If I Can Make it There

Renaming Manhattan’s Union Square as Sand Hill Road East may be premature, but it is easy to see that Silicon Valley’s venture capitalists are falling in love with the bright lights of the Big Apple.

In December, Canaan Partners announced the opening of its first Manhattan digs. The firm has been operating the space on 5th Ave. just a block from the square for a few months.

In January, Accel Partners found its own path east when it unveiled an office alongside several of its startups at 11th and Broadway.

“We believe we have to be in all the key entrepreneurial centers across the world [and] we think there’s specific momentum around the NYC area,” says Accel Partner Rich Wong.

The “Go East, young man” cry doesn’t end there. Just about every top firm on Sand Hill Road is sending key partners to New York to seek introductions and check out the lay of the land. Kleiner Perkins Caufield & Byers, Sequoia Capital, Mohr Davidow Ventures, Redpoint Ventures, Mayfield Fund and Lightspeed Venture Partners are all booking cross-country flights, drawn by the bright lights of Broadway and the rest of the city.

They may not open offices, but none of them want to miss perhaps the most dynamic investment environment of 2010 and probably 2011. And yet, as they crowd into the city that never sleeps, the one question is this: will their New York flirtation lead to overheated deal making and excess company formation? Some say the answer is yes and that signs are showing up already.

“The New York scene is incredibly hot,” says Fabrice Grinda, a New York-based angel investor and co-CEO of the New York classified site OLX. “There’s a lot of talent.” And there are tons of deals getting done as the energy and exuberance continues to rise.

Many of these transactions are promising. There’s microblogging site Tumblr Inc., which raised $35 million in funding last year from Sequoia, Spark Capital and Union Square Ventures, and Web publisher SquareSpace Inc., which pocketed $38.5 million from Accel and Index Ventures.

Canaan, Draper Fisher Jurvetson and others invested $40 million in video ad network Tremor Media Inc. Advertising startup AdKeeper Inc. raised $44 million from DCM, Oak Investment Partners, First Round Capital and others. Not to be ignored, location based social network Foursquare Labs Inc. took in $20 million in June from Accel, Andreessen Horowitz, Khosla Ventures, Redpoint and others.

All told in 2010, $1.87 billion went into 350 New York deals, putting the region ahead of Boston (313 deals) and trailing only the greater Silicon Valley metro areas of San Jose and San Francisco/Berkeley, according to the MoneyTree Survey from the National Venture Capital Association and PricewaterhouseCoopers, based on data from Thomson Reuters (publisher of VCJ).

The reason for the New York City’s resurgence after a period of relative quiet following the dot-com crash of a decade ago has to do with social media. The city was quick to integrate social media principles into well-established sectors of expertise—advertising, digital media, publishing, fashion, creative design, and financial services—spawning top quality startups with good growth prospects.

The New York scene is incredibly hot. There’s a lot of talent.”

Fabrice GrindaNew York-based angel and co-CEOOLX

Equally important, a generation of repeat entrepreneurs has come of age, a key piece of the entrepreneurial formula in Silicon Valley.

Rising Valuations

Already, the venture deal activity in “The City So Nice, They Named It Twice” is experiencing what some describe as a seed bubble. Valuations have moved up and deal competition is on the rise. Copycat companies lurk in the alleys. There are even signs that higher prices are moving up the food chain to early and expansion stage transactions.

Some argue that California valuations remain higher. But competition is heating up in New York to acquire technical talent. Engineers of all types are receiving good offers. In this environment, some angels say they have begun showing caution.

“It’s somewhat crazy the level of funding that is happening with some of these companies and how quickly it comes together,” says Brian O’Malley, a venture investor and partner at Battery Ventures, which made three investments in New York in 2010.

These days, pre-money seed company valuations can range from $500,000 to $5 million, a broad spectrum with the high end getting a bit stratospheric, Grinda says. “It kind of feels like there is a seed bubble coming along.”

