The VC drain: Yes, we’re a big importer of capital too

money-keithcooperAt the Technology Alliance annual luncheon this week in downtown Seattle, industry leaders lamented the sad state of the educational system. Zillow co-founder Rich Barton and Apex Learning CEO Cheryl Vedoe spoke in detail about how Washington state isn’t doing a good job of educating our own students, relying on “imported” talent to fuel the innovation economy.

“Don’t we want those children who grow up here in Washington, our own citizens, to have a fair shot at the jobs that we are creating here?” asked Vedoe.

If you think about startups as school-aged children, the same thing can be said about money.

Washington state startups are a huge importer of capital, in part because they have relatively few options in their backyards. And while this importation of capital may not get as much attention as the failing educational system, it’s a serious problem that has wide-ranging impact on the region and the startup community. And just like education, there’s not a lot being done about it.

I’ve written in the past about my concerns regarding Seattle’s dwindling venture capital community — including the disappearance of firms such as OVP Venture Partners and Frazier Technology Ventures.

When Polaris Venture Partners left town two years ago this month, a partner at the firm said they wanted to seek “a much more fertile place … to fish.” That stung, as did remarks earlier this year when Seattle venture capitalist Cam Myhrvold indicated that the entrepreneurs here weren’t up to snuff when compared to the Valley.

Money wasn’t the problem, he hypothesized, though that statement certainly is open to debate. Are the entrepreneurs really that much better in NYC or Silicon Valley? (Madrona Venture Group, which raised $300 million last year, the largest fund in its history, certainly believes there are good opportunities lurking in the NW).

The reason this topic popped into my mind today is that SoftBank, the venture capital arm of the big Japanese cell phone carrier, just announced a plan to invest $50 million in early-stage startups in … New York City.  It’s a great boost for the Big Apple, adding more fuel to a startup ecosystem that’s already firing under the leadership of an entrepreneurial Mayor and a super-charged VC community.

nyc-capitalNow, as I’ved noted before, I don’t think New York’s tech industry is any stronger than Seattle’s. In fact, I’m hard-pressed to name a NYC-based tech giant on the scale of Amazon.com, Expedia or Microsoft.

But here’s the deal. New York may not have those types of companies now, but they are trying pretty gosh-darned hard to build the next one, and those efforts come, in part, through home-grown capital.

Groundbreaking ideas and sharp entrepreneurs matter, but so does money. And the money has not been flowing in Seattle — at least not from VC firms headquartered here.

For the first time since 1993, Oregon companies raised more venture capital than Washington companies during the first quarter. New York’s haul of $715 million, meanwhile, was more than seven times greater what was raised in Washington state.

New York-based VC firm Union Square Ventures made big money when Tumblr sold to Yahoo for $1.1 billion, and Spark, which just opened an office in New York to track new deals, fared pretty well too, both posting a 15-fold return. Together, Bloomberg News notes that those two firms alone have seven portfolio companies in New York.

vc-trend11Seattle certainly has banked some succeses in recent months — like the blockbuster Tableau initial public offering that now values the maker of data visualization software at nearly $2 billion.

But here’s an interesting thing about Tableau, and many of the other big succeses in Seattle in recent years. The money behind these companies didn’t come from Seattle venture firms. In the case of Tableau, it pulled in cash from NEA and Meritech, two huge Silicon Valley powerhouses.

The same goes for Zillow, whose venture backers included Benchmark Capital and Technology Crossover Ventures. Success stories like PopCap Games — sold to EA for up to $1.2 billion — and DoubleDown Interactive — sold to IGT for up to $500 million — also were largely built without Seattle money.

It’s great that these companies are being built in Seattle, with other people’s money. But relying on imported capital — just like relying on imported brains — isn’t a long-term path to success.

  • dsternsf

    Love to see the what the guys at Founders Co-op could do with $50M in the NW!

  • Bill Bryant

    While Seattle would definitely benefit from our own version of Union Square, from a regional wealth creation it really doesn’t matter where the money came from, just so long as someone somewhere steps up. Take the case of Popcap. Assume that a local Seattle VC had had the perspicacity to invest early and owned 20% of the company at exit. They would have generated $240M….for the primary benefit of their LPs, which are trusts, foundations, pension funds and the like, spread across the county (and even if they are local, its not like a pension fund is re-investing in the local economy – they are paying benefits, and don’t care whether the money came from a Seattle exit or a Timbuktu exit).

    So the general partners of this mythical Seattle firm would have made $48M based on the typical 80:20 split between LPs and GPs. While that is real money and some of it no doubt would be reinvested by the GPs in ways that benefitted the local economy, its not really material relative to the much greater wealth in the hands of the founders and employees of Popcap.

