114. The Next Great Startup Ecosystem is… Part 2 (Chris Olsen)

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Today we cover Part 2 of The Next Great Startup Ecosystem with Chris Olsen of Drive Capital. In this segment we address:

  • chris olsen drive capital midwest venture capitalChris’ thoughts on engineering talent retention in the midwest vs. the valley
  • If the region presents unique challenges due to how spread out it is geographically
  • His take on an example midwest city, Ann Arbor, and why it exemplifies the opportunity in the midwest
  • His take on why the next great ecosystem will be one located close to the customer vs. the last great ecosystem which is located close to the talent
  • If he sees more coastal VCs entering the midwest
  • and finally, we discuss his major lessons learned since raising Drive’s first $250M fund in 2012.

Guest Links:

Drive Capital’s Midwest:

 Drive Capital Midwest Venture Ecosystem

Key Takeaways:

1- Why the Midwest?

When Chris made his first visit to Columbus, he met CrossChx founder Sean Lane. And Chris told Sean:

“Silicon Valley is the only place you can find and retain key talent.
It’s the only place you can scale a large organization.
It’s the only place you can get the smart money you’ll need to grow.
It’s the only place where people will understand what you are building.”

And Sean turned to Chris and said, “You’re wrong.”

Sean went on to ask Chris…

How many customers are located within a stone’s throw of us?
How many engineers can be hired on a $500k seed round?
How much office space can be had a $1/square foot?

It was at this point that Chris and Mark Kvamme began researching the data on the midwest. They were looking for the key ingredients that make for thriving startup ecosystems. Ingredients including:

-Number of engineers coming out of university
-Macroeconomic size of the economy
-Proximity to customers
-The number of billion-dollar companies being built

and here’s what they found:

-The Midwest graduates more engineers, every year, than anywhere else on the planet
-It graduates more CS students than any other region or country
-It also is the fifth largest economy in the world (recall that California is the eighth)
-It receives 25% of all research dollars
-and finally looking at the exit data… when Chris asked himself to name the $B companies, built in the midwest, over the past five years, he came up w/ four or five names where, in fact, there are 52 of them… accounting for over $400B of shareholder value.

Upon finishing the study, it was clear to Chris that while silicon valley has accounted for the majority of value in tech over the last 15 years, the value over the next 15 will come from outside the valley.

2- Why Now?

One of the first questions one must ask, is why haven’t the large VCs acknowledged the data and developed a major presence in the midwest?

1. The first reason, from Chris’ standpoint, is that a lot of venture funds have a farming approach. They set up shop, claim their turf and meet every company in their plot. Whereas Drive has taken a different approach. They don’t farm. They actively go out in their region and cold call every company that fits their thesis.
2. The second reason is that the firms are operating on an antiquated assumption. In the first few decades of the Internet, startups had to be physically close to technology. The technology, the talent and the ecosystem has to be dense and geographically co-located. Whereas now that’s not the case. Startups can access, build, and deploy global tech products from anywhere. And so Chris asked the question, if you don’t have to locate yourself next to technology, where should you be located. And Sean Lane had given him the answer. A startup should locate as close as to customers as possible. Remember that customers are the ones that fund every successful business in the long term. Investors may only fund a company for the first five years.
3. And the final reason why the major VCs haven’t located in the midwest is that Data lags. VCs tend to use data to drive decisions, which is inherently backward looking. Of course, you haven’t seen as many billion dollar companies in the midwest as the valley, but with the time-horizons of this business, one won’t find out if they missed the opportunity for 5-10 years. And even now it has started. Chris’ study found that entrepreneurs today are building more billion-dollar companies in the Midwest than in the last 50 years combined.

And Remember Chris’ recollection from talking to Sequoia founder, Don Valentine. Don shared that the establishment thought he was crazy, in the 70’s, to be building a venture firm in California. Up to that point, the startup funding activity was located in Boston. His peers told him that the only place you could do startups, the only place tech was happening was in Boston. There weren’t enough smart people or infrastructure to do startup in California. It’s crazy to think the pioneers of VC in the valley were very much the contrarians of their time.

3- Lessons and Observations After Three Years

1- Dealflow: When Drive first launched, the valley establishment assumed they’d be chasing their tails trying to put $250M to work. In fact, not only did Drive quickly find great companies and deploy the first fund, but they’ve gone on to raise a subsequent, larger fund to invest in the high-quality dealflow they’re seeing.
Speaking of dealflow, Chris mentioned that in their first year, they saw 1,800 companies. In the second year, they looked at 3,000. And last year they reviewed 3,500. For reference, Marc Andreesen has stated that they look at around 4,000 companies a year. This is a tremendous amount of high-quality dealflow.
2- Startup relocation: As opposed to seeing companies moving from the midwest to California, now he sees entrepreneurs relocating their businesses to the midwest
3- Engineering retention. Here Chris cited the example of ExactTarget from Indy. And how he asked Scott Dorsey how he outran the many, well-funded, valley-based competitors. And Scott said “I have the same engineering team I’ve had since the beginning. The guys who wrote my first line of code are the guys that wrote my last line of code. And secondly, I’m so close to my customers that my CTO would go out and visit a customer every single day.” Engineering turnover in Silicon Valley is a major problem and averages between 30-50% per year. Chris has observed, in his portfolio engineering turnover of ~12%.

From Chris’ standpoint, the time for funding in the Midwest is now and he’s already seeing it play out.

 
 

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Listener Feedback

Pete Maglio

The takeaways to end this episode are fantastic! Thanks @TheFullRatchet & @BenEinstein! pca.st/Fey4 #smartHardware #startups