106. Underserved Startup Ecosystems, Part 2 (Stuart Larkins & Ezra Galston)

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Today we cover Part 2 of Underserved Startup Ecosystems with Stuart Larkins & Ezra Galston of Chicago Ventures. In this segment we address:

  • Their opinion on why the majority of HNW accredited investors have never invested in venture.
  • How Chicago ventures has been so successful yielding follow-on funding for their portcos… having been ranked the 2nd seed fund in the country for follow-on funding by CB Insights.
  • Stuart & Ezra’s take on how the role of VCs will change in the coming decade as these ecosystems evovle.
  • Advice they have for entrepreneurs and investors working in these ecosytems.
  • ezraand we’ll wrap of w/ their final thoughts, my takeaways and a tip of the week.

Guest Links:

Key Takeaways:

1- Key Ingredients of the Ecosystem
-Time… As Ezra mentioned, many emerging ecosystems are less than a decade old w/ any sort of formality. Time is required for startups to mature, for operational capabilities to develop and for the marketing flywheel of successes to start driving more successes
2- Advantages of Underserved Ecosystems
-VCs, like Chicago Ventures, must really work on behalf of their portfolio companies… to help them build customers, develop partnerships and raise follow-on capital
-Stuart mentioned that it’s less about competition and more about coopetition between funds. This engenders a collaborative atmosphere within the startup ecosystem.
-Whether you see this as an advantage or disadvantage… There’s a difference in fund thesis between underserved vs. well-served… and in these emerging areas VCs can be more generalist and opportunistic whereas in well-served there needs to be more laser focus and differentiation
-Less of a reactionary response to a variety of funding sources… So a startup may be able to raise capital from different types of sources before, after or alongside VC capital. In an established ecosystem, this may raise a red flag and companies may suffer some signaling risk. In developing ecosystems it is much more common and acceptable.
3- Disadvantages of Underserved Ecosystems
-1st is related to Fred Wilson’s point that we discussed, which is that there’s a need for coastal VCs to come in and leads at the A round or later. Stuart discussed the single biggest weakness of underserved ecosystems, which was follow-on capital.
-There are identity issues early-on in an ecosystems development where there are limited success stories. For better or for worse, prior successes in a geography tend to drive the identity of the ecosystem. A “tech mafia” may exist in nearly every city and those founders know how to support similar businesses better than others. Ezra mentioned the ExactTarget mafia in Indy. Which is an overall positive for the city but also may cause investor to look only for startups that are similar.
-In an emerging region, with less success stories, there are a lower number of successful founders becoming advisors and mentors. Clearly, the community takes time to develop and those early entrepreneurs will not get nearly the support and guidance of those that come later.
4- Suggestions for those in Emerging Ecosystems
A suggestion from Ezra for Investors: If you’re entering a new ecosystem… you must be active, make investments, connect w/ the other active early-stage investors located there and, last but not least, have a regular presence in the region.
A suggestion from Stuart for Entrepreneurs: He strongly urged early founders to find a mentor… especially one with domain expertise in the target market.

Tip of the Week:    The Ecosystem Network Effect

*Please excuse any errors in the below transcript

Nick: So, putting aside the institutional LPs for a second, in my own discussions with high net worth retail investors in the midwest, I’ve often found that most have 0% of their portfolio allocated to venture. Why do you think that’s the case, and what do you think can be done to encourage greater LP allocation to venture?

Ezra: That’s a lay up for #Stuart

Stuart: Yeah, well, you know, I actually don’t necessarily agree with that. I mean, we touched on a little earlier the makeup of our fund. Our first fund was 100% individual investors. A lot of people scream and run away from that who are venture capitalists. But it’s been very helpful for us. I think the reason we were able to get a lot of high net worth individuals to come into venture is because of some of the recent successes, right? You know, with #GrubHub, #Cleversafe, #Trunk Club, #Fieldglass, all those. Some really high profile exits. People are saying, wow, you probably can make some money in venture. So we focused on bringing in that, that investor type and have been successful. The second fund is a similar make up as well. So I feel like maybe it’s just Chicago. Most of our money did come from just Chicago. There were a few outside of the, the region investors. But I feel like they are getting a little bit into venture now.

Nick: Certainly I’ve seen that in the tech community, and certain parts of the financial community. But outside of those, usually people look at me like, like I’m crazy when I

Ezra: Oh yeah,

Nick: mention venture.

