Venture Capital: North vs. South

In a town where even the mayor is a former venture capitalist, you’d think you’d find a large and vibrant venture capital community helping to grow local businesses.

But for years Los Angeles-area entrepreneurs have asked the same questions: Why do Northern California’s entrepreneurs seem to have access to all the money? And why are there so many more venture capitalists and investment bankers in the Bay Area? Venture capitalists invested a total of $618 million in Southern California in the first three quarters of this year, compared with $2.4 billion in Northern California, according to Coopers & Lybrand, the accounting firm.

So, The Times gathered some of the most prominent capital raisers, entrepreneurs and financial academics in Los Angeles to find some answers. What followed was a no-holds-barred debate on the perceived gap between Southern California’s entrepreneurs and the venture capital community. These experts offered their thoughts on how to bridge that gap and discussed whether the diversity of businesses and ethnic groups in Los Angeles demands a new model for venture capital here.

The participants were Brad Jones, general partner with Brentwood Venture Capital in Los Angeles; Rockwell Schnabel, co-founder of Trident Capital in Los Angeles; Doug Burke, an investment banker with Sutro & Co. in Los Angeles; and Chris Kanoff, co-director of corporate finance at Jefferies & Co. in Los Angeles. Also participating were Alfred Osborne, director of the Price Center for Entrepreneurial Studies at UCLA and a board member of Times Mirror Co.; Barry Wilson, chief operating officer for EC2, the high-technology business incubator at USC; and Rohit Shukla, director of the Los Angeles Regional Technology Alliance.

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Times: Why do you think many entrepreneurs complain that there is not enough local capital going to growing businesses in Southern California?

Schnabel: Clearly, they’re not informed. Southern California actually is sound and booming. So it now creates a great opportunity for people like ourselves who are all pursuing companies down here.

Jones: There’s no lack of money in Southern California. I think the problem in Southern California--if there is one--is that there haven’t been as many attractive start-up opportunities in the Southern California area for venture capitalists to fund.

The situation facing investors down here is that there are not enough qualified start-up opportunities. By “qualified” what I mean is they have to have a solid management team in place with a unique product idea. I think some of the people who say there is no money just don’t meet the criteria.

Wilson: What we’re trying to do [at EC2, the high-tech incubator at USC] is exactly what goes on in Northern California, where so often the deals get discussed over breakfast and lunch. Because the Southern California area is so diversified geographically . . . you don’t have that. What we’re hoping is to provide some type of spot where people come and see these types of companies and meet and discuss this.

Shukla: There are simply not enough qualified deals chasing what is really a record amount of money. Still, in 15 or 20 years, you know Southern California has lost eight or nine venture funds. That may have something to do with the fact that the principals in those funds could not raise additional money because they weren’t deserving of it and [had made some poor investments]. What we are doing [at the Los Angeles Regional Technology Alliance, a nonprofit group devoted to promoting local technology-based businesses] increasingly is establishing those linkages between the professional networks and [entrepreneurs] here.

Times: How effective are the venture forums that exist? Many seem to be training grounds for people who don’t quite have it together.

Shukla: I would suggest that they are exactly that--they are training grounds. For us to believe that we can use these forums to attract our Northern California venture brethren is to indulge in fantasy. Mainly because the compelling logic [on the part of venture capitalists] has been: “We see the deals that need to be done. We don’t need to come down to a forum to see them.” You’ll hear that over and over again.

Jones: I take a fairly negative view of [the training programs for entrepreneurs]. If somebody has been coached through writing their business plan and making their idea presentable to me, they’re probably not backable because it means they don’t have enough previous experience running a business to know how to put together a business plan.

Shukla: I would agree with you entirely, but here’s the issue: You’ve got to have a beginning somewhere. If you say that the Northern California success is directly attributable to the fact that people from within these companies are able to spin out from [one successful company to another], those people have acquired and sought help on their business plans, on their strategies and on their marketing. The coaching gives them the wide-angle view they need. But ultimately the entrepreneur has to do it [him or herself].

Times: What do you look for in the companies you invest in?

Kanoff: We are an investment bank and would take a company at the stage that these guys [venture capitalists] are ready to realize [gains] on their investments.

Jones: We evaluate companies really on three criteria: Do they have a unique, protectable technology that can create a barrier to entry in the marketplace? Is the market for their product large or growing very rapidly, or, if it’s a smaller market, can they essentially win all of it and own the market? Then, finally, the management--do they have sufficient experience to create a new company?

Burke: We recognize the paucity of capital around here, and we’re trying to address it [with some new ventures]. We have made a living by taking companies to other parts of the country to raise capital. The basis of my job, and my life, is to find capital. And many of the deals we have put together have been with capital from outside the Los Angeles community. We recognize that and are trying to address it with our seed fund.

Times: Why do you go out of town to get capital?

Burke: There are a lot of reasons for that. Trust Co. of the West, I think the smallest deal they’ll do is $15 million with some exceptions. That’s typically not a seed-type, first-stage investment. Capital Research won’t look at a deal that’s $100 million or less. And they want public stuff.

I would say that a lot of the venture capitalists have moved toward later-stage investing because of the economics of their business. They can raise money from pension funds. The faster they get companies public, the higher their returns can look, [and the faster they can] go and raise other funds.

If you raise $100 million from CalPERS [the California Public Employees’ Retirement System], the second you get the money, they want to know why it’s not out the door. And if you have to put it out in $100,000 increments, it can be very frustrating.

Osborne: There is still a view from entrepreneurs that somehow Southern California is underrepresented by venture capital. A lot of this has to do with the diversity of the community.

It’s not all just high technology or entertainment or the garment industry or biotechnology that’s looking for capital--there is a whole set of small but growing businesses. But these will not necessarily generate the kinds of returns that justify you being involved early on.

I don’t know how venture capital in Southern California organizes to deal with that. The answer seems to be a network of what I call angels [wealthy individuals with money to invest in growing companies] or side-by-side funds that help that process.

Jones: There’s a stronger angel group here now.

Osborne: But another issue I want to suggest is that the diversity of Los Angeles says that somehow some sectors don’t seem to get venture capital. It’s a little bit like being redlined, if you will, out of the venture capital business that nobody talks about. But that needs to be addressed if there’s going to be a supply of funds to a lot of other projects.

Shukla: Given the fact that venture capital is tied increasingly to the kinds of rates of returns that public markets have demanded over time, and given the fact that valuations are continuing to increase, do you think that [there is a] more appropriate model for the diverse communities you’re talking about?

Jones: The goal shouldn’t be for any entrepreneur who wants to start a business to get money. The goal should be for those that have good business propositions that can succeed to get money. For somebody who’s ultimately going to fail, [getting] money doesn’t help him in the end, and it certainly doesn’t help the investor that puts the money in.

Someone brought up a good point earlier that five to 10 years ago in L.A. there were probably six or eight more venture capital firms than there are today. I will agree with you that the reason they’re not here is that they invested in a lot of companies they shouldn’t have invested in.

Wilson: But it’s one thing to say there’s enough money out there. It’s another to say how do you access that money?

If we say that, then [most] of the venture funds that are operating in San Francisco right now aren’t really necessary. I think there is something added to the mix when you get talented venture capitalists involved in the marketplace who have experience in starting and growing companies. There’s not just a push system, there also is going to have to be a pull-share system to make this happen.

So I think it would be an overstatement to say that there’s plenty of money here and it’s all the entrepreneur’s problem.

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The complete transcript of The Times’ forum on venture capital can be found at http://images.nohib.com./smallbiz