The Venture Capital Stack + Regional Seed VC

I’ve been repeating myself more than usual, which is usually a sign that I need to write something down…

I’ve written before about the valuation stack in venture capital (or how a startup is like a t-shirt), and more recently on how institutional LPs view regionally-focused managers. This piece ties those two ideas together to shed light on how the regional VC opportunity connects (or doesn’t) to the broader capital market for tech innovation.

First, an observation: despite increasingly liquid global capital flows, capital markets are highly geographically concentrated; Wall Street is the North American hub for public securities, debt and derivatives; Sand Hill Road is the North American hub for private capital allocation to technology innovation. Yes, there are fantastic exceptions – like Foundry Group in Boulder – that mostly prove the rule, and thrive in part due to their deep connections to investors in the major money centers.

That last point sets up my next one: geographically distributed innovation centers can thrive if and only if they understand their position in, and points of connection to, the venture capital “stack”. Put another way, you can build a venture-scale company anywhere, as long as you have a realistic plan for how to attach your local opportunity to the global capital markets for innovation. Even if you’re successful at raising your first few rounds of capital locally, there are vanishingly few growth capital sources for tech innovation that don’t flow through San Francisco or New York.

The default solution for high-performing founders used to be to move themselves and their teams to the money center, shortening the path between innovation and capital. But the last decade has produced strong evidence that globally significant technology companies can actually be built in lots of places, not just the ones where money tends to pool. Global innovation platforms like Techstars (disclosure: I run Techstars Seattle) and 500 Startups have leaned into this opportunity, creating deeply-networked platforms to help entrepreneurs succeed wherever they are.

But there is a dangerous illusion in extending the logic of increasingly distributed innovation activity to assume that innovation finance is sure to follow. Despite its outsized media presence, the venture capital industry is a tiny one. Investing in risky and highly illiquid securities based on limited information requires a high degree of trust, and trust is mostly transmitted the old-fashioned way: through close personal relationships developed over time.

We should not expect to see a new, robust, full-stack innovation finance function emerge anywhere in North America outside of San Francisco and New York.

If you accept that premise, then the most important financing question for founders operating outside the major money centers is when and how to begin building bridges to those markets.

Because nearly all high-growth companies eventually make their way to money-center funding markets, most investors in those markets feel comfortable waiting for out-of-region opportunities to come to them; the potential cost of missing the occasional deal is far outweighed by the brutally low survival rate of very early stage companies in any market.

But as competition in money center markets intensifies (through new firm formation + accelerating global capital flows into the venture asset class), a growing number of firms are willing to look outside their home markets to get first look at up-and-coming investment opportunities.

As a self-taught venture investor in one of the world’s great cities for innovation (Seattle), but outside the major money centers for innovation finance, I’ve spent the past decade learning how to navigate these dynamics to create the best possible outcomes for the founding teams I back and the LPs whose money I invest. Here are my most important lessons from the past 10 years:

  • Fill the right hole. The capital markets gap between money center markets and everywhere else is most acute at the earliest stages (pre-seed and seed, in current parlance). The smaller / less-proven the market, the more likely money center investors are to wait until Series A or B before investing there. Courageous early-stage investors are sometimes willing to prospect for riskier deals in the biggest second-tier markets (cities like Austin, Seattle and Los Angeles), but generally prefer to work in syndication with a local partner. If you want to build a strong, defensible investing platform in a second-tier market, focus on the earliest stages of the venture stack.
  • Make friends early. If you live outside the money center markets, you will inevitably need friends and allies in those markets. Build those relationships early by inviting out-of-region investors into your deals. Share information and deal-flow freely with firms that show a genuine interest in supporting your market, and help local founders make out-of-region investor connections even in deals that aren’t a fit for your firm.
  • Play the long game.The typical venture fund has a 10-year life, and the best franchises go on for decades. GPs have to stay in business for many years – through good times and bad – to generate the kind of returns that keep founders and investors coming back for more. If you want great investors to allocate time and money to your market, don’t over-optimize on individual deals or rounds, but treat everyone you work with like a trusted partner that you want to work with for the rest of your career. What you lose in short-term benefit you’ll gain ten times over in repeat buyer relationships that bring your market closer to the money center without moving an inch.

I’ve bet my investing career on the premise that the Pacific Northwest will continue to produce investment returns like the ones that early investors in Microsoft, Amazon and Starbucks enjoyed. But I’m also certain that the growth capital for those opportunities will mostly come from outside the region. My mission in life is to help the best founders here build the kind of companies that the best investors anywhere would kill to invest in. It’s not always easy, but it’s the most fun I’ve ever had.