Texas Investment Landscape: Dark Ages or a New Beginning

There has been a Medium post floating around recently that attempts to shed a light on the startup capital landscape in Austin. I hope that you find this (my first ever blog post) to be a helpful alternative perspective on early stage investment in Texas through the lens of a practicing venture capitalist.

The blog post starts by mentioning an offer of investment from an Austin based “venture capital firm” (emphasis added by me). My partners and I have been investing in early stage companies in Austin for over 15 years now and have worked at or with most of the Austin based venture capital firms of relevance and we cannot imagine any one of them asking for those terms. Anyone that has participated in building a successful early stage company knows that highly punitive terms like that leave little incentive for the team to succeed and last I checked owning 100% of zero is still worth zero. So, I suspect there is a bit of a liberal definition of “venture capital firm” there. Since the only active firms cited in the article are LiveOak and Silverton, I want to be explicit that LiveOak has never done it and I am confident neither would Silverton. I don’t doubt that Richard did receive terms like this, but I can’t imagine it was from one of the large venture capital firms in Austin.

A couple more factual observations that influence the article’s conclusions and then I will address the bigger themes:

  • It is mentioned that LiveOak’s average size of later-stage deals hovers around $5.2MM with some being $10MM+. This is incorrect. Our median investment to date across our portfolio is $2.23MM.
  • The claim made about the Zebra Series A investment of $17MM alone accounting for 22% of the Silverton’s $75MM is not accurate. That $17MM is the size of the round, not Silverton’s check size. This overestimates what the firms are actually investing when assigning the entire round to a single investor in the round.

As I read the post, there were a few mischaracterizations that struck me and I want to address:

If it is not a seed deal it’s a “later-stage” deal

Let me tell you a bit about these so called later stage deals in our portfolio:

  • Of the 15 deals in our portfolio, 5 started as seed deals (of which one has since gone on to raise Series A capital) and the remaining 10 are Series A+ deals.
  • All 10 of those deals (listed as later stage deals in the “Dark Ages” post) were companies where we were the first institutional capital in. 5 of those were pre-revenue companies, 3 had minimal early revenues and only two had material traction.
  • So 86% of the deals had no revenues or trivial revenues when we made an investment and only 13% of the deals were later stage, and even then we were still the first institutional capital.

I haven’t analyzed other firm’s portfolios but I would be surprised if you find this to be different in Silverton’s portfolio. The local firms ARE taking mostly early stage risk!

As funds age, GPs take less risk and go for more later stage investments

While it is true that doing a seed deal that might take a long time to mature is easier in the early stages of a fund, this generalization is just plain wrong.

  • Partly it goes back to the definition of early as being seed stage alone. If we do a series A investment in a pre-revenue company in year 5 of the fund (which we have in the past and will in the future), that is by no means being “conservative” and “risk averse”.
  • A typical venture fund has a 10–12 year life with the first five years being the investment period when they can add new companies to the portfolio. So, even a new deal added in year 5 has between 5 and 7 years to get to an exit. It is also fairly common for our investors (limited partners) to extend the life of a fund beyond that if they see a portfolio company that is building value for them. So our investment strategy doesn’t shift purely as a result of the fund’s age.
  • Lastly, as a fund gets into years 4 and 5, most firms tend to try and raise a follow on fund that then starts a new clock all over again.

Austin’s funds have less money for early stage investments because later-stage deals have eaten a lot of the fund

While I whole heartedly support the argument that Austin (and more broadly Texas) needs more local early stage capital, I take issue with the conclusion and the causality assigned to it.

  • If the argument is that we take less risk in the later stages of a fund, see above…
  • If the argument is that reserves are removing a large part of the fund from being available to make new investments, then there is a need to understand our model better. We start with a model of what our portfolio should look like including: number of deals, desired stage of entry, average $/deal over its life etc. Once that model is dialed in, the fact that we have 10 deals done doesn’t impact the profile of the 11th deal as it was always expected to be of a certain profile.
  • Lastly, if you are one of our existing investments, you will be glad to know we reserve capital to support you in the future — life cycle investing is good for the entrepreneur and what makes institutional funds like us different from accelerators, angel investors and super angel seed funds.

So where are we in the macro venture capital cycle for Austin and broadly Texas:

  • Although Texas hasn’t kept pace with national venture capital numbers, Austin has — See Figure 1 below.
  • In fact, if you look at capital invested in deals under $2MM, Texas has grown at a 25% compound annual growth rate (CAGR) since 2009 while the equivalent number at the national level is 19%. Similarly deals that have raised between $2–10MM have grown at the same rate in Texas as at the national level — 10% CAGR. You can look at the number of deals (instead of $ invested) and you will see essentially the same trend. — See Figure 2A and 2B below.

Then why does it feel that there is not as much investment coming here in Texas? The primary area of difference has been in the deals raising greater than $10MM and in particular those raising greater than $50MM. See Figure 3 below.

  • Nationally the amount of capital in deals raising more than $50MM went from $1.9B in 2009–2010 to $20.8B in 2014–2015 — almost 11X increase.
  • In 2009–2010, 40% of capital nationally used to go to deals raising under $10MM. That fell almost in half to 21% in 2014–2015.
  • The 140 or so unicorns alone have raised over $80 billion. The 87 or so of those based in the US raised almost $50B.

In contrast Texas has been steady as she goes — about 36% in deals under $10MM, 47% into deals between $10–50MM and 18% in deals raising more than $50MM. That has remained virtually the same since 2009–2010 to 2014–2015.

Source: PitchBook, LiveOak Analysis

Venture Capital_IT.png

While it may seem like the “Dark ages of Austin’s startup capital”, having been in the business of providing it for the last 15+ years, I will end with these perspectives:

  • Restructuring of the early stage capital market is closer to the end than the beginning: Compared to the days when we were trying to raise LiveOak’s Fund, there are now several locally active funds focused on this market. We might have different strategies, personalities and quirks but we are all investing capital in Texas. It takes more than capital to build a successful company — the pattern matching of what works and what doesn’t, the people network to staff the teams, the relations with later stage investors and above all a demonstrated track record of successfully building companies in partnership with the entrepreneurs. In comparison to the market between 2009 and 2012, the local entrepreneurs should celebrate that there are experienced early stage investors who bring capital and a lot more to the market today.
  • Returns matter — It’s not a volume business: Number of startups might get us into rankings, create buzz and might even attract some capital in the short term. What keeps the capital here is returns. So, we are focusing on doing the only thing we know how to get more capital to come here — make conviction bets, work closely with our entrepreneurs to build real companies and set them up for big exits.

As Winston Churchill said — “A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty.” My partners and I at LiveOak not only see the opportunity, but we have bet our professional careers on it.