies businesses with the potential for strong growth and offers them a toolbox of services that includes market research, management development and financial expertise.

“It’s a different set of tools than what it takes to attract a company to the state,” he said. “It’s a new frontier, almost a new profession that’s being created.”

Economic gardening also involves linking entrepreneurs in networks with trade and professional associations, universities, roundtable groups and other service providers.

Companies also must have access to short-term, intense training by experts while conducting normal business operations, a process Lange likens to refueling a jet in flight.

“That’s a model we don’t use” in Michigan, he said.

Window of Opportunity

Several states, including Colorado, Florida and Georgia have embraced the economic gardening concept.

Last year, the Florida Legislature approved a $1.5 million appropriation to create the Florida Economic Gardening Institute. A team from the University of Central Florida will run the statewide business assistance program.

Still, Michigan has a chance to be at the forefront of this emerging field of economic development, Fowler said.

“Michigan has a real opportunity to lead here, but that window of opportunity is going to close soon,” he said. “We have to hit that window just right.”

That window will be open for the next six months during this year’s campaign to elect a new governor and Legislature, Fowler said.

SBAM has assembled a team that is working on a white paper outlining an economic gardening strategy for Michigan. The document will be distributed to every candidate for governor by late June.

“It’s good policy and it’s good politics,” Fowler said about economic gardening.

Expanding the Focus

The SBAM president said he also believes Michigan should shift its economic development strategy from targeting certain industries to focusing on aiding a broad range of growing companies.

State government’s development efforts are largely built around promoting investment in four industries—life sciences, alternative energy, advanced manufacturing and homeland security—with a heavy emphasis on green jobs.

But Fowler said only 14 businesses in this year’s Michigan 50 Companies to Watch are in the state’s four targeted industries.

“The rest are not targeted or helped by state government,” he said. “What if we helped all second-stage companies prosper, regardless of industry?”

Not all second-stage companies are looking to grow. Many are restaurants, retailers or family-owned operations that are content to remain small.

And others either don’t trust consultants that could advise them on growth strategies or think they’re too busy with day-to-day operations to bother, Lange said.

But for growth-oriented firms, what they do at the second stage of their development is crucial, said Tom Kinnear, a professor of entrepreneurial studies at the University of Michigan.

“This is the critical moment where everything takes off,” Kinnear said.

The need for capital changes from financing the development of a product to financing growth. Often, a new management team with experience in running fast-growing companies is required.

“A lot of firms get to the second stage and say, ‘What do we do now?’ ” Kinnear said.

Financing Challenges

Second-stage companies also are in sort of a no-man’s land in finding the type of financing they need, Kinnear and Lange said.

“They are too big to be small and too small to be big,” Lange said. “They don’t match the profiles banks and venture capital firms are looking for very well.”

The MEDC has a number of financing programs to help second-stage companies grow, said Kapila Viges, the MEDC’s director of entrepreneurship and innovation.

They include a Michigan Supplier Diversification Fund, established last year to help auto suppliers to enter new markets. The program uses $12 million in federal tobacco settlement money to leverage additional bank loan funds.

“Right now we’re trying to create this cultural shift and get people to think more entrepreneurially,” Viges said.
A House bill introduced in March would establish the Small Business Investment Credit aimed at high-net-worth angel investors. The credit would give investors a 25 percent tax credit against their state income tax for investing in small high-tech businesses, including those in information technology, biotechnology, advanced automotive technology, digital media and others. An investor would have to invest between $15,000 and $1 million to get the credit, which would be capped at $500,000 a year per investor.
The state would could hand out a maximum $10 million in credits annually. But Main said the program could generate $100 million a year in small-business investment.

“We think there could be a lot more people engaged in investing out of their own pockets,” he said. “Second-stage companies could be their cup of tea.”

Other Solutions

But Lange said more efforts are needed to support the growth of second-stage companies.

Bank financing is unavailable to many small businesses, he said. And venture capital investors often are looking to double returns on their investments over a fairly short period of time.

Michigan needs to develop a larger supply of “patient capital” provided by investors who are interested in hitting singles, rather than swinging at home-run investments, Lange said.

“We need investors who are seeking a 5-to-15 percent return on their investment. It’s something that should be looked at” by policymakers, Lange said.

Lange and others say rebuilding Michigan’s economy by focusing on a diverse group of second-stage companies is a better bet than continuing to rely on the fortunes of major corporations that lay off workers by the thousands in economic downturns.

“If we can continue to build them, our sustainability over rough times can be stronger,” Lange said.

Second-stage businesses can even spin off new companies that add to the state’s entrepreneurial dynamism.

Maestro founder Josh Little, for instance, recently created Bloomfire, a company that advances online training by allow more use of collaboration and social interaction.

The spin-off resulted from Maestro’s relentless focus on innovation, according to Randall.

“I think the state would want to think very, very seriously about companies like ours,” she said.