Heavenly deals in City of Angels

Richard Wolpert is a prominent angel investor who, over the years, has backed a series of successful Silicon Valley startups, including Kongregate, acquired for about $40 million by GameStop, and Mob.ly, purchased by Groupon.

But earlier this year, Wolpert came to a decision. Going forward, he will only invest in Los Angeles-based startups.

It’s quite a commitment, considering that for the last decade he has invested pretty much anywhere on the West Coast he desired.

“One reason is that you can get quality deals in LA at a lower valuation that you can get in Silicon Valley,” he said. “The competition among VCs is the Bay Area is higher than it is in LA.”

For instance, if a deal in LA is in the $7 million valuation range, that same deal in the Bay Area will be valued at about $12 million, said Wolpert, who is also the managing director of a prominent startup accelerator called Amplify.LA.

“I’m only looking to do local deals because the opportunity has become great enough in LA that I don’t have to look elsewhere for deal flow,” Wolpert said of his hometown. “If you can be in the same city as the companies you invest in, you can be more help to them. The number of people willing to take the plunge and start a company here is significantly higher than any time I’ve ever seen.”

There is a growing recognition that tech founders are the real celebrities in LA, especially with the emergence of such homegrown startup juggernauts as Snapchat, Tinder, Oculus VR, and The Honest Company, along with more mature billion-dollar companies Cornerstone OnDemand and TrueCar.

“LA and the broader Southern California region have emerged as a major force in the world of technology and venture capital,” states a new report on the LA venture scene produced by research firm CB Insights and Upfront Ventures.

The momentum is clearly reflected in the numbers. Funding to venture-backed tech startups in the greater LA area jumped 25 percent year-over-year to reach $2 billion in 2014, according to the report, called the “Los Angeles Tech Venture Capital Almanac.”

Similarly, through mid-June, VCs have pumped $2.4 billion into 95 deals in the Los Angeles metropolitan area, which already about equals the $2.5 billion that 194 LA-based startups raised in 2014, according to Thomson Reuters. Granted, the numbers are skewed by the hundreds of millions that Snapchat has raised in recent years, but Los Angeles tech companies should easily raise a record $3 billion this year and perhaps more than $4 billion.

To put that into perspective, venture investments in LA rival all of Massachusetts. Los Angeles is now the third largest tech startup community in the United States, behind Silicon Valley and New York City.

“In a smaller pond like LA, if we can work hard enough, we can get good deal flow and invest in the top 10 percent of companies.”

William Hsu

Co-founder and Managing Partner

Mucker Capital

VC-backed tech exits in LA also hit a six-year high in 2014 with 37 exits, including two IPOs: TrueCar, backed by Upfront Ventures and Anthem Ventures, and the Rubicon Project, whose backers include Mayfield Fund and Clearstone Venture Partners.

William Hsu and Erik Rannala, co-founders and managing partners of seed-stage venture firm Mucker Capital, are Bay Area transplants who moved to the Southland in 2006 and 2011, respectively. They shunned Silicon Valley and set up shop in the City of Angels for several reasons.

“A lot of VCs look for big trends in the belief that a rising tide raises all boats,” Hsu said. “We think about unexploited and underserved opportunities where we can make a difference and actually control that tide. That is LA for me.”

He said that he could be back in the Bay Area competing against 300 other VCs for deals, but he isn’t delusional enough to think Mucker would always come out as number one. In the Los Angeles ecosystem, however, there is less competition for an increasing number of attractive deals.

“In a smaller pond like LA, if we can work hard enough, we can get good deal flow and invest in the top 10 percent of companies,” Hsu said.

Kara Nortman, a partner at Upfront Ventures, was certain that staying in her hometown of LA would derail her career, so she avoided it for many years.

“I chose to live in San Francisco, New York, Boston and even Seattle over Los Angeles over a 15-year time period,” she recently wrote in a LinkedIn blog post. “I had typecast my hometown as an ‘entertainment town’ and I didn’t choose to build my career in that sector.”

But she said her return to Los Angeles eight years ago was the best thing she ever did, especially since it coincided with the renaissance of the LA tech sector and a blossoming number venture firms. She said the key advantage that LA holds over other leading startup communities, including San Francisco, Silicon Valley and New York, is that it is significantly more affordable.

“Building a startup is hard enough,” she said. “When living on a shoestring budget, it pays to be in a place where capital can be stretched a lot further.”

Hsu believes LA is rife with diamonds in the rough. The trick, he said, is being able to spot them. In the Bay Area, he says, everybody already knows the best entrepreneurs and the hottest deals. That’s not the case in LA.

He sees a lot of great entrepreneurs who simply do not have the same level of outward sophistication as they typical Silicon Valley counterpart. Nor do they have the same tech pedigrees in terms of employment at places like Facebook and Google, or the graduate degrees from Stanford University.

“One reason is that you can get quality deals in LA at a lower valuation that you can get in Silicon Valley. The competition among VCs is the Bay Area is higher than it is in LA.”

Richard Wolpert

Managing Director

Amplify.LA

But what they do have is the ability to execute.

“We see deals that we know VCs up north would not invest in, but we look beyond to see the potential of what the company could become 12 months from now,” Hsu said. “So we are always thinking about the fundamental understanding of the business, rather than how many buzzwords the entrepreneur uses or how the business has been packaged up.”

One such investment is ServiceTitan, a cloud-based software offering that helps residential contractors like plumbers and electricians improve service and increase sales. The co-founders came from plumbing families and saw a better way to operate the business.

Hsu said the company has grown rapidly over the past year and now is in position to land the largest Series A investment for an LA-based SaaS company in the last five years.

But not all is 80 degrees and sunny in Southern California. The one main criticism local investors give La La Land is that it doesn’t really have much on-the-ground financing for post-Series A deal.

“We are OK at Series A, but it’s the stuff beyond in which you have to leave Los Angeles and look for money in the Bay Area or elsewhere,” said Wolpert, who recently took on the CEO role at portfolio company HelloTech. “There just isn’t enough local firms to support later rounds. The Bay Area has those growth-stage funds, and LA really does not. We need that Series B and beyond capital here.”

But, for the best Los Angeles-based startups, the good news is that rest of the world is increasingly paying attention. Late-stage deals captured more than 40 percent of all funding in LA tech in 2014, according to CB Insights. And this year is off to a similar start, with later-stage deals accounting for more than 60 percent of all funding dollars, powered largely by Alibaba’s multi-hundred-million-dollar investment in Snapchat.

The local economy is also surprisingly diverse, which means a range of opportunity for investors. LA, of course, is the undisputed entertainment capital of the world, but that industry only accounts for about 10 percent of the city’s economy. Categories like retail, automotive, logistics, distribution and manufacturing, among others, play a role in employment and entrepreneurship in Southern California.

But celebrity still goes a long way in LA, which even the hard-core tech investors at Mucker Capital are willing to admit.

“We are not Hollywood people, we aren’t from the industry. But we do know there are lots of things that people from the industry can offer, so we spend some of our time cultivating those celebrity relationships,” said Hsu, who invested alongside Hollywood A-lister Jared Leto in Surf Air, a membership airline for executive travel.

But Hsu adds that if Mucker was investing in, say, a software analytics company for data scientists, they probably wouldn’t ask Snoop Dogg to get involved.

“Unless, of course, he was excited about the company and really wanted to play a role. Then we’d be happy to work with him,” said Hsu, like a true Hollywood player.

Tom Stein is a Palo Alto, Calif.-based contributor. He can be reached at tom.stein@yahoo.com.