Alex Kubicek needed $1 million. His company, Understory, designed sensors to prevent unnecessary repairs after severe hailstorms, something common in the US midwest. The technology stood to save insurance companies billions of dollars. Kubicek journeyed from Madison, Wisconsin, to Sand Hill Road, home of Silicon Valley’s investor class, to pitch his idea. None of the 30 venture capitalists (VC) were interested. “When we talked to people in the Bay Area, VCs would ask, ‘What does hail actually do?” he said in an interview. “If you’re not from the midwest, where severe storms are a big deal, it’s hard to imagine. There’s a narrow mindset in the Valley.”
Kubicek eventually caught the eye of a Boston hardware investor and packed his bags for the East Coast. Kubicek secured $2.1 million (with some help from Valley investors this time). The company has now raised $10 million while helping the insurance industry handle 8,000 claims and expanding fast.
It’s fashionable for Silicon Valley to talk about investing in flyover country these days. On a recent junket organized by Ohio congressional representative Tim Ryan, a gaggle of venture capitalists jumped aboard a luxury-appointed bus to tour the region. The plush accouterments included two mini refrigerators, vegan doughnuts and charcoal-infused kombucha. The crew traveled to Youngstown and Akron in Ohio; Detroit and Flint in Michigan; and South Bend, Indiana.
The news was good. Startups were plentiful. Local officials were enthused. Places like Columbus, Ohio, it was implied, might one day come to resemble something like Palo Alto. “If it weren’t for my kids, I’d totally move,” Cyan Banister, a partner at Founders Fund, told The New York Times. “This could be a really powerful ecosystem.”
What the VCs didn’t do (and have not done) was write many checks. The Wall Street Journal chronicled an exchange in Akron where local government officials pushed for investment in the region, and venture capitalists were clearly not interested. Local buy-in was needed first, they insisted. This was more than a matter of not wanting to go first (getting someone to write the first check is notoriously hard for entrepreneurs anywhere). It’s that the Bay Area still has little understanding, or faith, that midwestern startups are worth their time and dollars, an investor at a top Silicon Valley firm told Quartz.
“I’ve never heard it mentioned in more than passing,” he said about investment opportunities in the midwest. Beyond a partner’s occasional trip to Chicago, interest in the region was minimal. “I don’t think it’s real,” he said. “I’m not super-bullish on tech hubs that are not the Bay Area.” They all lacked the tech ecosystem of New York, Boston and Silicon Valley, he said. Their biggest advantage? “It’s cheaper,” he said.
If the midwest wants a piece of the technology economy, it’s on its own, at least at first. The digital economy there is growing. University towns like Madison and Pittsburgh, Pennsylvania, have humming high-tech hubs. Google and Facebook are setting up shop to attract talent and flee soaring labor costs. Companies like Salesforce have swooped in to buy the success stories, such as its $2.5 billion acquisition of Indianopolis-based ExactTarget. Even old industrial metros like Columbus and Akron have a smattering of startups and “mid-tech” jobs requiring technical skill but not college degrees.
None of these are enough to attract early stage investment from Silicon Valley firms. Data tell the story. Private equity research firm PitchBook analyzed investment data for Illinois, Indiana, Michigan, Minnesota, Ohio and Wisconsin between 2012 and 2018. Of the 4,726 venture deals in the region, Silicon Valley investors participated in just 519.
Most of this came late in companies’ lifecycles. While Valley firms accounted for almost a third of the region’s total venture dollars during this period, the money came in a few big checks once a company had begun to scale up. These are the top venture-backed exits of the region by deal size, according to PitchBook.
That’s essential, of course: Startups need growth capital, and it’s difficult to find. But it is not enough to create a startup ecosystem on its own. Early stage investment almost always comes from local investors. In the midwest, there are still few. Rev1, Drive and Rise of the Rest’s Revolution fund are among the largest. Most are well under $100M. That’s table stakes in Silicon Valley.
But the winds are shifting, say investors in the region, many emigrants from the Bay Area. “Last year we’ve seen more Silicon Valley visits than in the last four years,” claims Mark Kvamme, co-founder at Drive Capital who spent 13 years at Sequoia Capital. “What’s going to happen is the same thing that happened in New York,” referring to the explosion of startup activity in the city over the last decade. At the moment, limited partners (LP) who fill venture capitalists’ war chests don’t sprinkle their money evenly. As it’s considered an asset class, most LPs such as pension funds tend to place their money with proven firms in established markets. That means the coasts. Silicon Valley, therefore, is often relied on to write the large checks needed to get ambitious companies through their early years and lend some credibility to land the biggest customers and ward off competition.
If the Rust Belt wants to bail out its economy, almost all the early-stage investment is likely to be local. “[Capital] is the one thing this ecosystem is missing,” Kvamme admitted. But a handful of major exits, such as those below, have put millions into the hands of startup founders and local investors, while piquing the interest of prominent investors.
One of those is Steve Case, former CEO of AOL, who teamed up with JD Vance (author of Hillbilly Elegy) to launch a $150 million seed fund as part of his “Rise of the Rest” campaign. Their fund is among the largest investing in startups outside the existing hubs, although it’s early days. The fund has 55 confirmed investments, according to the fund.
Case said his job has been to jumpstart companies in unconventional locales, while reassuring investors from places like Silicon Valley that the deals have the potential to deliver venture-style returns. “More people are calling us to understand what the opportunities are,” Case said in an interview. “They’re interested in partnering because we will help curate deal flow for later stage rounds. …We’re not at a tipping point, but we’re approaching one.” Already, he says, Bay Area-based funds like NEA, Lightspeed and True Ventures have started investing in startups without the companies decamping for the coasts.
The logic that world-class companies need to relocate to one of three cities with the most venture investment—San Francisco, New York or Boston—is breaking down. For decades, it was common practice for blue-chip investors to demand promising startups relocate to Silicon Valley as a condition of taking their money. Less so today as the promise of a payday has finally arrived in the midwest.
Kubicek knows first hand. In 2016, the Understory founder was contemplating his next move. At the behest of his newest investor, Greg Robinson of 4490 Ventures, he moved his company back to Madison. The former Sand Hill Road investor said the city had changed. Technical talent was plentiful. Financing had arrived. Everything he needed was right there.