Stuart: I have, you know, I have had plenty, I’ve probably met with 200 people in the last year and a half and, you know, a 100 of them did give me those blank stares and say, venture what? But there are, I mean, it’s, it’s, I think the ones where we really had the most success are going to entrepreneurs. Folks who kind of, you know, are seeing recent successes in venture, wanting to have part of this be their, their capital allocation. Another thing that’s really attractive to these folks is they use, use us kind of as their deal flow, right? So we get a lot of our, not as their deal flow, they use us to react to their deal flow. So a lot of our investors send us deals. We probably get 5 a week from different investors. And, you know, our MO is they send us, we take a look at it. If we like it, we’ll get back to them. And a lot of times they co-invest with us on the deals too. So, and then a lot of the more successful entrepreneurs also want to give back. And, you know, it’s really as, as you know you do enough of your own angel investing, it’s hard to manage that plus have a full time job. So they look at us as their extension of their investor and give back into the community.

Nick: While we’re talking about the fund here, #CB Insights listed #Chicago Ventures as the 2nd ranked seed fund in the country for rate of follow-on funding. Why do you think you’ve been more successful in that regard than more established seed funds?

Stuart: I, I think it’s a, a little goes back to the ecosystem of the companies that we’re investing in, and what the businesses are trying to do. So we’re, you know, it could be good and bad that we’re probably not making as many risky investments as you see from early stage funds in the Valley. So a lot more of our companies have solid business models to start, getting really good traction. So they’re getting follow-on investments, right? They don’t tend to die as soon as companies in the Valley do. But they’re also not, you know, shooting for the moon or trying to be the next #Google or #Facebook. So that’s probably a, a good reason for it. #Ezra?

Ezra: Yeah, I mean, I think everyone would agree that kind of failure rates of companies across the entire asset class have probably been far lower than they should have been for the last 8 years just because NASDAQs been on fire for, you know, most of my professional career, right?

Nick: Fair enough

Ezra: Yeah. The other thing I would say that I think is might be a little bit, it will be controversial, so hopefully that drives some, you know, hits, #Nick, to, to the podcast, is that when you understand how ecosystems work, specially how deal flow works, in larger ecosystems, not always but it can be corrosive. Meaning that there are kind of concentric circles of investors who like to work together or people who chat on a regular basis. And companies can, you know, if one person has a bad experience, that bad experience can in a, in a community like San Fransisco, get to a large amount of people there very quickly. In Chicago, clearly there is an information flow, but I just don’t think that there’s that same kind of, I don’t know, reactionary flywheel to one element or another. I think that, I think that businesses being built in the midwest have more funding options. Meaning you can, you know, at one point raise from a traditional institution and at another point raise from a high net worth individual and nobody really bats an eye. I think if you try to do that in more mature ecosystems, people would be looking at the company with, wondering what signaling risks. So it’s, it’s a bit of a controversial statement, but I’ve seen it first hand with, you know, some of my friend groups on, on the coast and stuff like that. So everything’s a balance, meaning there’s a lot of positives to that, right. You can, a company that’s potentially earlier but, you know, starting to really hit an inflection point, can get a ton of positive buzz and move a lot faster with better people. But, you know, that’s just kind of the reality. It tips both ways. I think we’re in a good unique spot here in the midwest.

Nick: Well, good on you guys for that, that ranking. Because I do agree with #Stuart’s point earlier in the show that the follow-on capital in some of these underserved ecosystems is very challenging. So clearly you guys have collaborated with some other good folks and made sure that your best companies get, get funding. Okay. So, you know, as you see some of these distributed ecosystems evolve over the next decade, how do you think the role of VCs will change?

Stuart: It’s a good, good question. Something we really have looked a lot at. And, you know, one of the folks that I got to know early in my seed investing, angel investing career, was #Chris Fralic from #First Round Capital. I sat on the board of a company with him early on, and I really kind of, you know, look up to him as a, a solid investor, and their fund is a very successful fund. And what they’re doing I think is something we’re trying to emulate a little bit by, you know, not just being capital again, providing value for your portfolio companies. And that value comes in many, many different forms, you know. We’re not as fortunate to have as big a fund as they do, so, don’t have the teams that they do, but, we make up for it, you know, with pure grit and a lot of hard work on all of our team members. But it’s simple basics like, you know, knowing that you’ve got to do a lot of intros, get companies in to, you know, how are your portfolio companies going to be successful? Getting them new customers, right? So we’ll even get down there, help them build, you know, sales plans, sales pipelines. We’ll make calls for them, we’ll make introductions every way we can. We get involved in early stage biz development deals with our companies making sure that they are looking at the right ecosystems or product enhancements. So #Ezra gets really involved in marketing and looking at how you can do successful customer acquisition. We get really involved in those aspects. So I think the VC landscape’s changing by not just being capital but being a lot more of a resource and helpful extension to their management team.

