tech | growth | venture | 2017 November
0
archive,date,ajax_fade,page_not_loaded,,qode-title-hidden,qode-theme-ver-17.0,qode-theme-bridge,wpb-js-composer js-comp-ver-5.5.5,vc_responsive

For decades, incumbents in industries such as energy, healthcare, and finance have enjoyed the luxury of being protected by regulation. This has provided a moat against competition and eliminated the need for innovation leaving behind inefficient businesses and frustrated consumers. However, customer expectations are changing rapidly resulting in a demand for change and a major opportunity for building impactful, durable businesses.

Unsurprisingly, the concentration of talent in several regulated industries is actually higher outside of Silicon Valley and in cities where those sectors play an outsized role in the local economy.  This density enables several of the same qualities, such as network effects and proximity to potential customers, that make Silicon Valley a hub of innovation.  The metros listed below have a high number of industry experts and the technical talent to implement the solutions that will trigger a massive wave of disruption in regulated industries.

 

“I also see tremendous stuff happening in highly-regulated markets where there is such a demand for change. I think the dismantling of regulated markets through software is something to think about and watch.” – Chamath Palihapitiya

 

Energy: Houston

Houston is the energy capital of North America so it should be no surprise the city has a great chance to play a significant role in shaping the future of the energy sector. Texas accounts for 31% (335,000) of the nation’s oil and gas related jobs thanks in large part to its largest city and the international energy behemoths such as Exxon, Shell, Schlumberger, BP, and Engie that call Houston home.

The industry is full of seasoned employees who have spent most, if not all, of their careers in the space accumulating impressive field-specific experience. This dense, highly-specialized network creates unique advantages for energy-focused startups such as a labor-force with knowledge of a complex industry, hundreds of potential customers within close geographical proximity, and low-friction business development opportunities.

Traditional fuel sources aren’t the only major source of jobs as cleantech-related jobs number close to 50,000, while Texas ranks 1st and 9th in wind and solar generation respectively.  The diversity in energy sources has made Texas’ grid among the most complex and advanced in the US, but the fourth-highest penetration of smart meters (80%) gives startups the potential to easily access the energy usage data for approximately 7.5 million households.

Additionally, utility regulators in Texas are forward thinking when compared to the rest of the country and end-users are acutely aware of their energy usage due to volatile weather and comparatively large home sizes.  When combined, these factors make Houston the perfect testing ground for consumer and utility products such as demand-response, utility-scale IIoT, and grid security.

Sectors to watch: digital oilfield, cleantech, DER software, utility-focused IIoT

 

Finance: Atlanta

Atlanta affectionately calls itself “Transaction Alley” and with good reason.  Several of the world’s largest payment processors are headquartered or have major offices located in the city including First Data, Fiserv, Global Payments, and World Pay.  Additionally, Charlotte, currently the third largest banking city in the US, is only a one hour flight away.

These industry heavyweights provide Atlanta startups with the industry talent and local partnerships needed to fuel growth. One particular example is the Advanced Technology Development Center at Georgia Tech which includes a FinTech specific incubator funded in part by a $1M donation from World Pay in 2015.

In addition to large financial companies, Atlanta is home to large corporations like UPS, Home Depot, Delta Airlines, and Coca-Cola which provide growing startups with potential anchor customers. These firms don’t just represent large revenue opportunities, all of them have provided local incubators and co-working spaces with sponsorships and donations to support the local ecosystem.

The perception of Atlanta as a FinTech leader is already well underway due to the large successes of local startups Kabbage, Cardlytics, and BitPay.  For most, Groupon and Braintree helped to put Chicago’s tech ecosystem on the map. These companies have the visibility to cement Atlanta’s status as a FinTech hub for decades to come while incubating talent that could start the next wave of great companies in the space.

Sectors to watch: payment processing/disintermediation, cryptocurrency, authorization, automation

 

Healthcare: Nashville

Nashville is much more than the country music capital of the world. It’s also a major center of healthcare contributing more than $40B annually to the local economy and supplying residents with over 250,000 jobs.

The impressive numbers don’t end there.  Eighteen publicly traded healthcare firms, 4,000 small businesses related to healthcare, and Vanderbilt University (the 14th best medical research university according to US News) reside in the metro. The result is an unmatched opportunity for clinical trials via hospital systems like HCA and Vanderbilt as well as a large customer base software solutions for small and large practices.

Perhaps more than any other industry, healthcare requires a deep industry knowledge including, but not limited to, issues such as the regulatory pathway, intellectual property rights, and the role of insurance in the overall revenue of hospitals and small practices.  Nashville’s diverse but concentrated talent base provides founders with an abundance of resources as to solve these problems as they work to get their startup off the ground.

Sectors to watch: patient compliance, remote patient monitoring, small practice and hospital system operations

 

Regulated industries have been absent of major innovation for several decades but as customer expectations evolve these businesses will be next in line for a wave of disruption.  Due to the nuances of these sectors, it just so happens those waves are likely to be triggered from outside Silicon Valley. Instead, innovation will likely originate in the metros which know them best.

