I recently discussed Arizona’s entrepreneurial ecosystem, and I highlighted some of the great work being done across the community and specifically applied 5 factors that were highlighted by UPGlobal a keys to growing a sustainable entrepreneurial ecosystem. Arizona is showing great strength along 4 of the 5 areas, the gap: Capital. The biggest gap for the region is not talent, culture, support systems, or even the regulatory environment, it was a lack of capital. Business opportunity is built around finding gaps in markets. In this case, this particular gap coincides with my passion of helping to build the future in the southwest.
The Capital Gap
There are currently 3 active Venture Capital sources in Arizona and 2 core angel investment groups. The venture capital firms are Solstice Capital, Grayhawk Capital, and Tallwave Capital while the angel groups are Desert Angels and Arizona Tech Investors.
Over the several years, Solstice Capital has emerged as a major venture investor in the Tucson market and a significant presence in other areas of Arizona. While in Tucson, a significant amount of their fund was deployed to companies in the Northeast. Solstice Capital is also not investing in any new deals and will not be raising another fund. Other venture capital firms in the Phoenix metro area includeTallwave Capital who just closed their $13M fund and Grayhawk Capital who has managed 8 venture funds and invested in over 72 total investments within the technology space with a fund size of $70M. Grayhawk closed this round of funding in 2013 and expected to invest in about 15 companies. It appears they currently have investments in 11 companies already. Tallwave is making its first investments beginning this year out of their fund and a new venture firm, Wasabi Ventures is moving to Phoenix and expects to invest in 20 companies over the next two years. I would expect Grayhawk Capital to raise another fund in the next 3-5 years and it is unknown the size of investments that Wasabi Ventures is going to make.
While those are unknowns, what is known is the Southwest makes up over 12% of the nation’s GDP yet has attracted only 0.15% of the venture capital currently under management. At the end of 2013, that is over 98% of the $48.3B of venture capital not being invested in Arizona’s startup economy. I have seen and worked with the individuals who are the entrepreneurs building successful businesses. I also have seen the angel investment community step up and become one of the most active in the nation according to the HALO report.
There are companies being funded that are going to need additional funding and the angel investment community looks to also be supplementing follow-on rounds due to a lack of venture capital. This model introduces risk to the ecosystem by not continuing to grow the newest businesses at their earliest stages where angels tend to invest because they are not able to diversify their investment portfolios because they are overweight in follow-on rounds of existing investments. Rounds built and ready for a venture capital firm to invest.
Arizona presents a Great Market Opportunity
Among the 50 states, Arizona was ranked No. 19 for the amount of venture capital it attracted last year, moving up two spots, according to the report. We are also seeing that venture capital is seeing opportunity in Arizona.
Admittedly, it has been challenging to have VCs show us the money over the years. But last year, tech companies reported a nearly 127 percent increase in venture capital. That meant $257 million in investments compared to the $113.3 million in the previous year. It also reveals the outside world is as excited about Arizona as we are. – Steve Zylstra, AZ Tech Council
This still amounts to just a tiny fraction of the total investment in the $43B venture capital market. We are seeing greater concentration of wealth and investments fromventure capital firms occurring in Silicon Valley, Boston,and New York. Thesecapital-infused locations already are extremely expensive and the cost of living continues to grow, creating an environment that makes building capital efficient companies even more challenging. These locations are also not the only place for ideas and companies to be built as we have seen the recent growth of investment going into Chicago, DC, Austin and other locations.
Ideas and innovation are not location-dependent and what is concerning from a regional perspective is the human capital moving to Silicon Valley is disproportionately coming from the Southwest. Arizona is the 3rd largest source of human capital moving to Silicon Valley with Texas coming in 2nd, Nevada 14th, and Colorado 25th of global talent, not just from the United States.
Just to recap, Silicon Valley holds the capital and attracts talent to areas that have a significantly higher cost of living, they invest the capital where the cost of doing business is higher both in taxes and operating costs, and they invest at valuations far higher than what is occurring in the rest of the country. If companies were operating to maximize profitability, they would find more effective cost saving methods and that means building companies in more optimal locations. Instead, companies are built where there is capital and the capital being spent is greater in these expensive regions than it is in other areas of the country like Arizona.
Venture capital firm have an organized source of seed capital that is among the best in the nation. Angel investors in the southwest have been a robust source of seed stage capital for years and are among the most active in the country. More recently, we have experienced significant growth in the number of funded seed stage deals, due to the emergence of accelerators, super angels and new seed stage funds along with the other core elements needed in an entrepreneurial ecosystemidentified previously. We now need to see greater follow-on capital in the range of $1.5 to $7 million for companies, funding which is the sweet spot for venture capital.
Importance of Venture Capital to the Region
Some may ask, why is venture capital a big deal and why should it matter to anyone other than those guys building something in their garage? The reason is venture capital is rare among asset classes in that it is truly shared. Entrepreneurs and employees both benefit from appreciated stock and stock options and it creates new wealth not wealth transfer like many government programs. Further, Venture Capital amounts to 0.2% of the US GDP, yet venture-backed companies amount to 21% of GDP and 11% of Private Sector jobs. Further, for every employee in a venture-backed company, it creates 2.2 jobs outside of that company according to a recentstudy.
If we want to grow a new economy for Arizona, we must be committed to investing in the startup community and growing new ventures. This includes not just supporting and celebrating our local entrepreneurs, it means building an environment and recruiting venture capital firms to invest in what would otherwise be a thriving entrepreneurial economy in Arizona.
Venture capital’s role in driving U.S. innovation tells us more. No other investors assume more risk, employ more patience or partner more closely with entrepreneurs to bring breakthrough ideas and technologies to the marketplace. Over the last four decades, these products have changed the way we live and work in profound and countless ways. Moreover, such innovations drive the U.S. economy’s evolution by spawning new high-growth companies and, in many cases, entire new industries.
Venture capital plays a lead role by persistently identifying and funding only those ideas with this transformative potential — in good economic times and bad. Venture has proven itself to be the most effective mechanism for rapidly deploying capital to the most promising emerging technologies and industries — moving nimbly to where the future opportunities lie. The result has been millions of jobs, trillions of dollars in revenue, and immeasurable economic value that otherwise might never have come into being had these bright ideas not been initially funded and nurtured to sustainability. Arizona needs to make a concerted effort to recruit this type of capital through changes in both legislation and actively trying to recruit and build these firms as a core part of its economic development strategy.
Entrepreneur | Executive | Mentor | Investor