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San Diego's Venture Capital Problem

San Diego doesn’t pull as much venture capital funding for software startups as other regions but it’s a top money-getter for biotech.

Tech startup founders in San Diego often lament the difficulties of raising money in San Diego.

Much of that discussion centers on venture capital, funds invested in companies that intend to grow quickly. Investors hope that when these companies succeed they’ll get a payoff too.

For startups, this money can be essential. Without it, entrepreneurs can’t bring products to market or hire the people they need to do it.

And software companies in particular are quick to zero in on Silicon Valley and the plethora of money available there that isn’t in San Diego.

Indeed, San Diego’s venture capital landscape is a bit more barren than the Bay Area’s.

It also lags behind many other regions tracked by the MoneyTree report, a quarterly guide produced by PricewaterhouseCoopers and the National Venture Capital Association.

A recent Associated Press analysis of venture capital data found San Diego ranked 16th in the nation for venture capital deals for tech companies, which excludes biotech, behind Denver, Austin and Orange County.

Biotech is the big exception when it comes to the region’s relatively poor showing for funding: San Diego is the third most lucrative region for biotech venture capital funding in the nation.  At least some local experts and tech companies are eager to try out tactics that lured that crush of funding.

The local focus on biotech funding sets San Diego apart. In Silicon Valley and most other regions, the largest chunk of venture capital money flows to software companies.

The swift growth of software companies in San Diego has created a larger echo chamber of concerns. Indeed, more than 230 software companies started in San Diego County last year. At least some will seek venture capital money to quickly innovate and add jobs. Companies that can’t get funds here may grow more slowly or be lured closer to investors they find elsewhere.

Many companies are getting money, though.

Venture capitalists handed out about $765 million to San Diego area startups last year, and almost two-thirds of it went to life science companies, according to the MoneyTree report produced by PricewaterhouseCoopers and the National Venture Capital Association.

That trend continued in the first two quarters of this year.

 

The longtime venture capital focus on local biotech companies here says as much about the venture capital business as it does San Diego startups.

Venture capital investors – which can include university foundations, government pension funds and wealthy individuals – sign up with venture capital firms in hopes of making more money. Venture capital firms then search for entrepreneurs and companies that appear poised for success. They’re looking for startups that might go public or be bought by another company in the future.

Regions with big success stories get more venture capital money and more venture capital firms.

“Venture capital is mostly interested in home runs,” said Jeb Spencer, who leads a San Diego-based venture firm focused on software startups. “They’re interested in billion-dollar exits. That leaves the majority of software companies without funding.”

San Diego biotech startups benefit from past successes here.

Hybritech, one of the region’s first biotech companies, was founded in 1978 and purchased by pharma giant Eli Lilly for nearly $500 million less than 10 years later.

In the decades since, many other San Diego biotech companies have been purchased by major companies. Many entrepreneurs have been involved in multiple companies. Some have sunk buyout winnings into other startups or continued to work on new products.

That sort of ecosystem also exists for software companies in the Bay Area. PayPal and Facebook employees invest in other local startups, whose founders go on to invest in others, etc.

San Diego tech startup leaders say that’s happening far less often here.

“We don’t have the big winners in the last 10 years that can turn around and invest in tech companies right away,” said Brant Cooper, who’s advised and mentored countless tech startups in San Diego and elsewhere.

Cooper and other local startup backers believe increased investment outside traditional venture capital will help San Diego startups collect more of that cash over the long haul.

It’s not just about writing checks. They’re convinced having more San Diego tech veterans, particularly those from Qualcomm, mentor local companies and serve on their boards will lead to more money and success. Their involvement can sometimes make traditional venture capital investors feel more comfortable writing checks.

Essentially, they’d offer the same cachet that the San Diego biotech industry already has.

The non-biotech ecosystem is improving on some fronts.

So-called angel investors, who aren’t considered venture capitalists, are on the rise in San Diego and across the nation. These are seasoned entrepreneurs who’ve decided to share money, and often some expertise, with startups. And they tend to write checks to earlier-stage startups that struggle to appeal to traditional venture capital companies.

San Diego Tech Coast Angels, which is part of a national group, sunk $7.1 million in startups last year and is considered the second most active angel group in the U.S.  though some of that money has gone to biotech firms too.

Various groups and programs have also sprouted up to help startups outside the biotech space.

In April, a group of UC San Diego alums announced they’d start a university-focused venture capital fund to help entrepreneurs in a variety of sectors.  And groups like Startup San Diego, EvoNexus and many more advise tech startups on how to raise money.  Others, such as 1 Million Cups San Diego, connect startup founders with others who can offer feedback on their business models and more.

But whether those efforts lead to more venture capital money for non-biotech firms over the long haul hinges on what the tech entrepreneurs themselves accomplish and how successful their companies get.

“The reality check is we need some wins,” said Hieu Bui, founder of tech startup Cashie Commerce, which produces tools for online merchants. “(Most of) the wins that we’ve had are all in biotech. The wins are all that matter, really.”

This is part of our quest digging into the difficulties – real or perceived – of doing business in San Diego. Check out the previous story in our series, Who Does What for San Diego’s Business Community, and the next, How San Diego’s Manufacturing Sector Has Changed, in Four Charts.

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