The growth in the last decade of the Los Angeles (LA) venture ecosystem has caught the eye of venture capital firms and limited partners. Large exits like Snap’s IPO and Honey’s $4 billion cash acquisition by Paypal have also helped generate this interest in the Southern California region. As a result, we decided to take a closer look at LA. We are pleased to share our view of the LA ecosystem and the benefit for LPs and VCs of investing in young ecosystems like LA.

Overview

LA has the fifth largest venture capital market in the United States behind San Francisco, New York, San Jose and Boston according to Pitchbook Data Inc. 2019 was particularly active with 661 deals worth about $8 billion were completed up to mid-December. This activity has come despite its relatively young age. The oldest firm in the LA ecosystem was founded in the 1996 (Upfront Ventures) and most firms have been founded in the last decade.

As the market is young, VC firms in LA are mostly generalist according to Crunchbase. When LA funds do specialise, they focus on startups delivering consumer products which benefit from the strong media and gaming industries in the region. Being in this environment helps startups develop an understanding of brand, design and marketing according to Mark Suster, Managing Partner of Upfront Ventures in a Recode interview in 2017. This has helped ecosystem host three of the most popular consumer products, Tinder, Snap and Tik Tok which all have their US headquarters in LA.

The small size of LA VC funds has been viewed as a hurdle for the LA ecosystem due to the lack of LA-based follow-on funding. While some funds like Upfront Ventures, Mucker Capital and Fifth Wall have grown their fund sizes to invest in the later rounds of a successful company, LA startups will usually have a firm based in San Francisco in a funding round after the seed round.

What is the benefit to LPs to investing in young ecosystems?

The benefits to investing in a younger ecosystem for VCs is that companies have less competition for talent which leads to lower average salaries than in San Francisco. LA has half of the average cost of real estate especially compared to the costs of San Francisco according to CB Insights. This reduces the cost to founding a company and its burn rate.

Additionally, investing in a young ecosystem such as LA’s allows VCs to benefit from lower valuations at the early stages. However, the LA’s proximity to other US tech hubs gives access significant competition for companies with traction which can lead to significant mark-ups.

Investing early in an ecosystem provides the chance to create strong relationships with the universities, incubators and the prominent companies which will become key institutions in the market. The region has successful incubators in the ecosystem including Science which incubated the Dollar Shave Club which was sold to Unilever in 2019. Investing early in Los Angeles will also allow VCs to build a network within the many strong engineering schools in the area such as UCLA, USC and Caltech which increasingly provide talent to local startups. When compared to more developed ecosystems like San Francisco, it can become more difficult for an emerging manager to develop a relationship with the top universities. We believe gaining an early footprint in LA will help VCs gain a deep network with the first generation of successful companies. The more successful exits there are, a more experienced network builds within the ecosystem as employees and investors share pitfalls and tips from the early success stories. VCs should then get into contact with leaders at the first generation of early successful companies, so that they can partner with them as they become investors and founders in the next generation of companies. As a result, developing strong relationships with all of these institutions can provide the VCs valuable differentiation as the ecosystem becomes mature.

We believe that LA provides an opportunity to invest in an early ecosystem and build relationships in a region which has the underlying institutions which make more mature markets successful. As early successes build on themselves, we expect LA to provide unique opportunities for investors.

 

References

  1. www.crunchbase.com
  2. Full transcript: Venture capital firm Upfront Ventures’ Mark Suster – Recode Decode
  3. PayPal announces $4bn acquisition of deal-finding company Honey – Financial Times
  4. Los Angeles’ VC stars are on the rise amid mega-exits – Pitchbook
  5. PlayVS Raises $50 Million – Los Angeles Business Journal
  6. Stars Aligning: How Southern California Could Be the Next Great Tech Ecosystem – Boston Consulting Group