Ezra: I would add kind of one nuance on the emerging ecosystem part of it, which I’m personally focused on here at, at #CV- And again this might be a little bit controversial, so more and more hits hopefully everyone to, to the next podcast- is that I think the world is getting a lot of, is getting a lot smaller. I don’t think anyone’s questioning that. The access to information is becoming a lot more democratic. I mean, we, you know, we see that across, a lot of startups we invest in are trying to provide that, right? Make information more transparent. But that, that is true for entrepreneurs and founders as well. And so if you are a, if you are an entrepreneur and you have access to investors, even if you’re based in Chicago but you have access to investors across the world, you’re going to optimize for the best possible investor, not just a local investor. And so, part of what’s incumbent on us at #Chicago Ventures, or really an investor in any emerging ecosystem, is to build a strong enough track record, or more broadly, a strong enough brand, that even as the world becomes much smaller from an investor entrepreneur standpoint, you are still the go to kind of local fund. Because I don’t think what will ever change is entrepreneurs wanting a local partner in the room. I think like #Stuart said, you know, we show day in and day out how much value we add on a local basis, but you want to make sure that you stay relevant, right? Even as the world gets smaller and as the biggest brand name firms in the world are more closely connected to entrepreneurs in, in smaller ecosystems. So that’s something that I think we’re certainly focused on at #CV. I hope we’re doing a good job at building that. But our goal is to build a strong enough kind of reputation and track record that it doesn’t matter who else is calling, that you want to work with us as well.

Stuart: Being accessible, so half of our compares are within walking distance of our office. And we’re there very often.

Ezra: As well as texting pretty frequently as well.

Stuart: Yeah

Nick: Just with my own angel syndicate, I have noticed that my group of co-investors are distributed around the country, which has it’s own fair share of positives and negatives, right? You know, when it comes to deal flow and collaboration and working with entrepreneurs. Okay. What advice do you have for entrepreneurrs and/or early stage investor working in these ecosystems?

Stuart: Find a mentor if you’re an entrepreneur, you know. You need to, that’s first and first and foremost. Somebody who’s done it. And obviously a mentor that has domain expertise that, that you’re trying to work on ourselves. So that’s the most important thing. That’s what I’ve done in my entire career as an entrepreneur myself, and as a, #Chicago Ventures is my latest startup, right, I’ve got many entrepreneurs that are very successful VCs, that I rely on heavily for advice and, and obviously mentorship.

Ezra: Yeah, I agree with that. I think one of the benefits of being in the midwest is that we actually have a lot of, four to five hundred traditional businesses. It doesn’t matter what industry you’re trying to operate in. There are phenomenal businesses locally that have, that were innovated a decade ago or are very experienced there. And it is, I think we’re most impressed as investors when entrepreneurs have over executed in that regard on minimal resources, kind of gone out to domain experts, told their vision, told their story, and managed to really excite a number of people who we would assume would, you know, traditionally be kind of bears on a certain market or would be suspicious of any innovation in the market. And that’s, you know, I think that’s something that’s very doable here from, you know, a, a high level operator perspective.

Nick: If we could address any topic related to startups or venture, what topic do you think should be addressed and who would you like to hear speak about it?

Stuart: Wow, that’s a good question. I would like, gosh, what’s, I can’t remember her name, the woman that’s been in the news lately, taken the company to the billion dollar level

Ezra: Oh, #Elizabeth Holmes

Stuart: Yeah. Sorry, #Elizabeth. #Elizabeth, she was back in the news this morning

Ezra: #Theranos

Stuart: Yeah, #Theranos. Yeah. Back in the news this morning because she’s got some new

Ezra: the new test

Stuart: new product

Nick: New product released, right

Stuart: I’m like if this actually works and she turns it around, that is the interview that I think

Ezra: oh my gosh

Stuart: everybody in the world will want to have, right? Going from the ultimate highs to the ultimate lows back to the ultimate highs, right?

Nick: Assuming they get back up there.

Stuart: Assuming they get back up there, right. But yeah, I, I think the, the great kind of not disastrous stories but the one, the things that don’t go well are, are what we don’t highlight enough and learn more about. We always talk to the people who have had great successes. But I think you need to listen to people more that have had failures.

