L.A. Joins the Venture-Capital Revolution With a Vengeance
For most of the digitally driven 1990s, Southern California was perceived as a second-tier player. Venture-capital funds, hot IPOs and start-ups proliferated in the Bay Area and other cybercenters, while Los Angeles seemed hopelessly antiquated, struggling with its internal social rifts and the precipitous decline of its signature aerospace industry.
But at the dawn of the new century, the region is back on the cutting edge of technological change. Perhaps the clearest sign of this is the rapid growth and evolution of the region’s venture-capital industry, which has expanded from barely $100 million in 1994 to an estimated $1 billion this year. As a result, Southern California has moved from a virtual tie with technology also-rans like Philadelphia into a solid third place behind the traditional venture havens of Silicon Valley and greater Boston. More important, the region has become the exemplar of a new form of venture financing, based largely on the incubator model developed by Idealab Capital Partners in Pasadena, that stresses relatively small amounts of initial capital investment in order to first test new venture ideas.
Both the evolution of the Idealab model and the overall growth of the L.A.-centered venture community have their roots in a fundamental change in the nature of technology investing. For much of the past two decades, the vast majority of funds went to companies developing hardware critical to the digital revolution. Although the region played a prominent role in the early development of this hardware, most of the innovation took place in the highly cloistered world of the aerospace and defense industries. When the semiconductor, personal computer and disc-drive industries emerged, Southern California took a back seat to innovators and their venture-capitalist sponsors in the north and elsewhere.
Yet, beginning in the late 1990s, there has been a marked shift away from “hard” technology to “soft” skills relating less to the construction of the information superhighway than to content filling its pathways. In this soft revolution, Southern California’s traditional strengths as a cultural innovator and content provider have given it a new relevance.
“When semiconductor deals were hot, most of the knowledge was up north,” explains Brad Jones, a general partner at Redpoint Ventures, successor to Brentwood Associates, arguably L.A.’s most-respected venture fund. “But the Internet is a great leveler. Southern California can now also open up with the convergence of content and entertainment. All of the L.A. entertainment industry becomes part of the new media.”
The disbursement pattern of Jones’ fund, operated out of offices in Menlo Park and West Los Angeles, reflects these trends. Five or six years ago, his firm invested more than 60% of its money in Silicon Valley, 25% elsewhere in the country and 15% in Southern California. Today, Southern California accounts for some 40% of total disbursements, compared with 50% in Northern California and 10% elsewhere.
Growing venture-capital interest in Southern California is also demonstrated in the arrival of other funds. Northern California venture capitalist Tim Draper, for example, has established Zone Ventures in downtown Los Angeles, in part to nurture a still small, but growing Internet community in the region’s hard-pressed urban core. Other major players--SunAmerica and, just this week, French telecommunications giant Alcatel--have set up megafunds in the Southland.
Yet, not only will the volume of new funds shape this region’s high-technology future. The emergence of new players and new methods of investing, many tied to entertainment-industry models, may also turn Southern California into a major center of the digital economy. The most important of these Southland-based paradigms is called the incubator model. In contrast with the well-developed Silicon Valley pattern of megainvestments controlled by elite players, often backing established serial entrepreneurs, the incubator model calls for nurturing lots of “concepts” with minimal capital, sometimes as little as $1 million. In many ways, this approach mimics Hollywood financing of TV pilots, which are made to test the marketplace and depend on market acceptance before becoming full-scale productions.
By far the most successful of these incubators is Idealab, which was developed by Pasadena-based entrepreneur Bill Gross. He has helped nurture many mini-investments into major Internet players, among them eToys and Ticketmaster Online-Citysearch. Other Gross investments include Cooking.com, CarsDirect.com, GoTo.com, eWallet and Stamps.com.
In another duplication of the Hollywood model, Idealab’s success has spawned clones across the evolving Tech Coast, among them eCompanies, headed by EarthLink founder Sky Dayton and former Disney executive Jake Winebaum, which has raised some $130 million.
Ultimately the most critical advantage of the region’s venture-capital development may be the role played by prominent entertainment figures like Sandy Climan, former Creative Artists Agency executive-turned-venture-capitalist, former CAA boss Michael Ovitz, Winebaum and Chuck Davis, CEO of Bizrate.com. The involvement of these men, with their easy access to Hollywood talent and marketing prowess, makes Southern California competitive with even Silicon Valley.
“The magic now,” suggests Climan, who operates out of Entertainment Media Venture’s Bel-Air offices, “is to make the technology fun. That’s why people will be beating a path to L.A.”
Although lagging in “hardware,” Southern California, in particular L.A. County, appears to be outperforming the rest of the nation in creating software-related jobs. According to Milken Institute economist Ross DeVol, the county added 15,000 new jobs in this field from 1996-98, considerably more than New York and most other regions.
But for all this progress, the evolution of the technology and venture-capital community here still faces many hurdles. For one, the region lacks the kind of powerful investment-banking infrastructure available to competitors in New York or San Francisco. This often results in Southern California companies--GeoCities’ purchase by Yahoo is a prime example--becoming the targets of acquirers, rather than the acquirer, as Internet companies morph into media conglomerates.
At the same time, Southern California inadequately projects itself and its companies as major players in the information revolution. In sharp contrast to New York and the Bay Area, the local Southern California media were tardy in covering the emerging regional Internet and information industries. Similarly, the national media have, at least until recently, all but ignored Southern California’s rise as a new-media center. Although the region’s high-tech industries rank within the top five on virtually every objective measure, few national newspapers field a tech reporter here. This means local companies often lack the kind of “free” media play that their counterparts in New York, the Bay Area or even Austin, Texas, enjoy.
The indifference of national media toward the local venture-capital scene is matched by that of investors. Despite the growth of the regional Internet economy, some prominent Bay Area venture capitalists, who control by far the largest chunk of investment capital, still prefer to invest closer to home and in perceived “hot spots” like Austin or Raleigh-Durham, N.C. Some, like Sequoia Capital’s Michael Moritz, even hold to the idea that investing in Southern California-based companies has a pejorative connotation.
Yet, the key to the success of Southern California’s venture-capital economy lies not with persuading the outside world to invest, but with the region’s residents, entrepreneurs and investors. In the new economy, in which companies and funds can move anywhere, sensing oneself close to the epicenter of activity is often key to becoming one. When we begin acting like this region is, as it should be, one of the centers of the information revolution, the 21st-century transformation of Southern California will be well on its way. *
