Shotguns, Rifles, & the Death of Geography in Venture Capital

A column by Chad Waite of OVP in the current Venture Capital Journal combined with some post-presentation conversations after my talk at last week’s CVCA event got me thinking. And here is my conclusion: I think a lot of venture investors are pining for the past and dangerously adrift.
I’m not merely being critical of Chad’s post in VCJ. He actually makes very good points about the merits of shotgun and rifle strategies in venture investing. In case you’re not up on venture jargon, shotgun investing is when you identify an interesting market area and make as many small-ish investments as possible. You recognize, in effect, that you’re not smart enough to know which one will “work” in that category, so you hedge your bets.
But there is a catch, of course: Successful shotgun investors are merciless at culling the flock. If they make seven investments and a year later three aren’t doing as well as the other four, then they kill the three — right there, no fooling around. You have to be cold-hearted to be a good shotgun venture investor, and while venture folks investors think they are, when it comes time to kill an investment they suddenly lose the nerve.
The rifle investing metaphor is similar. In that approach you look at an area of interest and you work and analyze and turn over rocks and get smart until you feel good that you’re making the right investment(s). Rather than making 4-7, however, you might make one or two. And instead of giving up on them a year later if/when they aren’t getting enough momentum, you work your ass off with those few companies, acting like an unpaid member of management and exploiting the relatively small number of investees so that you can really add value.
Either approach can work. Some funds use one, some funds use the other, some funds alternate, and others simply try to defend, ex post, what they did by calling it shotgun or rifle investing.
While I’ll cheerfully grant all those strategies can work, here is one I’m concerned about: Geographic venture investing.
To most people in the venture world questioning geographic investing is heretical to the point of being silly. They will tell you over and over that the venture business is entirely a local one, an industry built around trying very hard to never be more than two hours from the bulk of your portfolio companies. And I grant that is true.
But I think geographic venture investing is in trouble. To the extent that your model is predicated on being a feeder to other funds, where, say, you can be the go-to venture guys in Atlanta or Philadelphia, or, okay, Canada, for that matter, you have a problem. Sure, it’s nice to imagine that you could eventually reach a point where any time KP got wind of a hot deal in Philadelphia they would you call you or your partner at your excellent $70-million fund there, but it’s a pipe-dream.
Why? Because that view has things precisely backwards. It is increasingly not the venture capitalists that drive the funding cycle, it is the entrepreneurs. If you were a hot startup in Philadelphia (or Canada) and you had the option would you go to the local guys, or would you, knowing your attractiveness, worm your way into a meeting at Sequoia/Oak/Mayfield/USVP/KP/NEA? If you could, it would be the latter, of course. Because you know full well those are the people with the capital and connections to really accelerate your business, and because you also know that there are ways you can structure your business to work with their fondness for local investments.
(Before some seasoned entrepreneurs write to me and say they would take the dumb money, just to keep the nosey parkers at Sequoia/Oak/Mayfield/USVP/KP/NEA out of their hair, let me just say fine. Come back and talk to me a year from now after they’ve had a few know-nothing unconnected nitwits on their board for a spell.)
Put another way, entrepreneurs’ increasing sophistication and their desire for high value-added investors trumps the local-first business model of too many second- and third-tier venture investors. Yes, local-first venture investing used to work, but that was back in the dark days before we had instant electronic communications, entrepreneurial venture capital sophistication, and near total information transparency. When it is as easy to pop off a note to someone who can introduce you to Mike at Sequoia as it is to contact the overworked and underpaid local venture guy you know what choice people are going to increasingly make.
Is this new and more geographically diverse approach to running a venture portfolio more expensive and harder work? You bet, because it requires different and more connected people, but it can also produce better returns — if you’re capable of making good investments (see shotguns and rifles above), and if you can forgo the temptation to be a feeder fund.
Some of the smartest first-tier partners I know have already figured this out, although they’d never admit it. They have made more geographically diverse investments in the last eighteen months than in the entire prior history of their fund. In adopting a more coherent strategy, whether via rifles or shotguns, they have been forced to throw a wider net, one that topples a long-cherished view of venture investing.
Funny thing, of course, is how many venture investors a) deny this is happening, and b) deny that it is even possible to do. I had a partner at one regional venture fund literally tell me last week that “It’s just too hard to do that; we can’t afford to dig so deeply into any one area.” Instead they just do the best due diligence they can and fund the best local companies possible. I’m sure you can see the problem with that approach a market, technology startups, where distance increasingly has no meaning.
While I wasn’t (and am not) suggesting that every venture fund suddenly needs to suddenly invest everywhere, I do think it’s time regional funds rethought their roles in the face of a changing marketplace. Being the go-to guys in Region X, where said region is somewhere in North America (geographically-specific strategies can still work elsewhere), is rapidly becoming like persisting in selling umbrellas in a rainforest that turned into a desert. Rather than complaining you better find a new way to make money.
Isn’t it ironic? Venture funds are fond of touting how their portfolio technology companies transform industries, but they currently aren’t thinking very clearly about how technology is changing their own markets.

Related posts:

  1. Newbies Flood Venture Capital (Again)
  2. Pining for the Glory Days of Venture Capital
  3. Wikis, the WSJ, and Venture Capital
  4. Speaking of Consumer-Centric Venture Capital …
  5. The Venture Capital Overhang

Comments

  1. Scott Benner says:

    It’s definitely true that entrepreneurs are much more selective today than they once were, but the one aspect of the top tier funds that will keep the regional funds alive is that the top tier funds are, for the most part, too big to invest in early stage deals. For those entrepreneurs that can’t bootstrap their companies or self-fund from their own pockets and are looking for their first $1-3 million, they are going to have to find their first round from somewhere other than Sand Hill Road because that is simply too small to attract SHR’s attention. Currently, the top tier funds have benefited from the great number of companies that have survived the past five years through self-funding; the companies did it because funding dried up, not because they necessarily wanted to use the slower, bootstrap growth method. So if the SHR VCs think the future will look like the present in this respect, I think they are mistaken.