Yesterday I was talking with a local angel investor that had a nice exit this year. One of the comments that came out of the discussion is that the vast majority of capital raised by the successful startup came from the usual money centers (CA, NYC, and Boston). I then pressed why the startup went out of the region to raise capital and the expected response came back: the valuation and terms were much better than local options. VCs outside the Valley play a different game.
Here’s the conundrum for regional venture investors:
- By focusing on deals where they “can’t lose money” and requiring terms like participating preferred, the only entrepreneurs that are going to sign on are the ones that can’t raise money on better terms from the money centers
- Entrepreneurs that can’t raise money from the money centers aren’t as likely to have big exits (see Build a $300 Million Pie So Everyone Can Get a Big Helping) and so the regional funds aren’t going to have outsized returns
- Without outsized returns, regional venture investors will only be able to raise modestly larger funds (assuming still top quartile returns but not top decile), and if they have a fund that does poorly, it’ll either kill the partnership or significantly reduce the size of the next fund
Regional venture investors often follow a playbook that’s geared towards ensuring a return, which limits potentially outsized returns. Only with outsized returns will a regional venture partnership be able to achieve the scale and size found in California and the Northeast.
What else? What are some more thoughts on the conundrum for regional venture investors?