Meanwhile, Series A rounds can generate $9 million pre-money valuations when a short while ago $6 million was the top. And expansion deals can award pre-money price tags of $30 million to $40 million, even with a company just on the cusp of real revenue generation, VCs say. Foursquare was rumored to get a $95 million pre-money valuation.

Still, New York has gotten to where it is for good reason. The city benefits from an active angel network. Josh Kopelman and his First Round Capital operate there. So does Chris Dixon, an investor and co-founder of the startup Hunch Inc., and even California-based angel Ron Conway has showed up.

This is no surprise given the city’s long suits. In some respects it was advertising that got the ball rolling. When Google bought DoubleClick for $3.1 billion in 2008, money signs lit up in the eyes of investors and entrepreneurs went on to start new ventures.

Company formation has since been robust. In fashion and ecommerce, hot companies such as Gilt Group and Ideeli Inc. compete. Etsy Inc., which markets handicrafts online, had gross merchandise sales of $314.3 million last year, while online food ordering service SeamlessWeb Professional Solutions has more than 1 million members.

In the financial space, SecondMarket Holdings runs an online market for trading private company shares and eBillme has an Internet payment system. When Facebook bought Hot Potato and Drop.io last year, it wanted valued developers in New York familiar with online media, not the sites.

The reason for the New York City’s resurgence after a period of relatively quiet following the dot-com crash of a decade ago has to do with social media. The city was quick to integrate social media principles into well-established sectors of expertise—advertising, digital media, publishing, fashion, creative design, and financial services—spawning top quality startups with good growth prospects.”

In the Wake of the Lehman Collapse

Meanwhile, the city’s ecosystem of repeat entrepreneurs, executives and engineers is growing and beginning to attract players from Europe. Many of the city’s new entrepreneurs have sophisticated networks of contacts at ad agencies, brands and in the financial industry.

Following the collapse of Lehman Brothers, a number of engineers and mathematicians, who were fired from banks and other financial institutions, became available for hire. Previously, if they weren’t headed for careers in the New York financial scene, they went to tech centers, such as Silicon Valley or elsewhere, looking for work. Now, they’re part of the startup scene.

“People are more open to joining startups,” says Cyrus Massoumi, CEO and co-founder of ZocDoc Inc., a New York-based operator of site that helps people make appointments with doctors and dentists. ZocDoc raised a $15 million series B round in August from Khosla Ventures and Founders Fund.

“The [entrepreneurial] ecosystem is so much more developed,” Massoumi says.

Despite the frothiness, real businesses are being formed. ZocDoc is a prime example. Appointments booked on the site are growing 20% a month with 250,000 people using the site monthly. Sixteen months ago, it was locally focused, serving just New York. Now it has expanded to five cities with a sixth to come shortly.

But while frothiness can be good for creativity and testing new ideas, some investors are cautious.

“I’m pretty rigorous [and] if you are somewhat careful, you can do pretty well,” Grinda says. But “I will probably do fewer deals in 2011.”

Edward Zimmerman, chair of the tech group at the law firm Lowenstein Sandler and an angel investor, says he thinks his “(investment) bar is higher this year than it was in late 2008, 2009 and even early 2010.” Then, talent was available and under funded, so valuations were quite attractive.

Nevertheless, Zimmerman doesn’t believe the market is at its top, and he may deploy as much capital in 2011 than he did in 2010.

In contrast, Warren Lee, venture partner at Canaan Partners, is moving full speed ahead. The firm has invested in New York since 1997, when it put money into DoubleClick, and has added investments in about 10 companies since 2004. In 2011, the pace will be about the same, or maybe will show an increase, he says.

It’s all about finding the one, two or three special deals.”

Rich WongPartnerAccel Partners

Lee plans to work at the new Canaan office full time with Venture Partner Daniel Ciporin.

“I see [the growing venture involvement] as a positive,” Lee says. Five years ago, startups had trouble getting funded. Not anymore. Money is available and a wide range of companies are receiving it.

