Mike Katz is in a Venture Capital Seminar class at Columbia. Below is an excerpt from his final paper. We’ve lightly edited his intro, and reprinted the rest from his blog with permission.
For the past six months, prominent players in the New York City technology community have loudly – and increasingly – asserted that NYC is “hot,” or “exploding,” or “insert any other dramatic adjective here.”
The individuals making these claims are as smart as they are savvy, and are astutely aware of the value of increased attention on the blogosphere. Although provocative, these declarations have generally lacked hard evidence and usually have been inspired by biased anecdotes from a select few.
I set out to go beyond one-off observations by analysing concrete macroeconomic data about technology entrepreneurship in NYC. As part of this process, I conducted 35 interviews with local investors, start-up founders, and government officials. It might be a long list of some of the who’s-who of New York, but it is unfortunately far from exhaustive.
If the lifeblood of an innovative environment lies in a community’s optimism, eagerness to defy odds, and diversity, New Yorkers have entrepreneurship wired into their DNA.
However, other variables such as (i) the amount of capital available for investment, (ii) the ability to attract and retain employees, and (iii) leadership in several subsectors to foster a community, are essential to turning ideas into thriving companies.
Early Dollars: Vibrancy of the Startup Investment Community
Angels and Seed Funds
In terms of investors, New York has a plethora of seed funds, micro venture capitalists, and wealthy individuals to financially help companies at the most embryonic stages. The centre for an Urban Future, a nonprofit that studies the overall health of New York City, estimates that these angel investors and their associated funds have “$250-500 million available for investment” over the next decade. Assuming an average angel/seed investment of $250,000 (which is conservative), this current aggregate pool of capital will fund somewhere between 1,000 and 2,000 companies in NYC.
Of note is that most of these funds are small and tend to diversify risk by co-investing with other angels. This practice increases overall activity, and hopefully speeds the rate at which this pool is deployed.
However, getting funding is only part of a thriving technology startup community; entrepreneurs need advice and guidance as much as they need money. In this area, New York appears to only have a nascent, albeit growing, network of experienced early-stage investors. In the words of outspoken entrepreneur, Matt Mireless of SpeakerText, “good luck finding angels in NYC who understand early-stage tech investing. Technically, they’re out there somewhere… But I haven’t seen them.”
Mireless also scolds the tight knit nature of the angel community in New York because although it enables easy collaboration amongst investors, it also means entrepreneurs do not have as many chances to impress this group. Mireless says there is “no learning on the job; you better wow them right out of the gate” or they will talk to each other and the company will never get funding. Although many in the community would disagree with him (or at least say he’s over the top), the crux of Mireless’s thesis appears true.
In short, the money is out there for young companies in New York City, but the community needs more seasoned very early-stage investment professionals and outlets for mentorship.
Traditional “Series A” Venture Capitalists
Once startups pass the initial funding hurdle and build a proof of concept, many will require more substantial capital from a VC. For businesses competing in sectors common to NYC (see the below section analysing the leading technology areas in New York), these investment sizes tend to creep into the low seven digit range, and the active VC firms in NYC often form syndicates of two to three firms per deal. Unlike other hotbeds of entrepreneurship – such as Silicon Valley, Boston, or the Research Triangle – venture capitalists in New York are reasonably accessible. This accessibility means that even entrepreneurs with poor social networks – but exceptional products – can still get meetings with investors.
Conversely, many entrepreneurs complain there are not enough investors in NYC capable of writing “real” Series A checks. The evidence suggests they are probably right (see below), but many non-NYC based firms have slowly crept into the five boroughs to fill this investing gap. Some Boston VCs that are active in New York include Matrix Partners, Spark Capital, Polaris (through Dog Patch Labs), Softbank, and General Catalyst (far from a complete list). Silicon Valley investors are also increasing their time in New York with Battery Ventures being particularly active. Finally, other tri-state area firms such as Edison and Updata, both of New Jersey, have enriched the entrepreneurial community of New York by investing here for many years.
Despite this interest from firms based outside the Big Apple, it is difficult to determine what percentage of these non-NYC firms have earmarked assets for investments in New York. Confounding this ambiguity further are firms like Bessemer which are based locally but have offices around the globe. Consequently, to assess how much “pure” New York VC money exists, I assembled the following table:
As mentioned in the caption, this data is simply a back-of-the-envelope analysis using public sources. In fact, I previously worked/interned for two of these firms and back then loved laughing at how wrong outsiders could be when trying to draw conclusions from fuzzy private information. I would never reveal confidential data, but I think this analysis – although likely extremely incorrect – provides some interesting insights.
With that said, this data comes from Capital IQ and details the two most recent funds for venture capital firms that meet the following three requirements: (1) the most recent fund exceeds $100 million, (2) the firm’s primary offices are in New York City, and (3) the firm has a bias to invest in NYC above other regions. In the far right column, I also attempted to estimate the capital that remains from the most recent fund (note: assumes half of the fund is reserved for follow-on investments, fees, etc. and the remainder is invested equally over five years. This equal allocation clearly happens infrequently in reality and five years is likely too long, but I tried to estimate variables that seemed consistent with trends in NYC).
As shown, all but one New York VC will need to raise a new fund in the next few years, and the aggregate estimated Series A capital available for investments in new startups is $197 million. Considering VCs have likely delayed deploying capital through the economic crisis, there is a respectable amount of dry powder remaining. Also, capital will increase further once fundraising returns to traditional levels. Interestingly, the data suggests the sum of NYC venture capital funding closely approximates the sum of angel/seed capital available (although this ignores entry by non-native firms as mentioned above and the creation of new vehicles such as AOL Ventures).
