Startups lacking later-stage funding
Report cites need for more venture capital firms.
Austin entrepreneurs have long complained about a lack of capital available here to grow their companies beyond the startup stage.
A new study bears that out. While Austin is a top city to launch a tech company, a shortage of later-stage capital sources is inhibiting companies from reaching their full potential, the survey finds.
Among the findings of the Capital Landscape Analysis, which was conducted by the Munday School of Business at St. Edward’s University:
While Austin is ranked No. 1 for startup activity by the Kauffman Foundation, it ranks 12th for venture capital funding, according National Venture Capital Association data.
A greater number of funding sources produces more and more investment, but Central Texas had just 144 — far fewer than the top four metro areas: Silicon Valley, 785; New York, 739; New England, 475 and Chicago/Midwest, 371.
While most metro areas average $10 million to $11 million per deal, Austin has a $5.4 million average deal size.
Total venture capital investment in Austin in 2014 was $620 million, compared with roughly $4 billion in both the New England and New York regions. Seattle and Southern California also got more funding, at $1.2 billion and $2.6 billion, respectively.
“It’s time for Central Texas to expand its investment vocabulary,” said Julie Huls, CEO of the Austin Technology Council, which released the survey with the Greater Austin Chamber of Commerce. “We are known for having a strong ecosystem for startups and early-stage companies. In order for us to continue to mature and raise our game, we need to assure that as companies move out of startup phase and into growth phase, that they have the resources they need.”
At first blush, the findings seemed obvious enough — the more sources of capital in a metro area, the more venture capital invested in startups there. But when David Altounian, who led the study, bounced his data off of various investors and entrepreneurs around Austin, one of them recognized a familiar pattern.
About 35 years ago, Bob Metcalfe posited what eventually became known as Metcalfe’s Law — that the power of a network increases faster and faster with every new connection it adds. So if Jane has 20 followers on Twitter and John has 10, the value of Jane’s network isn’t just twice as great as John’s — it’s four times greater.
Metcalfe noticed the same type of relationship in Altounian’s data and suggested he test it. Sure enough, the actual numbers closely resembled the model’s predictions. For example, the math behind Metcalfe’s Law suggested that startups in the three regions with the most funding sources — Silicon Valley, New York and New England — would receive 80.9 percent of all the venture capital investment in the country. In fact, Altounian found, they received 82.7 percent.
The same calculation for the bottom three regions, Austin, San Diego and Colorado, came out at 4.1 percent of all the venture capital invested in the country. They actually received 4.9 percent.
“We don’t have a dollar problem,” Altounian said. “We have a network problem.”
Of the nine tech-hub regions Altounian studied, only San Diego had fewer funding sources than Austin’s 144 — and only Colorado startups received less than the $620.6 million of venture capital invested here.
In Central Texas, the weaker network effect reveals itself through startups and investors alike. A recent CB Insights report looked at the investments raised by 13 of the top food delivery startups around the country, including Austin-based Favor.
While Favor operates in nine cities — fourthmost among all the firms included — only one other firm has raised less than its $15.1 million in funding, the report said. Favor has far fewer investors than similar Bay Area startups, and its funding per city, at about $1.7 million, was the lowest of all the firms in the report.
CrunchBase profiles of local VC firms and comparable ones in Silicon Valley show a similar pattern. On average, the California firms joined with more partners in each deal, and they worked with a much wider variety of partners from one deal to the next.
“It’s not a problem with the funds that are here,” Altounian said. “It’s that we don’t have enough of them.”
Austin once had the network that experts say is necessary for companies to evolve to the next stage, said Hall Martin, founder of Texas Entrepreneur Networks.
“In the 1990s, the venture community was strong in Austin, with over 30 VC firms here,” Martin said. “The dotcom crash took out most of those groups, and when the dust settled, most of the VCs exited the industry and found something else to do. What came back in their place were angel investors.”
Long-time investment firm Austin Ventures did remain active but shifted its focus to roll-up deals, which involve buying small companies and combining them to create a market leader. Last year, the venture firm announced plans to abandon a new fund that would have focused on growth companies.
In recent years, Austin’s investment community has been dominated by the “angels,” who are wealthy individuals who typically invest their own money in early-stage companies. Today, many of the companies that have received seed money from angels have launched products and signed customers and now require larger funding rounds for expansion.
“They need $5 million to $10 million checks, and angels aren’t writing checks that size,” Martin said. “They need Series B investment, and to get that, you have to go out of state.”
In fact, according to the new report, Austin-based startups received just 3.5 percent of all the latestage venture capital invested within the nine tech regions included in the study. Only Colorado firms got a smaller fraction, at 2.9 percent.
That’s the experience of Alan Knitowski, CEO of Austin-based Phunware, a mobile-app-maker for entertainment, sports and media firms. Founded in 2009, the company has raised more than $60 million, with about $7.5 million of that from angel investors in Austin.
Now Knitowski is gearing up to raise a $40 million round, and he knows he will need to leave Texas to do it.
“Once it gets beyond early-stage funding, that’s when you see lots of entrepreneurs having to go to the West Coast or East Coast or international,” he said. “You just don’t have anything here to draw from. Austin is a great place to do business, but we still have some growing up to do.”