Why Geography Matters in Venture Capital
My colleague Scott Lenet writes that sector, stage and geography are the three “pillars” of venture capital strategy. When entrepreneurs or other VCs ask, “what’s your investment strategy?” they most often are referring to these three decisions.
In our experience, most of these discussions focus on what industries to fund (i.e., sectors) and the maturity of the startups (i.e., stage), but geography seems to be the least discussed of the strategy pillars. However, geography plays an integral role in shaping a venture capital fund’s strategy and warrants focused examination.
Geography defines where startups you fund can be located. The main question regarding geographic focus is whether your portfolio companies need to be located nearby, or whether it is okay to fund startups globally. As Scott notes in 14 Points “some funds have a prohibition against international investments, for example, while others prefer to invest in companies that are located within a one-hour plane flight, to ensure a close relationship.” While it’s common for VCs to say that they invest in best-of-breed companies, no matter where they are located, is this a realistic approach for all funds?
Here are four considerations for local versus global investing: 1) sector, 2) stage, 3) monitoring & managing, and 4) community relations.
1. Geographic dependencies by sector
Venture capitalists must look for winners, and companies that can win their markets may be more likely to be found near industry clusters of excellence. Harvard Professor Michael Porter defines clusters as “critical masses — in one place — of unusual competitive success in particular fields.” Examples of clusters include “Detroit’s auto industry concentration, computer chip production in California’s Silicon Valley, London’s financial sector, the Napa Valley’s wine production, and Hollywood’s movie production industry.” Clusters of excellence attract all kinds of resources, including employees. And these employees’ culture — how people respond to change and interact with one another — may contribute to the competitive success in the cluster’s particular field. If a fund’s sectors of interest have clusters of excellence nearby, then investing locally may be appropriate. With many industries’ clusters of excellence concentrated in California, New York, and Massachusetts, it is not surprising that many VC funds are located in these states and invest in local startups. In fact, the amount of VC investment going to these three states (California, New York, and Massachusetts) increased from 75% in 2018 to 78% in 2019. However, if a fund’s sectors of interest do not have clusters of excellence nearby, then investing locally can be risky. In these cases, winners in the sectors of interest may be located elsewhere, and it would be prudent to target geographies that include the best potential investments.
2. Geographic dependencies by stage
Geographic focus often depends on stage preferences, too. If a fund is very involved with its startups and favors investing in seed stage deals, for example, then investing locally could make sense. Earlier stage companies generally require more hands on attention, making proximity an advantage. If your fund prefers investing in later-stage deals, it may be less critical to be near the startups you fund.
3. Geographic dependencies related to managing investments
Similarly, monitoring and managing considerations impact where a fund might invest, depending on the level of planned involvement with each portfolio company. As noted above with the seed stage deals, geographic proximity facilitates more frequent interactions. If you invest locally, it’s easier to attend board meetings, and there are decreased travel expenses to participate in company-related events. On the other hand, a little distance can also lead to healthy perspective and smoother relationships in some cases, and most information needed to monitor an investment can be collected remotely. If the intention is to maintain a real relationship — which can be especially important in corporate venture capital — the ability to meet frequently in person is an advantage.
4. Geographic dependencies on community relations
One of the most powerful factors in favor of local investing is that community considerations can influence a fund’s goals. Investing locally supports the community by creating new jobs and attracting talent, which in turn can strengthen the local economy. Kim Hart of Axios writes, “venture capital investment can play a crucial role in building fast-growing, tech-based communities.” A fund may boost its reputation through positive local press and marketing. However, this desire to support the local community could encourage relaxation of investment standards. This is a risk to be avoided, if possible. Funds should focus on applying the same stringent criteria for investment or risk making bad investments.
While geography seems basic, it’s a key part of any venture capital strategy and warrants a deliberate and thoughtful approach.
Liked what you read? Click 👏 to help others find this article.
Dean Drizin is a Senior Associate at Touchdown Ventures, a Registered Investment Adviser that provides “Venture Capital as a Service” to help corporations launch and manage their investment programs.
Unless otherwise indicated, commentary on this site reflects the personal opinions, viewpoints and analyses of the author and should not be regarded as a description of services provided by Touchdown or its affiliates. The opinions expressed here are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual on any security or advisory service. It is only intended to provide education about the financial industry. The views reflected in the commentary are subject to change at any time without notice. While all information presented, including from independent sources, is believed to be accurate, we make no representation or warranty as to accuracy or completeness. We reserve the right to change any part of these materials without notice and assume no obligation to provide updates. Nothing on this site constitutes investment advice, performance data or a recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Investing involves the risk of loss of some or all of an investment. Past performance is no guarantee of future results.
