Where venture capitalists invest and why

Entrepreneurs looking to raise capital are often told that investors like to keep things close to home. Is that true? The question influences where people locate companies. After all, if investors are only willing to invest in their own backyard, you might be better off starting your next company as close to capital as possible. Unless, of course, the conventional wisdom is wrong and investors are more flexible than we might have thought.

The argument in favor of investing locally is simple: Face-to-face meetings are much easier to facilitate when everyone’s within a short car ride or public transit trip from one another. Even in a time where video chatting is near-ubiquitous, there’s still something to be said for convening in person. Again, it makes sense.

“So what,” you might be asking yourself. Isn’t it obvious that investors would rather invest close to home, when possible? Sure, but as is typically the case with most plainly obvious things, when one takes a slightly closer look, nuance and variation abound.

So let’s delve a bit deeper, shall we? Using data from Crunchbase, we’ve built and analyzed a data set of nearly 36,700 venture capital deals struck by almost 21,000 investors with nearly 22,000 different U.S.-based startups between Q1 2012 and November 1, 2017. And it’s the goal of this article to use those findings to back up and, where necessary, bust the beliefs and biases about which investors have the most loyalty to their locales.

Most investment is local, but slightly less so over time

Let’s start with the basics. In the almost six years since the beginning of Q1 2012, an average of roughly 57 percent of all the financial relationships we analyzed were between companies and investors from the same state. Overall, roughly 50 percent of those ties were between investors and startups from the same metropolitan region.

However, it’s important to mention that this is the average over all deals, all kinds of investors and all stages of company development. There is plenty of deviation from these means to keep things interesting.

 

Staying somewhat abstract, it’s also interesting to note that, over time, startup investors are seemingly more willing to venture outside the familiar confines of their home states and metro areas to make their investments. The chart below shows a slow, yet steady decline in the number of times when investors and their portfolio companies shared a home base.

Now that we’ve restated the obvious — this time with data! — let’s go one step further. Are different types of investors more or less likely to seek out deals close to home?

Of course, every investor will tell you that, like snowflakes, they are unique, not just in their approach to investing, their perspective or — their favorite topic — the value they add. But just like there’s a difference between flurries and blizzards, so too are there categories of investor.

Certain investors are more anchored than others

Handily, much of Crunchbase’s investor data is tagged by type, and below we’ve displayed the nationwide averages of in-state versus out-of-state investment activity for several of the most common types of venture investor.

Here too, there aren’t many surprises. Government offices and similar state-backed entrepreneurship initiatives tend to invest close to the constituents they ostensibly serve, and most individual angel investors tend to invest within their own states, as well. Considering that many accelerator programs have a distinct geographic focus — for example, the various Techstars outposts in cities ranging from San Francisco and New York to comparatively smaller hubs in Kansas City — it’s not surprising to see that a majority of the deals accelerators source come from the same state in which they’re based.

With venture funds of all amounts of assets under management, many use their geography as a point of differentiation, especially if they’re located outside of Silicon Valley, so a slight bias toward investing in companies from the same state is expected.

However, moving up the financial stack a bit, we can see that, in general, opportunism begins to outweigh any particular affinity to a particular locale. Family investment offices — private wealth management firms that typically invest on behalf of a single (ultra-)high-net-worth family — and, more notably, corporate venture capital funds seem to be the most location-agnostic of the investor types we’ve surveyed here.

This predisposition for more earlier-stage investors to invest closer to home is again echoed in the data. Here, using the same classification rules Crunchbase News has used in its quarterly reports (which can be found at the end of this article under “Glossary of funding terms”), we’ve sorted the venture rounds into their various stages. Also where data was available, we delineated between lead investors on a round and those that have merely participated. Here, we display these investors’ tendency to invest in companies from their home state.

In general, it appears that being closer to portfolio companies is particularly important for angels and seed funds, which are typically the first formal source of outside funds for a company. But this becomes less important as companies mature.

