Nearly $1.5 billion has been invested in more than 200 different Nashville–based companies, mostly health care related, over the past 10 years, according to a recent survey dubbed Nashville Venture Capital Report: 2001-2011 (read here) and compiled by the Nashville Capital Network and the Nashville Health Care Council.

The survey is a first of its kind overview of the local venture capital investing industry revealing, to no one's surprise, the dominance of health car-related plays, which — according to survey compilers — neared $1 billion for the period.

But there’s a problem. And according to some local VC experts, the problem has existed for years and has slowed VC growth, even in health care, to the point of a complete absence of investments in the $5 million-plus range of capitalized companies.

According to Petra Capital Partners founding partner Michael Blackburn, the issue is will — or a lack thereof.

“Nobody would step up right now and write that $5 million check,” Blackburn said.

Funding at that level and above has to come from some pretty wealthy individuals or — as is common in other states — from institutional investors. Blackburn (pictured) said if institutional investors like the State of Tennessee, Vanderbilt University and other similar entities with large endowments and institutionally controlled dollars to invest would place segments of their portfolios in local VC efforts, the gap wouldn’t exist.

“If we could get a dozen people in a room, we could solve this problem tomorrow,” Blackburn said.

The challenge in some cases is policy. The State of Tennessee invests its institutional monies in $100 million increments using a fund for funds approach, common to the institutional investing world. But a rule prohibiting investments in less than $100 million blocks excludes its participation in the smaller plays.

Blackburn said other cities don’t have this concern.

“Austin, Silicon Valley, Boston — cities about this size — allow institutional investing in these smaller chunks, which attracts even more dollars as out-of-state investors gain confidence with second-stage VC efforts,” Blackburn said.  

The absence of institutional investing at the second-stage level isn’t attractive to out-of-state investors. If local institutions and a state’s government won’t invest, why should they?

In fact, giving unneeded credence to the absence of capital at this elusive second-stage level, Blackburn’s firm recently borrowed $50 million from the Small Business Administration to avail itself of these larger plays.

“It’s not the ideal way to do this, as borrowed funds come with restrictions,” Blackburn said.

But not everyone agrees with institutional participation. One local VC expert, who requested anonymity, said it isn’t advisable for institutional investors, like the State of Tennessee and Vanderbilt, to invest in post angel-stage VC companies.

“Those funds should be placed with a manager of managers, thereby invested by professionals familiar with the market,” the expert said.

The study acknowledges this problem. It reads in part, “The report also highlights a widening gap in Nashville’s venture capital market between the capital available to the earliest companies and the capital available to later stage ventures. This gap could become a problem as the number of promising start-ups continues to grow. However, this challenge also presents an interesting opportunity for growth capital venture capital firms who will have numerous attractive high-growth companies to consider for investment.”

The idea is that those already in the VC game will step up and make the larger play.

Although endowments, pension funds and the like certainly have sufficient time horizons to offset some of the risk inherent to post angel–stage investing, the idea hasn’t taken hold and the solution to filling this local VC funding gap alludes.