Venture capital firms with the most desirable addresses in the venture business – Sand Hill Road, Winter Street and the Big Apple – out perform VCs not located in venture capital centers. I’ve recently read a study produced by four researchers on venture capital as a local business that suggests that VCs located in the three US venture capital centers make better investments than VC firms based in non-venture capital hubs. (see my comments in italics at the bottom of this post for some discussion around the study’s methods.)
The study also suggests that venture capital funds actually seem to be more successful when they make investments outside of their home territory, despite the fact that VCs are notorious for preferring to invest close to home. The authors believe that because VCs are more hesitant to commit to an investment outside of their home turf then they raise the bar on these investments, thus becoming more successful when they make them. Additionally, it is possible that they face lower competition for deals in non-core venture markets. I can buy both of these arguments and would not be surprised if venture firms did better when investing in non-local startups.
The authors also reach another conclusion that I probably don’t agree with. They postulate that the superior returns delivered by VCs in SF, Boston and NYC are totally driven by their non-local investments out sided performance, “the out performance of venture capital firms based in the venture capital centers can be attributed to their out sized performance in investments made outside of the venture capital firms‟ office locations.” That is pretty hard to swallow. I’m pretty sure that many of the best venture capital investors make a ton of their returns from successful investments in their home regions. Local investments such as Sequoia investing in Google or CRV’s investments in EqualLogic probably drive more of their “success” than the sum of their other, non-local, investments.
One other interesting point drawn by the researchers is that the presence of a local co-investor does not raise the likelihood of success when a VC based in one of the venture centers invests in a non-venture hub startup. Many times, when a VC makes an investment in an area not close to home, they try to syndicate with a local venture firm. The theory is that this local firm can better help manage the investment, recruit talent local to the startup, coach management, etc. If I am reading the study correctly, these local firms don’t help the venture center VC. I guess this means that VCs based in one of the 3 hubs are just better investors than shops located in other areas?
So how does the reality of the venture capital real estate market impact the entrepreneur looking for funding?
But enough about venture capitalists. The more important fact to be drawn from this study is that it is easier for a startup to get funding if it is located in on of the three venture hubs. 49% of all VC investments were made in one of these three areas. If you are not based in a technology center and a venture firm appears to be interested, but asks, “where do you see putting the company’s headquarters,” or even more blatantly, “will you move the company to San Francisco after it receives funding,” you may seriously wish to consider indicating that you are open to moving the company. I understand that there may be reasons why this doesn’t make sense for your particular startup, but it will be much easier for you to get funded if you move.
Secondly, it appears from the study that VCs based in one of the 3 core venture regions are better investors than their less-optimally located brethren. This would suggest that startups not located in SF, Boston or NYC would be more likely to be successful if they take money from a VC located in one of these areas. This does fit in with some of what I observed during my time as a VC. We would often get referrals from funds not-located in one of those 3 markets looking for a syndicate partner for a particular investment. Many, many times these companies turned out to be “me-too” investments. By this I mean business plans that had already been beaten to death by Boston area VCs, but somehow still seemed like a good idea in a non-technology center. This is probably because the investors and entrepreneurs in those non-hub locations didn’t have the same level of access to deal flow as we did and so they didn’t realize that their idea’s time had come and gone. If investors in a hub area are saying that they’ve already seen your idea a dozen times then you should do a little more research into your startup’s competitive landscape.
A few things about the study:
This is a US focused study.
Success is defined as IPOs. This is a bit too narrow, but given the databases the researchers were using I understood why they did it. I don’t have enough data to decide if this makes the study meaningless. The vast majority of successful exits that I have seen have been exits through acquisition, not IPOs. However, I’ve only been an investor during a time when IPOs were not easy (since 2002, basically) so my viewpoint may be unfairly biases. The study looked back to 1975, I believe, so their view is much longer term than mine. They also can’t analyze differences in the level of success of an IPO – so Google’s IPO is as successful as an IPO for a company that later goes under. This is probably also a too great of a simplification, but I don’t know how they could do it differently given the databases they used. They also have tried to run the analyses again including the “merged of acquired” status in VentureXpert, but I do not believe that this part of the analysis is valid – in VentureXpert a failed company can be “acquired” by a larger player for peanuts. This happens often enough that I don’t think the M&A outcome in VentureXpert is a good measure of “success.”
Increasing the number of venture capital firms in a given CSA increases the number of new venture-backed companies. However, the SF Bay Area is 5x more productive in creating new venture-backed companies per venture firm than anywhere else. Also, regions with higher levels of “successful” investments spawn greater numbers of new venture-backed companies. This makes a lot of sense, given that entrepreneurs leave public companies and start businesses with their capital and knowledge, and that IPOs are inspirational to other entrepreneurs (and VCs) in a particular town.