What tech M&A knows that VC still doesn’t get

By Tim Schigel, Refinery Ventures

VCs are staring at a massive opportunity to make capital-efficient deals at better valuations, and it’s located squarely in the middle of the U.S.

Major tech companies are establishing footholds far from Silicon Valley. Amazon, Google, Microsoft and others are rapidly expanding in the Midwest and elsewhere.

Google, having outgrown California, has invested nearly $2.5 billion in Council Bluffs, Iowa, where the search giant is building what will be its largest data center. And it is filling new campuses in places as far-flung as Boulder, Colorado, and Ann Arbor, Michigan.

These moves are in large part an effort to cut costs by sourcing talent, office space and other assets for far less than the pricey Bay Area requires. But the trend is changing the M&A landscape as well.

For instance, startup exits in the Midwest surged last year, VentureBeat reports. Yet only 14 of the 22 exits in the region in 2017 were driven by traditional VCs. The rest were bootstrapped or supported by PE.

This proves we’re living in a new golden age for strategic investors. In fact, research from Lewis & Clark Ventures shows that a dozen states account for the bulk of deals away from the coasts. I’m sure you’ll be shocked when I tell you they’re in the same regions where strategic investors have established offices.

But missing from the list of big names involved are the likes of Andreessen Horowitz, Sequoia Capital, Khosla Ventures and other established VCs.

This is a mistake because in these geographies, VCs will find better-valued deals than anywhere else.

In addition, Silicon Valley’s dominance of VC is slipping. Bay Area companies raised a bit more than $19 billion in venture funding in 2017, down 12 percent from 2015, Bloomberg reports. Part of the reason is that big venture deals are now happening across the country.

In the list of VC deals by metro area, the shift from 2015 to 2017 is striking: The top six cities are unchanged, but the list now includes players, including Miami, Philadelphia, Indianapolis, Charlotte and others, that weren’t nearly as active just a few years ago.

Take Understory, a Madison, Wisconsin, company using weather-advisory data to help prevent unnecessary car repairs or crop damage from hailstorms. It might end up saving the insurance industry millions.

When the founder took his idea to Silicon Valley for his first $1 million round, no one was interested. Why? Because no one in California understood hail. It wasn’t something the state has to deal with. So he went back to the Midwest, talked to local investors — and has since raised more than $10 million from people who know exactly how big a problem ice falling from the sky is and who see the opportunity Understory presents.

It’s time for new partnerships.

Startups between the coasts need Silicon Valley money to reach later-stage funding, higher valuations and better returns. Silicon Valley investors (or Boston or New York investors for that matter) need access to deals that will net bigger returns with less capital.

Partnerships are already happening. Funds-of-funds like Renaissance Venture Capital Fund of Michigan and Cintrifuse in Cincinnati, where I serve on the board, are creating networks of funds that cross regional lines. And companies like P&G, Kroger, Western & Southern, Great American Insurance and others are starting to host venture firms in their home regions.

It’s incumbent on these players to ensure they keep their regional funds in the loop and not simply focus on bringing in brand-name VCs. But bringing coastal firms and competitors out to the Midwest for face-to-face meetings to discuss deal flow and other concerns can be a powerful force as well, and it’s something all VCs can do, wherever they’re located.

Firms and fund managers are on the ground in the non-coastal regions. They understand both the nuances of their areas and what Silicon Valley investors are looking for. They are the connective tissue that can link these two worlds.

You’ve heard it before, probably from Steve Case: We should be investing in the middle of America. What you haven’t realized is that someone has beaten the VCs to the punch.

It’s time to bridge the gap. With the right partnerships, more Middle-America startups will make it to later stages and garner bigger returns at better ratios.

Tim Schigel is a partner at Refinery Ventures, founder at ShareThis, proud dad, and part-time guitar slinger. Reach him at tim@refinery.com and (513) 238-7896.