Scaling Headcount: Educational Support & Finding Talent
Perhaps even more difficult for startups than finding helpful investors is attracting and retaining talented employees. New York has the largest consolidated workforce in the country, yet, like any other city, has challenges matching candidates with companies that can fully leverage employees’ skills. Also, Silicon Valley has long been a draw for the best engineering talent because that is where the startups were. However, as Fred Wilson of Union Square Ventures likes to half-joke, “nobody graduating in the top of his or her class from MIT, Carnegie Mellon, or Columbia actually wants to move into the California suburbs at age 22, buy a car, and commute every day to a nondescript office park. These kids would much rather enjoy the New York lifestyle of living in Williamsburg and hopping on the subway to code in an airy loft/office in SoHo.” As a result, the tide of this “westward migration” of technical talent is starting to turn due in large part to changing practices at New York’s schools as well as altered attitudes about the financial services sector.
Powerhouse Academic Institutions
In my chat with Mayor Bloomberg, he pressed that NYC’s universities have created “legendary inventions with no real companies.” Although this represents some hyperbole, Columbia, NYU, Pratt, Parsons, SVA, etc. are poor incubators for commercial enterprises. For example, in 2007, the most recent year for which data is available, the centre for an Urban Future noted that “NYU was number one among all U.S. universities with $791 million in royalties, while Columbia was number two, with $135 million. No other university topped $100 million.” Further investigation by the CUF suggests New York schools are unwilling to “swing for the fences” like Stanford, Harvard, and MIT do. This is a fundamental problem for New York – both inside and outside of schools – and an issue discussed in more detail in the below conclusion.
The Curse of Wall Street
Thousands of high-quality engineers and computer scientists might graduate from New York’s world class schools every year, but “these individuals have historically flocked to write algorithms for hedge funds rather than work on manipulating open APIs,” says David Lerner of Columbia University’s Technology Ventures Lab. With these Wall Street jobs come high wages and annual cash bonuses and the top talent is not accustomed to being paid in stock options. This is a hindrance for New York because founders make significantly below market salaries until they have a successful exit, and although the long run financial benefit might be on the side of founders, the difference in the interim is so stark (i.e. the dramatic change in lifestyle) that few technologists are willing to take the plunge. The collapse of the financial community has changed this slightly with so many “quants” out of work, but the attitude is still pervasive in NYC.
Technology Leadership: Finance and Media + 5 Exciting New Sectors
New York has always been a centre for finance and media, but from these two behemoth industries have emerged five sectors where New York is currently leading the technology world:
1) Advertising Technology. Google acquired NYC-based DoubleClick for its superior ability to match advertisers and publishers down the long tail of the curve. Out of this firm, a number of other companies like ContextWeb and MediaMath have been spawned or encouraged. Additionally, New York businesses outside of technology spend huge portions of their budgets on advertising and web promotions so it is not coincidental that the leading search marketing firms (such as Conductor, Altruik, and Clickable) are also based in Manhattan.
2) Advancements in Finance. Maybe Goldman Sachs’ innovation of credit default swaps is not a praise-worth advancement in recent news, but New York is home to the most innovative “fintech” firms in the world. SecondMarket, an online portal for shares in private companies, is the first of its kind to scale and is now experiencing significant network effects. Fynanz (a private student loan platform) and ProtEquity (a firm focused on creating downside protection tools for homeowners) both could not be born anywhere else.
3) Next Generation E-Commerce. New Yorkers have always needed to be creative to survive, so serving as home to the next generation of e-commerce is a perfect fit. Gilt Groupe, Etsy, VillageVines, Kickstarter, Quirky, etc. are redefining how transactions are sourced and executed in our changing economy.
4) Creative Content. In addition to finance, media is the second logical strength of New York. NYC is home to the cutting edge of what some have coined “Creative Content 2.0,” with Gawker, The Huffington Post, Daily Candy, Thrillist, LearnVest, JauntSetter, and countless others are eroding marketshare daily from “old school” media.
5) Collaboration & “Real” Social Interactions. New York City’s diverse neighborhoods, bustling restaurants, and crowded bars are examples of how the city’s residents crave social interaction. Maybe people like to get out because the apartments are so small, but NYC is the ideal playground for entrepreneurs developing tools that enable individuals to collaborate. FourSquare, Hot Potato, and Meetup all embody New York’s leadership in this sector.
Moving Forward: New York’s Key Areas for Improvement & Potential Solutions
Mentorship & Employee Development
To support younger and less experienced entrepreneurs, programs like Silicon Valley’s Y-Combinator and TechStars need to take hold in New York. I would like to see the Mayor’s office fund these initiatives, but VC firms should consider financing them too. These efforts will attract more entrepreneurs to NYC (and keep the ones we have) while providing tools vital startup success.
Also, the gap between new and seasoned entrepreneurs seems unfathomably wide in NYC. We need to close this. The Columbia Venture Community has already started formal mentorship programs, but opportunities for informal meetings and hands-on learning need to be more commonplace. Perhaps the Ace Hotel or Tom & Jerry’s can play the role of Buck’s of Woodside in Silicon Valley to facilitate this.
Need to Swing for the Fences
The most common remark shared by all three groups of people I interviewed was that New York needs, in the words of Joe Einhorn (CEO of Thingd), an “ecosystem for a few runaway successes.” As California has seen with the “PayPal Mafia,” and more recently with Google and Facebook, big successes lead to the next generation of new startups when employees leave and start new companies. These departing employees can tap an established network to avoid “reinventing the wheel” and also offer an opportunity for creative talent to remain in the economy and not get bored or retire to a desert island.
DoubleClick was a homerun, but it would be phenomenal for New York City to see other thriving businesses such as FourSquare, RecycleBank, Etsy, Gilt Groupe, and SecondMarket go public or be acquired for multiple hundreds of millions of dollars. These exits are the essential next step in furthering the community.