East / West Venture Capital

A main challenge for early stage entrepreneurs is raising Venture Capital to fund and sustain their initial operations. Securing investment requires adopting a variety of start-up, business and promotional strategies, however the challenge also demands that entrepreneurs understand the specific cultures of different Venture Capital communities. 

Here we examine the broad cultural differences between East Coast and West Coast Venture Capital communities.

While significant differences exist between the venture approaches and business values of each coast, these differences should not be considered exclusive to either coast of the United States.

The explored contrasts represent broad dichotomies between different Venture Capital approaches found within and beyond the shores of the USA. 

Historically Venture Capital firms preferred to invest in local companies. However, contemporary technologies across the globe are making it easier for investors to make capital investments in companies beyond their local communities, states and even countries. 

Still, entrepreneurs should recognize that it is both easier form an investment, due diligence, and relationship building perspective that being in the right location can significantly enhance the financing potential of your start-up. 

Truthfully, neither the cliches or assumptions of either West Coast or East Coast Venture Capital culture are totally accurate. They represent generalizations about different cultures and approaches to investing. Broadly speaking, it is becoming more common for Venture Capital firms on either side of the country to adopt traits of their coastal counterparts.  

Lets start with, 

 

The East Coast:

 

Culture: 

East cost investment culture is more conservative. The investors are jacket and tie, business formal, three piece suite types. They tend to be practical investors willing to do deals that offer clear paths to triple their money, in a short period of time, even if the opportunity to achieve a 10X return is minimal. 

East Coast investors are risk adverse and typically invest in companies with established operations who have familiar and proven executive teams. They are often cut-through negotiators who see the glass as half-empty, with deeply analytical minds who always think of the worst case scenario. 

The investment communities on the East Coast tend to be smaller and less open, which means that having inside connections to the communities can be essential for entrepreneurs to gain visibility and possible financing.

To build on that, the East Coast has fewer socializing and networking events for investors and entrepreneurs, with many of them taking place behind closed doors. Again, having connections can be make or break for East Coast entrepreneurs. 

 

Investment Style/Focus: 

East Coast investors tend to be more conservative, protective and stringent when it comes to offering term sheets. They don’t make quick decisions, will demand many screening and informational meetings, and will generally offer lower, “more accurate”, performance based valuations to seed stage companies. 

East Coast investors have a smaller appetite for seed stage investing, and prefer not to invest in the earliest rounds of financing that typically focus on prototype development and customer discovery.

East Coast Venture Capital is analytical, result and performance oriented, and the community is not keen to invest in ventures solely based on their growth potential. Entrepreneurs will be asked for hard evidence (sales) that supports the validity and potential of their venture. 

When approaching East Coast investors, entrepreneurs should be prepared to answer specific questions including: How big is the addressable market? How fast is it growing? What specific product features do you offer that will convince customers to buy from you instead of competitors? What evidence do you have to back up these claims? Why are you the best person or group to lead this venture?

 

Liquidity Preference:

East Coast investors prefer Participating Preferred investment deals. This deal structure ensures that the investors get the most value from their investment at the event of exit (when the company is sold) and especially if the business is sold for less than the expected price. 

Essentially, Participating Preferred ensures that at the event of exit the investor gets their investment return before anyone else, plus the ability to participate (benefit from) an agreed upon multiple of their initial investment before the rest of the shareholders. 

Entrepreneurs should be careful when agreeing to participating preferred deals. The “participating” portion of the deal can result in the entrepreneurs being cut out significantly from the proceeds of their company’s sale.

 

For example:

A Venture Capital firm with a 3X participating preferred invests $50 million in a startup for a 60% stake. The company is later sold for $100 million. The expectation is for the V.C. to receive $60 million of the $100 million, leaving the other $40 million for the leadership team, essentially the common shareholders. 

However, the Venture Capital firm receives more. It gets $50 million of the proceeds and $30 million more – which represents the 60% of the remaining $50 million. This means that the Venture Capital firm gets $80 million, or 80% of the proceeds, leaving the leadership team with a only $20 million. 

 

To get the best possible investment deal, East Coast entrepreneurs should consider creating a competitive bidding process among East and West Coast Venture Capital firms. Applying this strategy can boost a company’s valuation to twice as high compared to a strategy solely focused on the East Coast Venture Capital community. 

