For many investors, the coronavirus has effectively taken geography out of the equation when it comes to vetting new opportunities.
While this dynamic opens up startups to more investment opportunities, venture capital firms that focus on a specific region are in a thornier spot. The competitive advantage they once had when raising — the notion that they’re focused on an area no one else is — is potentially threatened.
Natasha Mascarenhas, Danny Crichton and Alex Wilhelm of the TechCrunch Equity crew discussed the future of geographicically-focused funds given the uptick of remote investing:
- Natasha: Early-stage regional funds can win if they remain focused
- Alex: Geo-focused venture funds will be weakened, but won’t die
- Danny: Geo-focused venture funds are dead (and should never have existed)
Natasha: Early-stage regional funds can win if they remain focused
Since 2014, Steve Case and his team have made an annual bus trip across the country to meet startups in emerging startup hubs. Five days, five cities and at least $500,000 of investment dollars given to startups. Case would even offer to fly out promising and hard-to-reach startups to have them join the trip.
The Rise of the Rest fund, with more than $300 million in assets under management, has invested in over 130 startups across 70 cities, including Austin, Chicago, Detroit, Los Angeles, New Orleans and Washington, D.C.
The tour was canceled this year; a bus tour feels a bit like that thing we nostalgically sigh at from the Before Times. The coronavirus has allowed any investor to effectively become their own mini-Rise of the Rest fund, investing beyond their backyards since Zoom makes everyone the same distance away.
But I don’t think this temporary taste bud means geographically focused funds are completely squashed. In fact, I think that this time period just emphasizes the true competitive advantage of geo-focused funds: outward (and loud) explicitness that a team is interested in a specific local ecosystem.
I believe seed and early-stage startups are enjoying the sudden interest from big-name firms realizing they can invest virtually. I also think that these same startups will want a local partner and champion when it comes down to their early first checks. A San Francisco-based VC I talked to yesterday told me that he’s still winning deals by physically going for socially distant walks and picnics. At the end of the day, he argued, a competitive deal might only be won by the partners that show up for the team. Literally.
The future of geographic investment depends largely on founders, not journalists. But my guess is that big names will continue to woo local startups into giving some of that sweet, sweet equity, but after a while, they might get bored and resort back to their backyards. Local investors will continue to be necessary pipelines.
And sure, while a fund like Rise of the Rest no longer has the same pitch as it did pre-COVID, I have a feeling that Case isn’t struggling to get into deals. It’s all about the explicitness of the mission.
Alex: Geo-focused venture funds will be weakened, but won’t die
If I was writing a tweet, it would be easy to write that “the geo-focused fund is totes kaput,” and simply sit back and collect my likes and retweets. But it wouldn’t be true, even if the tweet would have contained a kernel of truth.
In the new world of ubiquitous video-chat and investors cutting checks with increasing abandon to companies around the world, it’s simple to presume that geo-focused funds will lose out to the bigger, more famous funds that can swoop in with a bigger brand and maybe a bigger check and, ta-da, take over the best deal flow.
And that will happen to some degree; a16z money spends well in Chicago and Boston and Austin and New York City. But some is not all, and the Stanford boys will not conquer all.
Here’s why. First, talent spotting is much harder when you are three time zones away. And if you can’t spot talent, you will miss the formation of new startups. Startups that you can invest in. This could mean that geo-focused funds trend even earlier-stage in the future. I don’t know.
And, second, relationships matter. It’s easy to presume that everyone is driven strictly by access to more famous money, but I don’t think that’s true. Founders have heard stories of VCs gone bad — we all have — and thus having a bit of trust with someone that you’ve known locally for a while will have some play.
This is not to say that more VCs being more willing to invest outside of their backyard means that geo-focused funds are going to be as strong as they once were. But to write them off is to make the same mistake, in my view, as folks who have decided that offices are over. Namely, reading a trend accurately, and then overstating the conclusion. Offices are not dead, but they are going to change and lose some of their former luster.
So it will go with geo-focused funds.
One more thing. Don’t think for a minute that VCs are going to stay so willing to write checks over Zoom. They won’t. They are going right back to summoning folks to their offices when they can. Because they can. And so they will. And that will leave even more room for geo-focused funds to kick butt in their local markets.
Danny: Geo-focused venture funds are dead (and should never have existed)
Venture capital is an irrational business. Venture firms and their managing partners take huge risks betting on often inexperienced founders, and despite tens of thousands of investment data points and decades of benchmark history, performance in the asset class remains just slightly above a hungry monkey throwing banana darts at an associate’s market map.
Alex’s freshwater alma mater proved that free markets are rational and efficient, but there was nothing rational about the geographical dispersion of venture firms and their investments. Investors predominantly bet on startups located close to their offices, and as a consequence, founders felt compelled to relocate from smaller cities to the vital hubs of the Bay Area, New York City and Boston. That pattern loosened in the last five years or so as investors struggled to win deals given ever keener local competition, but the basic investment concentration in major startup hubs continued.
That narrow-mindedness offered an arbitrage opportunity for venture funds that were geographically focused. The idea was simple: VCs in Silicon Valley and New York wouldn’t make the trek to cities like Atlanta, or Austin, or Toronto, or at the least, wouldn’t make the trek often enough to scour those markets for interesting startups. Local investors who were deeply embedded in the scene could beat those distant firms with earlier term sheets at lower valuations — and then could acquire a quick markup when the coastal investment firms came shortly after and executed a follow-on round.
Like all arbitrage opportunities, though, in a free market, the arb eventually whittles away. More and more firms raised in smaller cities, adding more capital to weaker startup ecosystems that couldn’t possibly take the level of investment dollars targeting local companies. The big funds also became more flexible about geography over time, investing earlier and earlier in non-hub cities and outflanking the local firms, who couldn’t offer Valley valuations and make their economics work.
Then COVID-19 hit, and the thesis met a rapid demise via Zoom.
VCs are now scattered throughout the United States. The geographical fundraise advantages of being located near South Park or Broadway evaporated, and startups across the country have near-instant access to the best funds that will take their meetings. They say that on the internet, no one knows you’re a dog, and when in a Zoom pitch meeting, no one knows you’re in Kansas. Distance (speaking domestically here — international investments are more complicated) no longer matters.
It should never have mattered before, of course, but then, sometimes idiots Harvard Business grads need a global pandemic to prove that they can actually do their jobs in novel ways. The arbitrage that existed for geographical-focused venture funds is gone, and there is now functionally a nationwide market for VC investments compared to the archipelago of local regions that existed before.
There is still room for the absolute earliest capital in these regions, accelerators and pre-PMF funds that will invest in founders with no idea for a startup yet. For all other funds larger than a few million though, the transition is clear: they will likely build upon a successful portfolio company or an area of interest and become vertical-focused. The knowledge arbitrage for an industry vertical is much more defensible than knowledge that the 279 should be avoided at certain times of the day in downtown Pittsburgh or that Tomukun is the best Korean BBQ in Ann Arbor.
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