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Los Angeles’ VC stars are on the rise amid mega-exits

The city of stars is stepping out of Silicon Valley’s shadow.

The city of stars is stepping out of Silicon Valley’s shadow.

PayPal‘s recent $4 billion acquisition of shopping-discount platform Honey was the latest indication that Los Angeles can pull off billion-dollar exits. The deal represented the city’s largest sale of a tech startup and was the second-biggest exit after Snap‘s $19.7 billion IPO in 2017. In another high-profile episode, Dollar Shave Club sold to Unilever for $1 billion in 2016.

Until recently, the city’s venture capitalists have been best known for seed rounds in a region that is home to only a few large firms. However, the local startup ecosystem has been maturing with the arrival of bigger VC funds and a growing presence of big tech companies seeking to capitalize on the world’s entertainment capital.

“In the early days, I think the technology environment was pretty thin,” said Mike Jones, CEO of Science, Inc., a Santa Monica-based incubator and investor. “The (major VC) firms were really headquartered in San Francisco, and they kind of looked at Los Angeles like a scouting arm. Over the last 10 years, that’s changed substantially.”

Honey’s sale to Silicon Valley-based PayPal is set to deliver staggering returns to local backers like BAM Ventures and Mucker Capital, which helped raise a total of $49 million for the startup.

Last year, Los Angeles hit a fundraising record, and 2019 isn’t far behind. So far this year, the area was home to 661 venture deals, collectively worth about $8 billion, according to PitchBook estimates. That puts the area in fifth place in deal size and count, behind San Francisco, New York, San Jose and Boston.

Just far enough

Los Angeles’ relative proximity to its northern neighbor, San Francisco, has long defined the city’s VC ecosystem.

“Historically, if you were great company looking for venture funding, no matter where you were located, you would presumably pay a visit to Silicon Valley at some point,” Shamin Walsh, a managing director at BAM Ventures, said via email. “The ecosystem in LA is continuing to mature, but evolving beyond a regional player into a market you seek out simply because you want to work with a particular VC will continue to be a challenge.”

At the same time, the tech industry’s biggest companies are building large outposts in the city, bringing in valuable new talent and raising the market’s profile for investors. Google signed for a third Los Angeles campus in January, while Northern California-based Netflix remains one of the city’s largest commercial tenets. Amazon‘s film production arm moved into historic Culver City Studios in 2017. And Elon Musk’s SpaceX has called suburban Hawthorne, CA, home since 2002.

Proximity to Silicon Valley adds up to a net positive, said John Keatley, a native Angeleno who co-founded and helms Scratch Financial, a mobile app that connects pet owners with affordable veterinary care. The Pasadena-based company, widely known as ScratchPay, has raised about $73 million to date.

“You can choose to fly under the radar if you want and avoid the Bay Area echo chamber, or you can stay close to it. You can recruit from that pool when you want to, or recruit locally,” Keatley said in an email. “It’s like going to college within a day’s drive from your parents’ house. You can go home and do laundry when you want or stay away when you want.”

The Series A problem

Seed funds still define Los Angeles’ venture ecosystem. Larger local funds raised by the likes of Upfront Ventures and Fifth Wall Ventures, could help propel LA startups up the capital stack, further improving the city’s venture capital reputation. Fifth Wall, for example, closed a $503 million real estate technology-focused fund in July, putting it among the largest funds based in the area.

But the general dearth of Los Angeles-based funds able to lead a Series A or later-stage round has created a “logjam” for local startups looking to move past seed stages, said Andy Wilson, executive director of the Alliance for Southern California Innovation, a nonprofit that promotes growth of the region’s entrepreneurial ecosystem.

“Series A is still a place where it’s still a little bit of a leap of faith, and that’s where relationships matter,” Wilson said. “I think even though we are able to import capital here, the standard of performance tends to be significantly higher than what they would be if we were still in the same ecosystem.”

In the case of ScratchPay, it was helpful to have a local investor with a strong Los Angeles presence (though a New York headquarters) lead its $6.4 million Series A in 2018, CEO Keatley said.

“It probably would have helped to have more local funds that could lead our A round,” Keatley said.

However, PitchBook data suggests that the Series A problem could be shrinking. The number of Los Angeles-based seed funds—those with less than $50 million in commitments—have dropped precipitously as a share of total fundraising in recent years, while new funds capable of making larger investments are gaining ground. In 2016, vehicles with less than $50 million accounted for 71.4% of fundraising efforts in LA; so far in 2019, that figure is just 9.1%.

And the Series A problem might not be that problematic in practice, said Brendan Wallace, CEO and co-founder of Fifth Wall, a Venice Beach-based firm that primarily participates in Series A and B rounds for startups located in a variety of markets. “I don’t think Los Angeles startups are particularly hamstrung by the absence of institutional capital in LA,” he said.

It might even help. According to Shamin Walsh, deals done with firms outside Southern California can generate valuable buzz, benefiting the Los Angeles venture ecosystem in the long term.

“This is going to help build more of a national interest in us, and the more folks that come to us, the better it is in establishing LA as a destination and not as a stopover on the journey to an exit,” Walsh wrote.

‘Inclusive innovation’

A powerful confluence of creative legacy industries and new technologies positions the city for even greater growth in the next few years, assuming current market conditions persist.

Media, retail and real estate all have deep roots in Southern California—yet they’re quick to adapt to new technologies. Myriad other industries including esports, commercial space, fashion, medtech and transportation also have strong roots in Los Angeles.

“I think you’ll see the large technology incumbents that are actually not based in Los Angeles further establish a presence in Los Angeles simply because of that fact,” Wallace said.

But the key to the region’s venture future might lie in what Andy Wilson calls “inclusive innovation.” The city’s infamous urban sprawl also leads to one of its greatest strengths: diversity.

Wilson added: “We believe that the disparate perspectives, different backgrounds, different cultures actually bring creative problem solving in a much wider spectrum.”

12/12/19: article updated to correct 2019 deal flow figures.

Featured image via miroslav_1/iStock/Getty Images Plus

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