Sep 16 2008
Venture Capital Crisis in Southern California?
If you follow the venture market, or if you have recently tried to raise money for an early stage company, you know that there is a serious “funding gap” in the early stage market across the US. By way of background, we believe that raising early rounds of capital has become extremely difficult for a number of reasons. The short story is that the number of funds who are willing (or able) to profitably invest in “Series A” is shrinking. This is happening despite the fact that historically, early stage funds are the best performing funds. The dynamics behind this phenomenon will be the topic for another post.
This summer, we set out to study how this national trend plays out in Southern California. The bad news is that the “funding gap” in our area is even worse than we expected. Consider:
- Southern California has less than 3% of venture capital dollars raised since 2002; amounts raised in Silicon Valley, Boston and New York at 10X, 6X and 5X more respectively.
- One measure of how hard it is to raise money locally is how many venture dollars are available for every start-up that gets funded within a region. In this regard, the story is even worse. Southern California is at the bottom of the barrel with other major markets having at least 2X and as much as 7X more capital ready to deploy into start-ups.
One might argue that there aren’t deals to be done… however, this is not the case. From June 2007 to June 2008 the Southern California region was second only to Silicon Valley in terms of the number of deals done. The issue is that the deals are not being done by local investors! In Southern California in Q1 of 2008:
- 3 out of every 4 dollars invested in venture backed companies came from VCs outside of Southern California.
- Worse yet, almost 9 out of every 10 dollars invested in seed or early stage deals came from outside Southern California.
Some might pose the question, “if the deals get done anyway, why does it matter where the money comes from?” From the perspective of a start-up that actually receives funding, it might not matter. However, consider the following:
- Ask any CEO who has raised funds from outside his own region about his or her experiences. If the company wasn’t required to relocate nearer the investor, they likely faced significant overhead associated with travel and did not benefit from local connections and advice nearly as much as locally funded companies do.
- More important, there is no way to measure who never got funding and gave up. What we do know is that the earlier the round of capital the less likely that outside groups will travel to invest in our region. One can infer from the data that raising money for a start-up in Southern California essentially means that you must look elsewhere for capital. From direct experience, I can tell you that this dramatically reduces the number of start-ups that are likely to get funded.
In this market climate, it is unlikely that this problem will improve. However, it is something that everyone in Southern California should care about whether or not they are an entrepreneur. Entrepreneurs and their companies are the growth engine for our economy and without access to capital they will wither and die; or move elsewhere. Further, given that early stage investing has historically produced very high returns, we are essentially exporting our investment gains to other regions.
Stay tuned for more on the topic and feel free to drop a line for more details on our market study.