A few days ago, I published a post on the importance of setting up internal processes for fundraising.  Part II focuses on identifying the correct potential firms, interacting with them during the process, and finally closing the deal.  Let’s jump in.

Raising capital, like any sales process, becomes easier when you identify the proper targets and their individual goals.  However, in this case, a deal will hopefully lead to a long-term relationship with a partner or partners who want play an important role in the success of the company.

When raising institutional capital, there are generally two types of prospective investors: venture (private equity) and strategic (CVC).  It’s important to know the traits of each category in order to craft a pitch that will resonate and understand the terms that will matter if the deal begins to materialize.

Venture capitalists are primarily financially motivated. As a founder, it’s important to research a firm’s thesis, geo-focus (if applicable), and stage focus to find the best fit. While the chief goal for a VC is optimizing ownership, good investors are seeking a deal on fair terms that will leave the founder with enough equity as to maximize the incentive to pursue long-term value creation or seek additional capital.

Corporate venture capital is a little more tricky as it pertains to motivation.  Depending on the CVC, the reasons for investing can range from outsourced R&D, first-look at potential acquisitions, reduced customer acquisition costs, or synergies with upside potential.

It’s easy to imagine the difficulty in predicting the motivations of a CVC and the potential hazards that come with misaligned incentives.  Combine these uncertainties with the typically longer deal process and it becomes clear that raising capital from a strategic requires careful consideration.

The next factors are ones we see many founders neglect to consider: understanding both how and where you fit in a VC fund.

  1. How: the combination of thesis (discussed earlier) and funding stage.  In the slide above, we use a $100M fund as our example.  Typically, a fund makes 20-25 investments and reserves for follow-on. (note: this varies by fund, but this is the typical model).  Let’s assume this fund reserves $60M to maintain or increase its position in the winners, leaving $40M for initial investments. This means an average first check lands somewhere in the neighborhood of $2M. If you’re asking for $500K, it’s unlikely (though not impossible) this fund is too large.
  2. Where: the age of the fund and how this will impact the VC’s need for an exit.  Most investments are made during years 1-5 of a 10-year fund. Depending on the stage, a startup can be great for either end of that timeframe. However, it becomes possible to be pressured into an early exit due to a mistimed investment or have a board seat change hands in a secondary sale of equity.

It’s completely fair for founders to ask questions surrounding these issues.  I would argue it shows maturity in both understanding the venture process and wanting to ensure that both parties are completely aligned for the entirety of the partnership.

Much too often, we see cold-emails that are clearly of the “spray and pray” variety meaning founders are emailing as many potential investors as possible with no difference in message.  My advice to those startups would be to take a step back and really consider building a targeted pipeline of potential investors.

Start with a wide funnel that encompasses all the investors in either the industry, technology, or geographic region in which you operate then begin to narrow by the remaining criteria plus average investment size. For example, if you are a healthcare company in Dallas you might build a funnel of all healthcare investors which have done a deal in the last 12-18 months in the US, then narrow by the ones who have made an investment in your technology (ex. software/hardware), and finally by Texas.

Once you’ve selected the top 20% of firms that seem like potential fits, find the partners which made the investments.  Generally, all will have an online presence wether it be Twitter, a blog, podcast appearances, or just quotes in press releases, find something to use in the initial outreach which explains why it’s the right fit for a partnership outside of capital.

Though it varies from round to round and startup to startup, fundraising often requires thousands of interactions with hundreds of contacts.  It is essential to keep up with these contacts in an organized way while delivering positive news throughout the process.

For this reason, in addition to a CRM, we highly recommend finding a meaningful KPI which is unlikely to go down and sharing an update at the end of every week. The weekly update serves several purposes: it creates a trend line from dots, it shows accountability, it shows execution ability, and it keeps your startup at the top of the investor’s mind.

As the interactions with prospective investors increase, it becomes important to filter the noise and avoid “kissing a lot of frogs.”  After all, you’re still running a business and time is precious.  We encourage entrepreneurs to do their diligence on investors including asking service providers such as banks and lawyers for their opinions.  Association with the wrong investor can be a negative signal to the investors you covet.

Lastly, ALWAYS authentically respond to no’s.  They are an amazing chance to show humility and learn.  When a founder ignores a no, it feels like a confirmation, right or wrong, I made the right decision.  After sending a response, move on.  Time is money.

It’s often said time is the enemy of all deals.  Once a VC has agreed to invest, work to close as quickly as possible. Often, it’s hard to manage the process especially when it pertains to service providers but there are steps that can be controlled.

The groundwork laid in the previous post really comes into play as the close nears. Thorough research on comps helps guide the valuation process and an organized data room containing the appropriate materials increases the speed of diligence by reducing the need to find materials and limiting unnecessary communication.

Much like the previous post, this one was long in nature.  However, I hope these tips are potentially useful and maybe introduced a few unfamiliar nuances in the fundraising process.

Credit: John Tough, partner Invenergy Future Fund, for the inspiring the images used in this post.  

Part I can be found here.