By Lydia DePillis
WWR Article Summary (tl;dr) Venture capital has become increasingly concentrated in Silicon Valley, Los Angeles, New York, and Boston. According to the National Venture Capital Association, this leaves only 22.2 percent of the total for the rest of the country. Cities like Houston, are trying to figure out what can be done to raise capital and keep promising start-ups in their city.
One of the biggest ingredients local tech startups need to thrive is cash — usually in the form of venture capital — at the point when they’re trying to firm up their business models and acquire customers. Houston, as we’ve discussed, hasn’t fared well in that regard. So, what to do about it?
For now, it seems that the best chance Houston has is teaching local people with money how to invest in startups, and convincing them that it would be worth their while.
Wealthy individuals who back new companies are known as angel investors.
Houston isn’t the only city feeling a cash crunch. Venture capital has become increasingly concentrated in Silicon Valley, Los Angeles, New York, and Boston, leaving only 22.2 percent of the total for the rest of the country in 2015 — down from 48.6 percent in 2005, according to the National Venture Capital Association.
Here’s the tough part: Attracting investment is a supply and a demand issue at the same time. You need capital to fund the startups, but it’s hard to get investors’ attention without a critical mass of startups.
Members of Houston’s innovation ecosystem place different degrees of emphasis on different sides of that chicken-and-egg problem.
“When you get the right entrepreneurial activity happening on the ground here, the money will be found,” says Rakesh Agrawal, a local angel investor who founded a video clipping company called Snapstream. “If we had a dozen really great deals, not to say that they would all succeed, but we could go around to our networks and find money for them.”
Supporting Agrawal’s point of view, it’s possible to rattle off a long list of startups that have found money locally (or elsewhere) and are still around: The cloud manufacturing platform Macrofab, a tool for financial asset managers called Harvest, and perhaps most notably the IT security provider AlertLogic.
Too often, however, the best startups tend to leave for more fertile funding territory — where venture capitalists are willing to invest on terms that make their companies worth more — keeping the pipeline perpetually leaky.
“Unfortunately, it keeps happening,” says Juliana Garaizar, managing director of the Houston Angel Network, a group of investors who provide small amounts of cash to new companies before they’re ready for venture capital. About a third of the nearly 300 companies HAN has backed since 2004 have left, seeking both funding and developer talent. “Normally they are the most promising ones,” Garaizar adds.
“Promise” can be a hard thing to recognize. Houston’s investors tend to demand substantial real traction — customers, patents, name recognition — before they write checks, while those in the richest venture capital environments are willing to take more risk.
Bala Raja, a PhD chemical engineer who moved from Houston to Silicon Valley after his app-based medical diagnostic startup was accepted into the highest-profile accelerator in the country, says Texas investors turned him down constantly. He understands why: As a first-time entrepreneur, he doesn’t have the kind of track record yet that inspires confidence.
Funders in Silicon Valley, on the other hand, are willing to take a chance on crazy ideas if they find them compelling. “One of our investors has invested in a startup that only works if they can realign the laws of physics,” Raja says, by way of illustration.
To spawn and hold onto more tech startups, Houston will either have to attract more venture capital from the coasts, or gin it up locally. To that end, Doug Erwin, chairman of a local venture firm called RedHouse, is talking up a Texas-wide fund that could give investors in San Antonio and Dallas more access to startups in Houston and Austin and vice versa. “You’re spreading the good deals around, so everybody gets a piece of it,” Erwin says.
John Reale, the CEO of the one-year-old startup accelerator Station Houston, is designing an education program that will allow local rich people to invest alongside professional venture firms like Houston-based Mercury Fund. Cities like New York have seen some success doing that, with investors teaching each other other the ropes until the ecosystem reached critical mass.
It might be outside peoples’ comfort zone at first, Reale knows. And lots of people could lose their money. But even Houston’s preferred investment strategy — financing oil drilling — has risks.
“You could lose your money shooting holes in the ground,” Reale says.