This is a post I’ve wanted to write for a long time, but I needed the time to digest all the other great posts on the topics by other investors, and to analyze specific portfolio data from Haystack over the last five years. Well, that time has finally come. As a warning, this post will have more subheading than usual, and it will be packed with lots of links — please click through and read them. I believe this is an important post for both founders and investors in the Bay Area and outside the Bay Area to read carefully.

When I began investing a little over five years ago, it felt like the conventional wisdom was that one had to invest in the Bay Area to harvest venture-like returns. Of course, that was not 100% true, with innovative startups and large outcomes occurring in Europe, in Asia, and other parts of the USA. But, it wasn’t directionally wrong, looking at enormous multinational companies like Apple, Google, and Facebook which rose from the hallowed ground of Silicon Valley.

From an investment point of view, managing and deploying capital in the same physical area makes sense, where investors can work with young companies and help them with a variety of things. More recently, this trend has shifted a bit within the Bay Area, which today’s giants like Uber, Airbnb, and Stripe being built in San Francisco proper while incumbents down south have begun scooping up premium commercial real estate in the city.

Over the past two years, however, I’ve felt that something is out of balance. Yes, the concentration of entrepreneurial founding and management talent is here in the Bay Area, but so too is lots of private money, more and more large platforms which continue to grow in market share. And, so, I began to ask myself, in the face of intense local inflation for rents, for talent, for simply getting around — are the fundamental of the Bay Area’s local conditions simply inhospitable to fledgling startups that I am trying to invest in? Will folks be able to buy a house and raise their families here? Will the Bay Area’s cost structure compress the precious runway these newco’s have? Will the next company to raise $100M in financing just poach from decent seed-stage companies and pay triple the amount to lock up talent? These questions have been rattling around my brain. Anyone who spends time with me knows I obsess over it.

So, about two years ago, as a Bay Area resident, living right off Sand Hill Road, started intentionally investing outside the Bay Area. I wouldn’t say I’m entirely comfortable with it just yet — it is hard — but I’m getting more comfortable with each passing month. Below, I’m going to share some of the influential data and posts I’ve collected along the way, because it is too easy and en-vogue to say “the Bay Area is overheated” or to make armchair claims without the benefit of data. Here goes….

Learning From USV and Foundry

If you follow me on Twitter, you’ve by now gathered I often share Fred Wilson’s posts. I have been reading Fred’s blog AVC for about a decade now. I sort of feel mentored by Fred via his blog, which is pretty remarkable for just writing words on the web and sharing them. One topic Fred has been writing about for many years is the geographic diversity at his firm, USV. Fred and his partners Albert, John, Andy, before Brad, now Rebecca have operated headquartered out of New York City, and have invested successfully near home (Esty, MongoDB, Kickstarter), in the Bay Area (Twitter, Coinbase) and in Europe (SoundCloud).

To highlight some of Fred’s writing on the topic, consider the following: In 2015, writing about how roughly 25% of USV’s investments were based in Europe; In 2016, citing Richard Florida’s work on global venture capital distribution tilting toward going global and urban; later in 2016, writing about “The Spillover Effect” from the Bay Area to other parts of the country due to the rising cost for talent; and again in 2016, writing about “tiers” of startups hubs in the USA, which caused a bit of a backlash for his classification, but was directionally correct. The argument threaded through Fred’s posts above is that significant venture-scale opportunities for VCs existed outside the Bay Area.

Another firm linked closely to USV — Foundry Group in Boulder — has also been investing with an eye for geographic diversity. While I don’t have portfolio level stats for them, their new endeavor Foundry Next (to invest in smaller funds and then follow-on into key investments) has built up an LP basket of 23 positions in a variety of new VC funds. Of the 23 funds listed here, 13 are in the Bay Area, 3 in NYC, 3 in Boston, 2 in LA, and one each in Detroit, Seattle, Toronto, Waterloo, Indianapolis, and Fargo, North Dakota. This is a very clever way of helping new funds get their footing and hearing about what is working before others may pick up the scent.

Global and Local

Of course, over the last decade, the rest of the world doesn’t need to read these blogs to see what’s going on. I caught a glimpse of this energy during my Venture Partner tenure with the folks at GGV Capital, who’ve been successfully investing exclusively across China and the U.S. and seen the rise of absolute juggernauts with deeply global ambitions such as Baidu, Alibaba, Tencent, and Xiaomi. More recently, as I sit as a Venture Partner at Lightspeed, their franchise model across Israel, India, and China lends even more credence to the fact that consumer-level and application-grade innovation now knows no geographical boundaries. Just like Sequoia with their franchise model, or Accel, or the other larger funs, the top-tier venture capital firms have scaled up and out to grab these opportunities.

