Migration of Capital


By John Shumate

I read with interest Fred Wilson’s blog post, concerning the geographic concentration of startups worldwide. I’m a huge fan of Fred and his blog. If you are interested in VC-backed companies and don’t subscribe, you should. He’s a great teacher and generously shares the wisdom he has accumulated from decades of operating and investing in technology startups.

Fred shared findings from a 2012 report that showed that the majority of venture capital, and consequently startup companies, can be found in the major international cities, namely New York and the SF Bay Area. There’s no news there, but the report and Fred support the premise that startups should be based in these great international commerce hubs where the best talent naturally gravitates due to factors including density, great universities, open mindedness and tolerance.

That doesn’t sit well with me. I’m biased of course, because I make my home in Louisville, KY and serve many startup clients that are building thriving companies in the Midwest, Mid Atlantic, and Southeast. I have also served a great number of New York, Boston, and Silicon Valley clients as well as the VC’s that fund them.

Clearly, it’s a great deal easier to raise angel and seed capital – often at higher valuations – from investors in New York and Silicon Valley. There are incubators and case competitions and an entire ecosystem built around the pursuit of the next great tech startup. In my neck of the woods, private capital does not flow as freely. Generally, companies need to bootstrap their way to a clear path to profitability and/or exit in order to have a chance at limited regional VC funding.

When I get to review the portfolio holdings of VCs here in the “middle” of the country, I frequently see companies that make a lot of sense. Perhaps there aren’t as many unicorn candidates, but there are plenty of companies working to solve important problems, led by entrepreneurs who put everything they have into the venture, aiming to create not only value for themselves, but also jobs and prestige for their hometown. Because they had to bootstrap, they often have leaner cost structures and less squishy business models. Sure, it is often harder to find technical talent, but good talent often costs less than half the price of those big metropolitan hubs.

Fred makes great points about the benefits of face time with the investors who contribute value far beyond the dollars they put into companies. However, private jets aren’t required to build relationships with great investors. Amazing startups in the lesser American cities can be found, backed by the local corporations who certainly have insight into what the future holds for their industry. One of my favorite valuations from 2015 was performed for a local “mom and pop” retail operation with an amazing brand, undergoing a transformation by an “A Team” of executives from local Fortune 500 companies. No exaggeration, they got a CEO who was the retired COO of a multinational consumer packaged goods company that you have definitely heard of as well as other C-types from the tent pole employers in that geography. Imagine LeBron James showing up to play on your child’s YMCA basketball team, and you get the idea.

The “density” that drives creativity and invention in the “great” cities, can also drive away exceptionally talented entrepreneurs who need sun, space, and a lower cost structure for their ideas to flourish. The fact is that there are a great many entrepreneurs who are bright, sophisticated and inclusive who do not live in the major international cities. They weigh the benefits of the quality of life outside of the big cities and consciously choose to build their companies in cities with a good enough airport and a dramatically lower cost of doing business. For venture capital, they will need to compete for the limited funding available through regional funding platforms that behave more like private equity than true venture capital. Those who obtain funding are backed by local capital that definitely wants a return, but equally seeks jobs and prestige for their hometown.

Coastal investors are beginning to recognize these diamonds in the rough as well, as they get tired of investing in picked-over over-valued deals in the Valley. New venture funds are starting to make a play in these underserved regions. Drive Capital, a group of former Sequoia guys, realized the size of the unmet funding need in the Midwest and started a $250M fund to serve the region. They are currently building a follow-on fund. East coast investment connectors like VentureOut are starting to introduce angel investors from New York to early-stage rock stars in the middle of the country. These are just a couple of the groups that are expanding their geographic horizons across the U.S. Sure, you can follow the crowd the Bay Area, or you can go against the grain and have your pick of some great new companies. Personally, I’m betting on some of these sharp entrepreneurs who are taking the “low road.”

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