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.
