This post is written by Jose Ancer, a Technology and Venture Capital Partner at Miller Egan.
Some things in life are certainties. The sun will rise tomorrow, you will be taxed for something… and startup ecosystem players across the world, outside of Silicon Valley and NYC, will complain about the lack of local VC capital, and the need for more foreign capital. Are they correct in complaining? I’m not going to answer that question. Too debatable, and the debate gets you nowhere.
What I am going to say, and I’m saying this as someone who manages a legal practice with visibility into a decent number of 2nd/3rd ‘tier’ ecosystems in the U.S., is that there are a lot of reasons to be optimistic about the overall trends in this area.
The Historical ‘Scarcity Culture’ of Local Venture Capital
In many tech ecosystems, there’s historically been a culture among the institutional investor community that directly reflected the scarcity of local capital, and of information about that capital. I will call this ‘scarcity culture.’ Trying not to come off as too judgmental, because all institutional capital plays a vital role in the business community, regardless of its approach, I would say that scarcity culture is largely summarized with the following statement:
You don’t like our terms or our behavior? What can you do about it? What alternatives do you actually have?
Does this mean that all local VCs outside of the densest markets think that way? Of course not. But it is definitely there, in a variety of ways.
Anyone with a broad enough visibility into American venture capital knows it is an absolute fact that California VCs are generally ‘friendlier’ than the VCs of any other ecosystem. By ‘friendlier,’ I mean that they are OK with higher valuations, they are more transparent in their intentions, and they tend to show significantly more deference to a founder team in terms of providing coaching/opportunities for growth as opposed to an early pink slip. Why is that?
Is it something in the water? The weather? Have they achieved a new level of enlightenment? Hell no. California VCs have the same job as VCs anywhere else: to make money. The answer lies in one very simple word: competition. And increasingly over the past few years it is magnified by one more factor: increased transparency through technology and decreased friction in networks.
Competition and Reputation.
Let’s use an analogy here. Do you think that restaurant service is better or worse in dense urban environments relative to small rural areas? Obviously it’s better. There’s more competition.
In an environment where a quality founder team can, if they don’t like one particular set of VCs, walk almost literally across the street and talk to 10 more, investors have learned (rightly) that to be an asshole is to step right into a massive adverse selection problem. Combine a truly competitive market with inter-connected networks where reputational information flows freely, and you have a system that naturally corrects for bad behavior. The really good companies, the one’s that everyone would want to invest in, don’t have to put up with anyone’s nonsense; and they do their homework.
Contrast that with ecosystems where only a handful of investors, many of whom collude with one another, are available for companies that need serious funds, and you have a very clear explanation for why California capital is ‘sunnier.’
California VCs are more “founder friendly,’ because their circumstances make founder friendliness an almost essential requirement for deal flow.
Most assholes can’t even survive in that environment, so it selects for ‘nicer’ people.I am not saying that west coast money is all cotton candy and rainbows; nor am I saying that non-SV local VCs are all difficult to work with. But broadly and relatively speaking California VCs can be easier for a founder/management team to get along with. It is also no surprise that the rise of industry/vertical-focused VC and VC ‘value-add services’ has come out of California. They’ve got to find a way of differentiating themselves in the noise.
Improving Local VC. Accessing out-of-state VC.
I think we can arrive at some useful ideas for both improving the local investor environment in non-SV markets, and in increasing the flow of capital between markets; beyond the “great companies attract great capital” truism that rightfully causes eye-rolls among founders.
Information flows most freely when the consequences of sharing it are minimized. You better believe that in some markets where key players serve as gatekeepers (see: Gatekeepers and Ecosystems) the threat of being black-listed somehow for speaking honestly is real. You will never get accurate market information on blogs, on twitter, on panels, or in highly public events where anyone and everyone is watching.
To use Brad Feld’s categories: there are entrepreneurs, and then there are “feeders,” which sort of means everyone else. Events and communities where the whole ecosystem is invited are great. But that entrepreneur v. feeder divide is crucial, and there need to be ways for entrepreneurs to share information with each other, confidentially and alone.
Is building those out-of-state relationship easy? Of course not. But it needs to start early.
The companies that successfully receive out-of-state participation in their Series A round often were building those relationships at seed. And the best intro to a particular investor is through a founder that they already invested in, so local founders who’ve accepted out-of-state capital are vital to encouraging that capital to engage more local companies. Once a foreign VC has made an investment in a city, it is a lot easier for them to look at others.
Why the optimism?
So, is raising a Series A outside of Silicon Valley and NYC really hard? Absolutely. Then why the reason for optimism?
Because every single variable/dynamic mentioned above is improving, and at an accelerated pace.
Founders are finding each other and communicating directly, sharing accurate information about the investor community and other market players; aided by modern networking and communication tools. Local angels and entrepreneurs are actively using those same tools to expand their networks far beyond their local ecosystem. Tools for long-distance communication and investor relations are maturing. And accelerators and prominent angels are increasingly becoming curation mechanisms leveraged by institutional investors to reduce search costs and explore new markets.
We are certainly seeing all of this happening at an increasing rate in our work in the market. As additional funds that are more comfortable operating in the new environment pop up, and as geographic barriers are reduced for capital flows, the more established players are increasingly more concerned with their brands and reputation. Instead of a “scarcity culture,” an open, transparent market culture favors investors that deliver real value and build durable, authentic brands.
Raising local and out-of-state institutional capital, and ensuring you’re working with good people, is still extremely hard if you’re not in a top-tier ecosystem. And speaking as ‘just’ a lawyer, I don’t want to minimize that fact in any way.