Venture capital needs strong local flavor (by Matt Harbaugh)

This comes in response to a recent article in the Wall Street Journal reporting on the concentration of Venture Capital deals going to the Silicon Valley, bypassing other parts of the country.   In times of increased risk aversion (such as the past year), one of the ways VCs will try to reduce their risk is by choosing investments that are closer to home – especially for the earliest-stage startups, which will likely require more oversight by the VCs.  Perhaps more importantly, the WSJ article notes that Silicon Valley is getting a larger share of a shrinking VC pie, as fewer VC firms outside of Silicon Valley have been able to raise “fresh” funds to invest.

Several industry watchers have recently predicted that the national VC industry will shrink by as much as 50% in the coming years, as institutional Limited Partners (managers of pension funds, endowments, etc.) reduce their exposure to the venture capital asset class and focus their remaining VC fund allocations on the large brand-name firms (“no one ever got fired for picking Kleiner Perkins”).  Unfortunately, most of these brand-name firms are located in Silicon Valley (and to a lesser extent in Boston), so the shrinking of the VC pie could further exacerbate the geographic concentration of investments.

I take issue with the comment in the article that implies that startups outside of Silicon Valley represent “weaker ideas.”  At Innovation Works, we continued to see strong ideas from Pittsburgh-based startups throughout 2009 – we made 32 investments through our Seed Fund, 12 investments through AlphaLab, and through our other programs we funded numerous new innovations at the universities and companies throughout Southwestern Pennsylvania.   I expect that when the PWC MoneyTree numbers are released next week, the 2009 investment activity of Innovation Works’ Seed Fund will place us in the top five most active seed/early-stage investors in the United States (our numbers would have been even higher, but for the state budget debacle, which dramatically reduced our investment activity during Q3).

Granted, Silicon Valley’s startup ecosystem is decades ahead of Pittsburgh’s (or anywhere else in the world).   But, over the past ten years our region has dramatically increased its capabilities to launch and develop innovative entrepreneurial companies.  Our universities have climbed into the top tier of federally-funded research institutions, Innovation Works and other local groups are recognized nationally as leaders in the field of “venture development,” we are attracting an increasing number of experienced technology executives and repeat entrepreneurs, and we have a growing number of lawyers and accountants who are adept at working with entrepreneurial high-growth companies.   

At this point, Pittsburgh’s remaining gap seems to be an insufficient supply of traditional venture capital from VC firms and active angel investors to support the companies that are being spawned.   Unfortunately, as long as the managers of pension funds and endowments (and the investment advisors of high net worth families) believe the conventional wisdom that the best ideas and “safest” VC investment opportunities are located in Silicon Valley, the money will continue to be concentrated in the brand-name VC firms, and those firms will continue to invest in their own backyard.

by Matt Harbaugh, Chief Investment Officer of Innovation Works, Inc.

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