Empowering Excluded Investors
This is Part 2 of 3 in a series on Global Startup Success
If you haven’t already, read Part 1 “Consistent Funding is the Necessary Element for a Startup Ecosystem”
In the absence of the complete funding infrastructure found in Silicon Valley and a few other geographic locations like New York, Boston, China, and India, where major firms invest, startups face a Valley of Death once they reach the growth stage. The most promising companies in the few places like Silicon Valley are generally able to connect to name-brand investors, ensuring a consistent pipeline of investment. The seamless network of investors and associated mentors, advisors and other ecosystem participants is a large reason for the success of these funded companies in these locations. Being part of the club dramatically increases the likelihood of a startup’s success.
What is less well understood is the exclusivity of that funding and support infrastructure. With rare exceptions, the best Valley venture capitalists and angels are the backbone of the networked community, and have no need to raise capital from new investors or external investment groups. Investors interested in startup investment that are located outside these networks are excluded from investing in these promising companies.
Consequently, investors not already plugged into the Valley A-list VCs are not getting the returns they should. Seeming opportunities like Demo Days are an illusion — companies still needing funding on demo day are unlikely to have high potential. Demo days are inventory clearance sales. The vast majority of companies on offer at a demo are unlikely to ever post meaningful returns. Similarly, the hundreds of second- and third-tier funds exist to fund weak copycats and to invest in later rounds of the winners when the ROI is marginal. Joining these funds is similarly a high risk investment with little chance of an outsized return.
It is unfortunate that the real ROIs of most VC, angel groups and microVC funds are unavailable. I have long suspected that outside the clear winners like Sequoia, Benchmark, Andreessen Horowitz, Lightspeed, First Round, Founders, Baseline, Greylock, Union Square, etc., say the top 25, most funds and firms are moderate performers at best. Most have an ROI that does not justify the risk investors are taking, because the system isn’t any longer founded on accurate judgment of potential winners. Instead, potential winners gravitate to the best firms (with the caveat that those firms earned their track-records by being consistently talented selectors in the beginning).
Where does this leave individual investors, small institutions and unconnected angel pools? The best place for them to invest is in their local regions. There, they are likely to be well connected, have expertise in the industry that startups are targeting, able to perform due diligence, and to be able to effectively manage the investment by close contact. The problem here, generally, there are limited investment opportunities in smaller regions outside the main startup ecosystems, making it difficult to diversify high risk investments.
But given the insights I’ve outlined above, companies not in the Silicon Valley region or its few competitors generally are not seen by the best firms (notwithstanding the effort some of the larger firms have made to establish beachheads in places like China, Europe, and India). So there are a wealth of excellent founders, startups, and products outside these major startup regions that are desperate for investment and have potentially high risk-to-reward.
The question is, how to identify them? How to get the data needed to vet them, and how to connect and invest? This is where ExtraVallis comes in, and will be discussed in our next post, “A Global Funding Ecosystem”.