Canaan—which has made nine investments there over the past several years, including in startups blip.tv, OpenSky and Tremor Media—has loaded their New York digs with what it calls a “digital living room.” The showcase room features an Xbox Kinect360, powered by 3D-sensing technology from its Israeli portfolio company PrimeSense, and a GoogleTV, featuring Web video content from Canaan portfolio company blip.tv.

The new office also includes enough room for an incubator as well as shared office space where established Canaan portfolio companies based in other cities can gain an early foothold in the New York market.

Other California firms are paying close attention to New York City, too. GGV Capital doesn’t have an office in New York, and yet “I think we’re watching (the city) as actively as other Sand Hill Road firms,” Partner Jeff Richards says.

New York is important and “we are spending time there,” adds Mohr Davidow spokeswoman Pamela Mahoney. The firm has an interest in building relationships with entrepreneurs and with technologies buyers. It doesn’t yet have an office.

Accel’s Wong also is upbeat. The firm has 15 announced investments in New York—including Bauble Bar, Bonobos, Etsy, Glam Media, Learnvest and Quidsi—and a few more are ready to be unveiled in coming weeks. Accel is even considering moving to a new location in the city by the summer with more room.

The two partners expected to spend the most time at the office are Jim Breyer and Theresia Gouw Ranzetta. Breyer, who for many years was on the board of New York-based Marvel Entertainment, could spend an equal amount of time in New York and California.

Wong says he is not overly concerned about the possibility of excess investing. “It’s all about finding the one, two or three special deals,” he says. And having them pay the price of the ticket and the workspace.

VC PERSPECTIVE

Despite an Uptick in NY Startups, Tech Talent Remains Hard To Find

People are more open to joining startups. … The [entrepreneurial] ecosystem is so much more developed.”

Cyrus MassoumiCEO and co-founderZocDoc Inc.

By Warren Lee, Venture Partner, Canaan Partners

The NYC tech scene is hot. Very hot.

Funding for Internet and software companies in New York City has increased dramatically in the past several years, and VCs nationwide are spending significant time in the city.

Of the 25 largest rounds in 2010, 23 were led by venture firms based outside of New York, including AppNexus (which raised $50 million), Tremor ($40 million) and Squarespace ($38 million).

More importantly, compared to a decade ago, the depth and breadth of startups based there has improved substantially. It’s not just online advertising anymore, but leaders in fast-growing sectors, such as next-generation e-commerce (Etsy, Gilt, Ideeli and OpenSky), financial services (SecondMarket), mobile (Foursquare and Hot Potato), Internet (Aviary, Squarespace and Tumblr), media (Huffington Post and Sulia), and video (blip.tv, Boxee, Simulmedia and Tremor) that make their home there.

Even tech companies and startups located outside the state are establishing significant presences here. Google, for example, recently became a big landlord in Gotham City with its purchase of an office building for $1.9 billion. It now has more than 2,000 employees in New York.

Facebook expanded its office here and last year acquired two Brooklyn-based companies: Drop.io and Hot Potato.

Despite all this, there continues to be challenges. One of the biggest is attracting talented developers and engineers to work at these startups. Like other regions, cultivating local tech talent and convincing engineers and developers to re-locate to NYC continues to be daunting tasks.

Fortunately, efforts are underway to combat this problem. For instance, Mayor Bloomberg announced in December an initiative to build an engineering and research school in the city, à la Stanford University or MIT. Also, numerous accelerator programs, such as SeedStart and TechStars have also set up shop in the city.

Finally, several programs have started to help recruit tech talent to the city. One example is HackNY, which is a summer program that places computationally and quantitatively expert students with New York City-based companies.

Another promising effort is the NYC Turing Fellowship Program, which matches outstanding computer science, engineering, and mathematics students from the top universities and colleges in North America to paid summer internships with 25 of the leading technology startups in NYC and also includes a summer curriculum consisting of mentoring and education and a $5,000 fellowship award.

New York City has the potential to become a major center for innovation and technology, but only if it can successfully attract the best and brightest to join its companies.

Warren Lee is co-organizer of the NYC Turing Fellowship Program, and Canaan Partner is a financial sponsor of the program.