Austin’s VC Scene Leads Texas, But Startups May Start Looking Elsewhere for Funding

Mar 14, 2016

There’s a big debate happening among Austin entrepreneurs over venture capital in the city – specifically, whether there is enough venture capital flowing into the city’s startups. It’s a debate that could reshape Austin’s identity – or, maybe it’s a debate because of Austin’s identity.

    

Last year Austin was named the top startup environment in the nation by the Kauffman Foundation. The year before that, it was No. 2.

That successful environment wouldn’t be possible without an active investment community ready to pour cash into what could be the next big thing.

The Austin Chamber of Commerce estimates that in 2014, $620 million in venture capital flowed through the city’s startups. A lot of money, but it ranks well behind cities that Austin might consider its tech peers, like Seattle, Los Angeles, Boston, New York and Silicon Valley.

So does Austin need more money to keep its startup environment successful?

What is venture capital?

There are tiers to investing in new companies, and all come with their own strings. At the very beginning, entrepreneurs will use personal savings, credit or rely on family and friends. This is a relatively small amount of money in the thousands. Assuming it grows, the business moves to the seed level, where angel investors may pump in hundreds of thousands of dollars, allowing the business to thrive.

The next step is where the big money comes in – that’s the venture capital, or VC. These are funds pooled from institutional investors, like pensions and high-net-worth individuals. On this tier, we’re talking millions of dollars – but this is not a lottery. The funds make investments with substantial risk, usually in new or rapidly expanding businesses, hoping for a big payday in the end.

Fund managers are targeting 20 percent yield over about a decade and will make most, if not all, of their money from only 20 percent of the companies. Running a venture capital firm is like betting on every couple at the prom to be married in 10 years: Most won’t, but the payout on the ones that do makes up for all the losses.

The problem

There’s been a lot said and written lately by entrepreneurs in Austin about how there is not enough venture capital to support its startup scene. Is that actually the case? Richard Bagdonas, chief healthcare architect at Austin-based MI7, has been launching companies since the ‘80s, and in Austin since the ‘90s. He says Austin fundraising has descended into the Dark Ages.

“There’s an imbalance on the number of investors, the amount of capital that’s being invested in Austin, compared with the number of startups that have begun over the last few years. So, I believe we’re in the Dark Ages of venture capital here in Austin, and I look forward to moving into more of a Renaissance period.”

And some entrepreneurs like Joah Spearman, the co-founder and CEO of Localeur, say they may have to move their companies. Localeur is an app that wants you to live and travel like a local, giving you the what’s-what on where to go in major cities based on reviews from residents of those cities. Spearman says the company has hit the requisite benchmarks of number of users and cities where it operates. He says much of the venture capital interest in Localeur is coming from non-locals.

“I’ve pitched the Austin VC firms already … some of them have told us that we need to get a Silicon Valley firm to invest in us first in order for them to invest, and some of them have not even been willing to hear our full pitch,” Spearman says. He’s going to pitch in Silicon Valley this spring.

But isn't Austin supposed to be the hub of tech entrepreneurship? Where did all of that money go? Did it just leave?

At the Capital Factory offices in Austin.
Credit Miguel Gutierrez Jr. for KUT News

The void

For more than 30 years, the king of venture capital in Austin was the aptly named Austin Ventures, which specialized in local startups. Austin Ventures raised nearly $4 billion, turning startups like HomeAway into household names. According to Fortune Magazine, $900 million was raised just eight years ago for its tenth fund. Attempts to raise an 11th fund recently were unsuccessful, and now its partners have splintered into other pursuits. Austin Ventures still exists, but it’s effectively managing its portfolio of companies into exits. 

Its departure from the market may be what is sounding the alarm. But like any vacuum, another fund, or funds, will fill it.

Aglomeration

Michelle Skelding leads the Global Tech and Innovation team at the Austin Chamber of Commerce. She says despite the doom and gloom , there have already been $150 million in deals this year.

“This year, we are off to a very strong start again, so overall compared to 2001, we’ve had the strongest three years and the start for this year than ever before,” she says.

And it’s not just Austin tooting its horn: Rice University just released a study this week saying Austin leads all other Texas cities for venture-capital in the state.

Ed Egan is a fellow with Rice University’s Baker Institute and Director of the McNair Center for Entrepreneurship and Innovation. He says Austin’s recent success is because of aglomeration – a big SAT word that means everything is lumped together in big clusters, or as some like to put it, entrepreneurship hubs.

“These are co-working spaces with an accelerator built in, sort of a training program, where a whole bunch of startups will get together and rent flex space. Sometimes you’ll get 400 or 500 startups in a single place. As this thing grows and as startups mature and leave, they tend to leave straight into the buildings around the accelerator. The VCs turn up there, too. And that’s really what happened around the Capital Factory.”

At an Ask Me Anything event at the Capital Factory, founder and executive director Joshua Baer held court in front of a room packed with small business owners. The topic? “Intro to Fundraising.”

The level of money he’s talking about is a far cry from the millions that would come from VC sources, but the talent and investor network generated now could take them that next level.

There’s another undercurrent running through the startup community. Austin entrepreneurs may fall victim to the lifestyle the city is famous for, and consequently may curb their ambitions on what exactly they’re hoping to do in life. After all, it’s Austin.

“I’ve heard some VCs say, ‘Oh, those Austin people, they’ll build up the business until it’s worth about $50 million, then they’ll sell it and go buy a house on the lake and retire.’ And probably to a lot of people in Austin that sounds like a pretty good plan. That doesn’t sound so bad," Baer says. "But, to a venture capitalist, $50 million for most of those companies, that’s not enough. They want to see you to take that much further. They want you to be more ambitious. What’s going to attract venture capital in particular, which is what people are complaining about, is they need to see people shooting for the stars. They want to see Elon Musks. They want to see Mark Zuckerbergs. They want to see people that are really pushing it all the way."

The market

Brian Sharples, CEO of HomeAway, says much of the complaining could be a generational thing.

“We have now, more than ever, a lot of pretty young, inexperienced people starting businesses, having this expectation that people are going to throw lots of money at them. But the reality is that the top VC folks now look at people with experience.” 

But what do the VCs think? Mike Maples used to live in Austin and helped take a couple of companies public. He moved out to Palo Alto 11 years ago and co-founded Floodgate, a venture capital firm.

He sees no issues in Austin’s VC market.

“I would say it’s roughly right-sized for the amount of entrepreneurial activity. More money is always better for entrepreneurs. So if there was more money and more choices and more smart people investing, that would be a good thing. But I don’t think Austin has a critical lack of capital that will impede its growth in the long term.”

Carlos Del Rio is on the other end of the spectrum. The founder of SceneCheck is just beginning his fundraising push. He’s undaunted by the investor climate, however you might characterize it.

“It’s a little conservative, but you know, it’s Texas. It’s still encouraging. Everybody wants you to succeed. That’s the great thing about Austin.”