Interestingly, seed and angel-stage companies are more likely to take on a lead investor who’s in the same metro region, but as they proceed through the funding cycle, they’re more inclined to find lead investors outside their metro regions. So, for a first round, a company’s legitimacy in the market gets a boost when a well-respected local investor leads the round. But at Series A and beyond, there may be benefits to having a non-local investor lead the round, particularly if a company is located outside a major tech hub. This latter point could go some way to explaining why lead investors often come from out of state in subsequent rounds.

Location, location, location!

So if different types of investors are more likely to park their money closer to home, and investors at different stages exhibit similar kinds of variability, does an investor’s location affect their likelihood of investing closer to home? This is likely the most contentious question we’re tackling here, and the answers may be surprising because they both contradict and bolster certain regional stereotypes.

Below, we present a chart that divides U.S. venture investment by regions as defined by the U.S. Census Bureau. We show the proportion of investor-company relationships that are intra-regional (i.e. both parties come from the same region) and the outside regions where investors are most likely to invest. In doing so, we’re able to show both the degree to which investors from a particular region are inward-focused and where they’re most likely to invest when they want their money to travel a bit.

For such a historically pioneering region, venture investors in the West are fairly cloistered when it comes to making deals. This is in no small part because investors in the San Francisco Bay Area live in the region’s — indeed, the nation’s — surpassingly dominant single market for venture investing activity.

In the Bay Area, out of almost 36,000 company-investor ties captured in our data set, almost exactly two-thirds (66.2 percent, for those of you dying to know) of those were between Bay Area companies and Bay Area investors. And for those brave, pioneering investors who want to venture back east for their deals, well, they basically overlook companies based in the South and Midwest, with only rare exceptions.

Which brings us to the Northeast. All of those stereotypes about “coastal elites,” at least as far as venture investing is concerned, are borne out by the data here. Although East Coast investors are much more likely to invest outside of their region than their West Coast counterparts, it’s only because a relatively large chunk of their out-of-region investments are on the Pacific coast.

It’s the investors in the middle and southern parts of the country that seem to have the most geographically diverse portfolios, at least when it comes to those investments outside the region.

To take just one example, investors from Chicago, the largest market for venture investment from both the South and Midwest, are far below the national average when it comes to investing inside their own metro areas. For the nation as a whole, 50 percent of investor-company relationships are within the same metro area. However, in the case of Chicago investors in particular, just over 37 percent of those relationships are between investors and companies both located in the greater Chicago metro area. At least from this perspective, it seems like Chicago investors’ reputation for being insular is somewhat unearned.

Perhaps with the exception of Chicago, America’s South and Midwest (again, as defined by the Census Bureau) generally lacks a deep well of startup investment opportunities. It makes sense that the average investor from that part of the country will seek potential investments a little further afield. As we saw in the chart above, that often means going east or west.

Most investment will stay local for a long time to come

As a general rule of thumb, it’s safe to say that venture investment tends to be a local affair. But as we’ve seen here, there aren’t really hard-and-fast rules, just patterns and probabilities. If you’re a founder based in the Bay Area and you’re raising a seed round, chances are good that the lead investor will also be based in the Bay Area. If you’re an angel investor in Boston, you’re likely to invest in startups based in Boston or thereabouts. There are, of course, plenty of exceptions, so data isn’t destiny here.

It will be interesting to see how all of this changes over time, though. As we mentioned in the beginning, communicating across wide distances is a richer experience now than ever before. It’s not like board meetings will be conducted through Snap Stories, but it wouldn’t be surprising to see investors venture away from home more often. Despite this, there’s something to be said for investors paying closest attention to their home turf. No amount of research or interviews, done from afar, will replace the “ground truth” learned from being somewhere in person — at least not yet.

Glossary of funding terms

• Seed/angel include financings that are classified as a seed or angel, including accelerator fundings and equity crowdfunding below $5 million.
• Early-stage venture include financings that are classified as a Series A or B, venture rounds without a designated series that are below $15 million and equity crowdfunding above $5 million.
• Late-stage venture include financings that are classified as a Series C+ and venture rounds greater than $15 million.
• Technology Growth include private equity investments with participation from venture investors.

Featured Image: Li-Anne Dias