Participating Preferred deals are often perceived as unfair. However, some argue that the deal structure helps align the incentives of investors and entrepreneurs. Plus, these deals can indicate real confidence in the leadership team’s ability to deliver a 3X return on their investors money. Moreover, the deal type can render companies more “backable” for future investment. 

It is essential that entrepreneurs to carefully understand any Participating Preferred structured deal and how it can affect the future economic returns for all the involved parties. 

 

The West Coast:

 

Culture:

West Coast investment culture tends to be much more laid back with a higher risk appetite compared to the East. The Investors tend to be younger, business casual, flip-flip surfing types.  

West Coast investors value big ideas more than financials. They tend to see the glass as half full, and demonstrate a higher willingness to take significant risks or gambles on unproven companies, technologies, and early-career leaders. Broadly speaking, they tend to be more optimistic and less risk adverse. 

The West Coast entrepreneurial ecosystem is also radically different from the East Coast. The environment engenders a pseudo-celebrity culture with people often referring to investors or successful entrepreneurs by their first name only. The presumption is that anyone listening in the conversation understands who is being referred to. In a way, this is representative of the pervasive hype culture of the West Coast. 

The hype/celebrity culture has its benefits and drawbacks. When your company is hot, it can dramatically help drive sales and customer awareness. But, it can have the opposite effect if your company operates in an industry that isn’t popular in the contemporary moment. Investors will easily think little of a venture and its team based on how popular the problem it aims to solve is, rather than the actual performance or strategic trajectory of the business. 

The investment community on the West Coast tends to be larger, less formal, and more welcoming compared to the East. With many more participants, the community organizes a lot of socializing events that provide unique networking opportunities for investors and entrepreneurs.

 

Investment Style/Focus:

West Coast investors are more intuitive with their investment strategies. They are more flexible in how they negotiate with entrepreneurs, determine valuations, and define exit strategies. Broadly speaking, West Coast investors offer young businesses higher valuations, and base the valuation more on potential and less on economic performance. 

As with their East Coast counterparts, investors in the West increasingly avoid the earliest rounds of financing that focus on prototype development and customer discovery. 

However, should they recognize significant growth potential in a venture and believe in the leadership they will be more inclined and anxious to invest. Particularly if the investors missed out on a comparable venture opportunity with significant potential that another venture rival captured. 

To build on this, West Coast investors are prone to momentum investing. Investors often make numerous bets on companies in the same space, and will even accumulate a portfolio of companies that compete with one another in some form. 

West Coast investors generally prefer to bet on ventures that remind them of previous successes. If they like the market a venture operates in, it’s ability to penetrate it, and the leadership team’s ability to execute, they will likely invest in the business with confidence. 

 

Liquidity Preferences:

West Coast investors are more flexible with the types of deals they are willing to make with entrepreneurs compared to Eastern counterparts, and Participating Preferred structured deals are less common. 

Typically, if the entrepreneur or founding team makes a capital investment in the first round of financing their business, they can adopt a stronger negotiating position with future investors. In this scenario ventures can ensure that the investment terms with investors and capital partners are set to only 1X preferred. This gives the right to investors to get their money back 1 times before the other investors get to benefit from the proceeds. 

Entrepreneurs familiar with the West Coast ecosystem often ask investors for a “clean term sheet”, which represents a term sheet with a 1X Preferred rather than 3X Participating Preferred structure. The 1X Preferred deal structure awards the company a higher valuation, which results in the Venture Capital firm receiving less equity than it otherwise would at a lower valuation. 

 

Conclusion

 

Besides the cultural differences between the East and West Coast Venture Capital communities, they also exhibit differences in the types of deals they prefer to invest in. 

While East Coast investors are more interested in ventures within the financial services, manufacturing and bio-tech industries, West Coast investors tend to more interested in information technology, internet and entertainment industries. While this is not exclusively true, the trends are reflective of the different investment cultures found on either coast. 

Entrepreneurs should study the venture markets on either coast and the rest of the country carefully before determining which specific Venture Capital firm to approach for investment. 

Broadly speaking a diverse investment community is a great asset for the United States economy.

The different investment cultures allow for a variety of venture-backed business to emerge and positively impact the economy. From a macro perspective the diverse investment communities present across the United States work well in tandem.

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Send me a question: moebius@zenofwuwei.com