After taking in a number of questions from my readers and the attendees at VC in the OC a couple of weeks ago, I thought I’d post a short note and invite all of you to respond with the types of information you’d like to see me post on OC VC.  So, do you feel you are  included in OC’s emerging start-up community…excluded…or just secluded?  Now’s the time to speak up… Either way, please write in with your thoughts (no spam, please).

As a Side Bar, I’d  like to publicly thank Scott Santagata / Dorsey & Whitney for their hospitality the other night at the Angels’ game.  Networking with other VCs, attorneys, and entrepreneurs over beers and hot dogs while watching the Angels is hard to beat!

I had the honor and privilege of moderating a panel of SoCal VCs at Wednesday’s VC in the OC event and thought I’d summarize the answers here for those of you who either didn’t attend, didn’t take notes, or didn’t have enough coffee to remember. Prior to the event, I collected questions from the registrants through the registration process and directly through my blog and email. I then added my own questions and spent some time with the panel going through them prior to our session. What follows are the most frequent questions I received along with the categories they fell into during the session. If you have questions that didn’t get answered, feel free to submit them to me and I’ll do my best to get back to you with a timely answer. I also strongly encourage you to visit Ask the VC as well as Brad and Jason have done an excellent job with the questions and answers they post.

Industry Stats & Trends

Q: What investment sectors are hot for investment?

A: The general sentiment here was that most VCs don’t chase “hot sectors”. Rather, most VCs look for and fund companies capable of becoming large sustainable companies in a particular sector by solving some critical problem within that sector in a manner that is faster / better /cheaper (it varies here) and/or disrupts the sector in such a way so as to have a competitive advantage within that sector relative to others in that sector. Sectors become “hot” when large numbers of companies recognize an opportunity within a sector and attempt to exploit it for their (and their investors’) economic gain.

Q: Relative to the rest of the U.S., how is Southern California doing in terms of venture investments?

A: SoCal is doing very well and is now the #2 region in the U.S. for venture investment (see Mark Heesen’s slides below). Within just the first half of 2007 in Orange County, VCs invested $327M in 31 companies according the the NVCA/PWC/Thompson data.

Q: Where do you think the venture industry is heading in the next few years - nationally and locally?

A: The venture industry “peaked” several years ago in terms of VC funds and the total capital under management. As most folks predicted, there are significantly fewer VC funds these days (almost half as many) but the total capital under management did not decrease correspondingly. Thus, the average fund size has increased considerably and many funds migrated to the later stages a few years back. This was partly due to the large fund sizes (necessitating larger and, therefore, later stage deals) and partly due to where most funds were in their fund life cycles (see my previous post on the topic by clicking here). The lower interest rates and credit markets caused an institutional shift from venture capital to buy-out by the limited partners within the alternative asset class but we may see a shift back over the next couple of years in light of the current market environment. Locally, the breadth and depth of the SoCal economy and recent trends suggest that SoCal becomes and even larger region for venture investment.

VC Basics

Q: What do VCs look for in a company?

A: While different VCs / funds have different criteria, most look for the following elements to one degree or another: 1) strong management team; 2) addressing a large and growing market; 3) have a distinct competitive advantage and/or defensible IP; 4) and are in a particular sector that VC / fund has an interest and/or background in for diligence purposes.

Q: What 2 or 3 things can entrepreneurs not hear enough of?

A: The panelists all had different answers here but all agreed that 1) entrepreneurs should do their homework and only target VCs that are investing in their particular sector and at their company’s stage of development; 2) be flexible to the possibility that the company may need to bring in other expertise to run the company at one point; and 3) while they do give advice to the CEO and company, boards of directors are there to govern the company not as an advisory board.

Q: Why don’t VCs sign NDAs?

A: The short answer here is an inability and unwillingness to compartmentalize. VCs see hundreds (in some cases thousands) of companies a year and many of them are almost identical in terms of their products, services, or targeted markets. As most non-disclosure agreements (”NDAs”) contain use restrictions on how the information received thereunder is treated, it’s not pragmatic (to say the least) to sign such agreements. In fact, entrepreneurs lose credibility when asking VCs to sign them. Having said that, most investment docs do contain confidentiality clauses so it’s not that VCs don’t sign NDAs…it’s just that they only sign them when they make an investment in the company.

Local Dynamics

Q: Do VCs only invest locally?

A: The short answer here is not really. You can see my post “Location, Location, Location” below for a more detailed explanation. All of the panelists invest across the SoCal venture landscape and some even invest outside SoCal. In fact, both Versant Ventures and Palomar Ventures have offices in Silicon Valley.

Q: Is there a difference between the L.A., Orange County, and San Diego areas in terms of venture investments?

A: It depends on who you ask. Locally, there does seem to be a real difference between the sub-regions based on which sectors are strong where and the logistics of operating in each sub-region. Outside SoCal, most if not all consider SoCal one region… just as Silicon Valley encompasses the San Jose, San Francisco, and East Bay areas in terms of venture investments. The L.A. area has a much stronger concentration of digital media and consumer internet activity given its roots in the entertainment industry. Orange County is particularly strong for medical devices and analog / mixed-signal semiconductors. San Diego has a core competency in wireless and biotech.