    Again, the fact that these companies were funded by out of state doesn’t really matter. The question is would there be MORE Popcaps if there had a local version of Union Square – would they have backed companies that we haven’t heard of that might later have gone onto great success. I can think of two examples of companies that tried to raise here, were unsuccessful and then went to the Valley to have great sucess (Box, Twilio). Two may be two too many, but my own sense is that the companies that should be funded, are funded, and that angels are increasingly filling in.

    • Thomas R.

      I agree with you regarding most of the proceeds of a successful exit benefiting the LPs, who are spread all across the country. But what about the CEOs and senior executives? They’re local, why aren’t they reinvesting in the startup ecosystem here?

      • johnhcook

        Good stuff Bill. My point is that if there’s more risk capital available in our backyards it is a good thing. We all know how challenging it is for VCs to hop on planes to do deals, choosing instead to partner and work with companies in a 50-mile radius. I’d say that the truly exceptional companies will get funding, and VCs will travel for them.

        That said, at the same time, there’s a shrinking pool of sources of capital in the region. That’s due in part to the changing dynamics in VC, but it doesn’t seem like a positive trend line. You can count the # of active VCs in the region on one hand.

        Also, I am just surprised by the numbers. The deal flow would suggest that there’s more than triple the entrepreneurial talent in NYC when compared to Seattle.

        Based on history, you can actually make a far better case that disruptive and ground-breaking companies are coming out of Seattle — Zillow, Expedia, Microsoft, Amazon, Isilon, Tableau, etc.

        I’d take the lineup in Seattle any day over NYC. Yet, there is this total imbalance in capital. I guess you could argue that there are more people in NYC, and therefore more entrepreneurs. But, going back in history, the two regions actually were far closer in terms of VC. But NYC took off, and Seattle, well, just look at the numbers.

        I guess I am trying to make sense of that.

        Now, granted, some of that money going into NYC startups is going to go into really, really bad investments that tank. But at least it is flowing.

        And, really, at the end of the day, we don’t know which of the companies could break out and reach that next milestone or go onto bigger success if they had a bit more fuel in the tank.

        I think a $50 million seed/early-stage fund in Seattle would be a really nice addition to the community.

        • Thomas R.

          Just curious, John what startups would you invest in if you could? It would be interesting to see how your hypothetical portfolio would stack up against some VCs.

          • johnhcook

            Now, that would be interesting, and something that would likely be disastrous. I am a terrible investor. :) That said, I tend to like the bootstrappy non-VC route, though those companies aren’t typically on the home run path that many VCs look for.

    • Pioneer Square Ventures

      If you asked Bay area founders what would happen if all the VC’s on Sand Hill Road up and moved to Pioneer Sqaure, I’m guessing they would not like that and there would be fewer Bay area hits and a surge in Seattle hits in the long term. Thoughts?

  • Carl Wester
  • Rich Barton

    Based on the highly anecdotal data of # of entrepreneurs that flow through my office, the offices of the Second Avenue Partners guys 2 floors down from me, and the density of pitches i see happening at Cafe Fonte across the street from my building, i’d say seed stage coding and pitching is alive and well here in the Emerald City. The talent and money corridor between the bay area and Seattle is fast and wide and very well used. Most of the people I work with here in Seattle (and in the bay area, actually) have cruised this corridor. Most of the money I have raised for various companies has also made this trip (though, i’ll correct you from above and remind you that the first $6m into Zillow came from the founding team, which was local, not imported). Anyway, instead of being the insecure and potentially annoying little brother to our kick-ass big brother down south, perhaps we should ask what more we can do for him so that he continues to take good care of us and invites us to all those killer parties that i know are happening over the next decade…

    • johnhcook

      Hi Rich. I don’t think there’s a shortage of entrepreneurial activity in Seattle, just a lack of risk capital for these companies. I think a home-grown VC/angel ecosystem, or at least a stronger one, would be much welcome news for the region. And I really don’t think it would take much — 2 new independent $50M funds could really add a lot of horsepower here.

  • John Pollard

    There was a cool poster/graphic floating around in ~2006 that showed the startup diaspora in the Seattle area…Expedia, Microsoft, Amazon, Real etc. being major hubs, and the various companies that sprung from them. It’d be interesting to see that updated, and maybe color coded to get a sense of whether there really is weakening of the pace here.

  • Bill Bryant

    The implication of the last comment is that somehow the supply of venture capital is the causal factor – that if we somehow say doubled the amount of venture capital available to invest, that somehow we’d double the outcomes.

    What is in scarce supply is not capital. Its not ideas. Its great entrepreneurs. VC is not the tail wagging the dog. It follows entrepreneurs pursuing their ideas.