The global story is undeniable, but what about what’s going in the USA outside the Bay Area? Before we leave the Bay Area, consider this stat: In 2017, NYC received more venture capital dollars than the South Bay (aka The Peninsula, or what is really Silicon Valley). San Francisco proper was #1, and taken on the whole, the Bay Area, of course, receives more venture capital investment than anywhere else, naturally. However, while no American city will take that mantle in the foreseeable future, more cities beyond NYC, LA, Seattle, and Boston are getting more venture capital dollars as the private markets grow. Bloomberg published an incredible piece full of graphs and graphics looking back at 2017 venture capital data, which is worth a close examination. Pitchbook also published interesting historical data going back to 2010 for the Top 20 cities (not including the Bay Area) to receive venture dollars and how those numbers change year over year.

Migration, Diasporas, and Rejuvenation

For a host of reasons (including the housing and transportation crisis in the Bay Area), the region now carries two key risks: One, will we witness talent migration away from the Bay Area, where entrepreneurial talent simply opts-out of the system? And, two, will the next generation of builders and dreamers be able to afford to live in the Bay Area? (I can’t even tackle the more systemic issue around immigration here, but consider that yet another risk to value creation for the region.)

On question #1, we see good indicators that folks are leaving. Job site Indeed blogged that nearly 50% of Bay Area-based technology job seekers searched outside the Bay Area, and this climbed to nearly 60% for the age 55-64 bracket; on that same blog, Indeed demonstrated a city like Austin, for instance, saw both the largest decrease in outbound job searches as well as the highest increases in inbound searches (i.e. people looking to move to Austin).

Redfin, the Seattle-based home buying site/app, has been beating this drum for years, recently stating that we will see “mass migration” from the Bay Area based on housing. The CEO writes “Silicon Valley is going to leave Silicon Valley… the technology companies… they’re chasing talent, and talent is chasing affordable housing.” Redfin specifically identifies Denver, San Antonio, and Houston as the next hubs newer generations will seek out. (I cannot name the company, but heard from a friend that a very large SF-based startup that’s looking to build a new location outside the Bay Area offered relocation packages for folks to move and it filled up to 100 requests in a day. People are voting with their feet.)

On question #2, it’s too early to tell. How many fresh college graduates are going to LA or Seattle or New York versus coming to the Bay Area? I think it will take a few years to understand these numbers and the impact. A blog entry for another day.

On the ground, I am seeing more hybrid solutions. There are quite a growing number of founders who start a company in the Bay Area and are technically headquartered there, but then they “offshore” some parts of the operation (to another country) to keep costs sane; or they “onshore” to a lower-cost center with the USA (such as having an engineering office in Portland); there’s also “nearshoring” where the executives may be in San Francisco proper but customer support and other staff may be in Santa Clara or the East Bay, to help save costs; and then there are companies which are entirely “distributed” from the beginning. Much of this would fly in the face of conventional Silicon Valley lore, but today are usually considered basic norms. “Raise here, but deploy elsewhere” is not a crazy strategy in today’s times.

Haystack Portfolio Data

We spent a good part of this year analyzing portfolio data across three previous Haystack funds and the fourth which is currently underway. Here are the high-level geographic stats:

Of all the companies Haystack has invested in, 68% are in the Bay Area, with 32% outside the Bay Area (20% in LA, NYC, Boston, or Seattle; and 12% in a host of other cities, including in Canada).

Of the companies in the Bay Area (which makes up 68% of the total portfolio), 41% (of the total portfolio) are in San Francisco proper, while 27% (of the total portfolio) are mainly spread across the South Bay, the East Bay, and one in the North Bay.

Of the Haystack companies which are in major startup hubs outside the Bay Area (which makes up 20% of the total portfolio), 13% are in NYC, 4% in LA, and nearly 2% each in Seattle and Boston.

In terms of dollars at work,

In Haystack II, nearly 10% of the fund’s capital was invested outside the Bay Area.

In Haystack III, nearly 25% of the fund’s capital was invested outside the Bay Area.

In the current fund, Haystack IV, a bit over 50% of the capital invested to date has been invested outside the Bay Area, though it’s early in the fund’s life and this percentage could change quickly in a few months or by next year.

The Future and Future Posts

This is as far as I’ve gotten. It will take more time to see if my instincts were right. And there are more posts to write about the challenges and opportunities created by the flattening of company creation and venture funding. For instance, I’ve noticed within Haystack’s companies outside the Bay Area, it’s possible to build up a core team and recruit people out to their headquarters, but then preparing the companies for follow-on Series A financing in the Bay Area is a grueling exercise. New technologies make it easier to communicate quickly across state borders, but how do you make for serendipitous interactions or peer pressure from being around other startups? That’s just the tip of the iceberg. I have lots more to share on this for founders, so hopefully, I can get through it during the summer.