Q: Do you work with out-of-area funds when making investments?

A: Absolutely. Some ~80% of dollars invested in SoCal come from outside the region and most funds want to syndicate with a local fund so as to have “feet on the street” in terms of governing their joint investment. In some cases, local funds look to outside funds to syndicate with and in other cases outside funds pull in local funds.

Personal

Q: What has been your proudest moment being a VC?

A: Most answered this question by citing an example of when one of their portfolio companies had a liquidity event - either by being acquired or by going public. The sentiment being that it feels very good to see hard work rewarded. Remember, VCs are in the business of such liquidty events not to just fund companies in general.
Q: How does one become a VC?

A: The answer here is that there isn’t a “one size fits all answer” as VCs come from all different backgrounds and walks of life. I do, however, think that the venture profession is one that finds you rather than you finding it. Most VCs I know (myself included) where pulled into the profession by other VCs and/or limited partners after having had a successful career in a related profession that others felt would translate well to success as a VC.

Well, we had another sold out VC in the OC with 500+ registered attendees. Mark Heesen, President of the NVCA kicked us off with an excellent keynote and he has graciously allowed me to share his presentation with all of you so you can check it out below. After the keynote, I moderated a panel of SoCal VCs that included Randy Lunn, Leo Spiegel, Charles Warden, and Bob Holman. I will post a summary of our Q&A session in a separate post tomorrow after I’ve had a chance to reconcile my notes. Until then, enjoy Mark’s presentation below.

I spent last week in NYC for a board meeting and decided to abandon any thoughts of travel for the Labor Day Weekend and just stay home.  While speaking with a neighbor of mine about an idea he has, I started thinking about conversations I had with the neighbors I had during my “official ‘Valley tour” several years back…  You see, much has been said and written about VCs not investing outside of their proverbial backyards so I thought I would address the matter here in light of next week’s VC in the OC and the seemingly recent shift in VC investment dollars to SoCal to the extent that I’m a SoCal VC.  So, is it true that VCs only invest in companies near their offices?

I think the answer to the question is a bit complicated.  Historically, VCs have certainly invested a majority of their capital into companies in their geographic regions for a number of simple reasons.

 Reason # 1: Personal networks tend to be local

Most VCs back entrepreneurs they have a direct, personal relationship with…or folks that they know “once removed” through a close, personal, trusted deal source.  It stands to reason that most of these relationships occur locally either through prior careers (most VCs have had more than one and most were significantly relevant to being a VC), their alma maters, church, kids’ schools, neighborhood, etc.  Similarly, VCs “trusted service providers / deal sources” tend to also be local and, not surprisingly, refer folks to the VCs that they themselves know locally.  There are a number of reasons Silicon Valley is Silicon Valley and one of them is what I’ll euphemistically refer to as “the perpetuity of location”— the continued success of its VC ecosystem continuing to support this theory.

 Reason #2: The logic of local logistics

“Return on Time” is a mantra you learn early as a VC as there simply aren’t enough hours in any given day to sort through all the myriad of deals that come your way.  Thus, deals tend to get done locally as it is far more efficient and convenient to invest in a company you can simply hop into your car and go visit.  The earlier the stage of investor the VC is, the more time he or she will spend with their portfolio company helping to build it.  There are regular and irregular board meetings, interviewing management candidates, finding suitable and affordable office space, and a whole bunch of other things that need to get done early on in a company’s life and it is just easier to help with these matters if the company is local.

 Rule #3: Tech transfer has been short-distance

Over the past several decades, a significant number of venture backed companies have spun out of universities and research institutes.  The spinning-out of these companies has historically been a “local” endeavor such that the folks involved in such spin-out, whether as founder, investor, attorney, etc., have been geographically near the university.  It’s arguably less true these days than it has been historically, but it still remains true enough to mention here.

Reason #4: See reason 1 and 2 above

The fact that most VCs have historically operated while subscribing to the first two reasons I cite tended to perpetuate the cliché as entrepreneurs will typically (if not always) approach their local VCs before seeking capital from a fund in another geographical region.  The first two reasons are also applicable to entrepreneurs as well.

So, does this mean that it is in fact true that VCs only invest in local companies?  No.  While the reasons for doing so remain valid, globalization has changed things significantly and VCs are much more willing and able to invest in companies outside their geographical region.  For example, I spent 10-15 nights a month not only outside the area but outside the country in places like Russia, China, India, Germany, and South America and, while I developed professional and personal relationships in these places, it would be inherently more difficult to do deals in these regions from afar.  In fact, most U.S. based venture funds doing deals in these foreign regions are actually doing so from that region through a parallel fund structure and utilize/employ local people to make such investments.  In addition to globalization, “nationalization” has also occurred within the past decade or two such that one can now find pockets of VCs and start-ups in most of the major regions within the U.S.  If there is a lesson here in all this, I guess it would be that the “think globally but act locally” adage has a least one more meaning for me these days.  I hope you had a great Labor Day Weekend and look forward to seeing many of you next week when we discuss our own local endeavors.