Nick: What startup investor has inspired and influenced you most, and why?

Stuart: For me, I mentioned earlier #Chris Fralic from #First Round Capital. I had the pleasure of, you know, as an angel investor, in a company that he led the round in, sitting on the board with, with him. And learned a lot, you know. This is back in 2009, right when I was getting into my angel investing before I even started the fund. So followed his career closely. #Seth Levine from, from #Foundry Group is another guy that I invested with early as again an angel investor and got to work with on a board of a company. And both those funds are, are very successful obviously, but well known and the founders, the partners are, are really kind of role models for kind of what I want to, want to be as a venture capitalist as I grow up.

Ezra: I think we’re all trying to grow up in the venture world. Actually kind of on that idea, I mean, I’m proud to have gone through a fellowship called The Kauffman Fellows, which is kind of a, a training ground or a, a, kind of a, almost like a YPO for kind of up and coming VCs in the VC world. And one of the things that I guess I personally struggled with and I guess one of the investors that I look up to is that I’m just, I’m kind of a, a nice guy. I struggle to be mean. I don’t really curse. #Stuart’s given me feedback to be more aggressive, you know. #Jason Duboe has given me feedback to be more aggressive. And, and there’s certainly a balance to struck. But at the end of the day, you know, one of the people that, I reach out to a lot of investors and some of them never even met me face to face, I just harass them so much by email that they start responding. But, you know, one of them is, is kind of #David Hornik, who’s the ultimate nice guy and has managed to figure out how to use that to his advantage even when there are people, he’s certainly aggressive, but even when there are people who are, you know, far more, you know alpha or whatever out there, right. And so I think that you need to be self aware about what your own strengths and weaknesses are. And at least in this industry you need to, in my mind be very aware of your weaknesses so that you don’t allow them to be a pitfall. But then embrace your strengths, whatever they might be. I just, I don’t know, I like being nice. I think it’s important to give people, you know, real feedback when, when it’s, when it’s necessary but for me I needed to go out and find mentors who were also nice but had figured out how to use that, just kind of that natural personality to their advantage rather than allow it to, to hinder them.

Nick: I just had #Dave McClure on the program and he was so calm and so soft spoken. And I said, #Dave, what’s going on here? And he said, you know, sometimes I’m fire and brimstone but it’s important to have a voice that’s heard. So I was, I thought it was funny that he kind of ratcheted a bit back when he was on the program.

Ezra: Yeah I’ve actually had, so #Dave mentored a few people through #Kauffman Fellows. And I’ve gotten to spend a fair amount of time around him. And I’ve, he’s, you know, in person is, is not like #Twitter, at least from what I’ve seen. But, you know, that’s probably true of, that’s probably true of a lot of people.

Nick: Was #Jonathan Triest in the #Kauffman group with

Ezra: Yeah

Nick: you?

Ezra: He’s a, he’s a good friend of mine. He is 2 years behind me. So I was class 18, he’s class 20.

Nick: Is that right?

Ezra: Yeah

Nick: Okay. Very cool

Ezra: Yeah, there’s a lot of great people in the program. So,

Nick: Hilarious guy. Okay. And then to wrap up, guys, what’s the best way for listeners to connect with each of you?

Ezra: I’m ezra@chicagoventures.com. I’m probably better on #Twitter than I am in email. But, you know, whatever works.

Stuart: Yeah, he’s, the’s the young one in the group. So. You can handwrite me a letter and mail it to me. Just kidding.

Ezra: People do that, though. We get it

Stuart: We do, we do

Nick: Does that still exist?

Stuart: It does. So I’m stuart@chicagoventures.com You have to spell Stuart the right way. And I’ll let you do the research on what the right way is. But I’m also on #Twitter, just not as active. #Ezra is teaching me how to, how to use it more. My kids actually are teaching me how to use social media more, it’s crazy what they are doing.

Ezra: His daughter has like a 7 figure snapchat score.

Stuart: She does. She does

Ezra: It might be like, that might be top kind of thousand in the country

Stuart: Yeah. Not sure whether I should be proud of that or not.

Nick: Well, guys, it was a huge pleasure having you on the program. #Stuart, it’s been great to connect with you. And #Ezra, I look forward to many other productive offline conversations about the startups in the areas. So guys,

Ezra: Absolutely

Nick: keep doing what you’ve been doing with #Chicago Ventures. And thank you so much for doing it.

Stuart: Thank you. It’s been a pleasure.

Ezra: Thank you