Blair Garrou: Investing in the Middle of the Country

Houston, Texas. Definitely not the most obvious location for a venture capital firm.
We often get asked why we chose to base DFJ Mercury in Houston. In part, it’s actually a simple matter of convenience. We are a seed and startup venture capital firm focused on entrepreneurs and innovation that originate in the middle of the country – what we call the “Midcontinent.” When you are a super-regional fund visiting the number of states that we do, you grow to love Houston for its central location and terrific airport system. There is no substitute for in-person day trips that allow frequent interaction with our entrepreneurs.

But why focus on investing in the Midcontinent? Because innovation isn’t just a coastal endeavor. How can it be with top ranked research-driven university systems such as those in Michigan, Wisconsin, Colorado, Illinois and Texas? In addition, while entrepreneurs in the Midcontinent may have less experience on a per capita basis than their West and East coast brethren, they have a quality that makes them characteristically middle America. They are naturally capital efficient. This fits squarely with our fund’s core objectives.

Our goal is to be a disciplined venture capital firm, targeting highly capital-efficient deals with reasonable valuations led by entrepreneurs employing bootstrapping techniques in information technology or science-based startups. Since capital doesn’t rain down in the middle of the country as it can on the coasts, entrepreneurs tend to be more capital efficient when it comes to their business model (revenue first) and are less affected by valuation bubbles during boom times. However, looking at any comparable metric, the Midcontinent does not get a proportional share of venture money for its early-stage companies.

These regional attributes – university ecosystems, capital efficient entrepreneurs and a venture capital vacuum – combine to make a great investment opportunity. Since inception in 2005, DFJ Mercury has had the privilege of reviewing thousands of opportunities and has become one of the most active firms in the middle of the country. Over the past seven years, we have developed our own framework for investing in the Midcontinent that will continue to allow us to identify, advise, fund, build and exit great startup companies.

Identify “Commercialization Gaps” The delta between a state’s R&D spend vs. VC spend – the “Commercialization Gap” – is a great indicator of hidden value in a state’s entrepreneurial ecosystem. The Midcontinent has many of the largest Commercialization Gaps in the U.S. with Michigan leading the pack (over 70:1) and Illinois, Wisconsin and Texas in the Top 10.

Work with regional startup development organizations. All of our targeted states within the Midcontinent have strong research-driven university systems with established tech transfer offices that have long been regional hubs of innovation. Building from this core, many of these communities have spent considerable time and resources in building out their entrepreneurial ecosystems, launching incubators and other organizations that are producing venture-ready startup companies. These communities also have long-standing, active, local angel networks. When we enter a new region, we work to build relationships with these groups to help us better understand their ecosystem and identify both deal flow and talent. Our team helped create similar entities in Texas so we have an appreciation for how hard these folks work to build and help startups.

Actively participate in regional seed accelerators. To assist in building our Internet and digital media deal flow and ecosystem development, we have spent considerable time working with mentor-driven, for-profit seed accelerators. We have invested in and are active with many of the seed accelerators in the Midcontinent including TechStars, Excelerate, the Brandery, TechWildcatters and SURGE, a new efficient energy software accelerator we are helping to launch in Houston. These seed accelerators have enabled us to source not only deal flow, but also relationships and talent as a result of our advising and mentoring activities. We also gather incredible insight into technology and startup trends through our interaction with hundreds of mentors and well-advised companies every year.

Invest before the team or business plan is set in stone. Our seed investment strategy finds us often investing in deals prior to a complete management team or business plan being formed. This strategy is no different than the scope of venture activity that is dominating the coasts – small, nimble teams launching startups in a lean, capital efficient manner. We have found that these same bootstrapping methodologies can be applied for some, but not all, science-based startups. As such, our fund actively seeks out opportunities to fund small scientific teams with great ideas looking for proof-of-concept funding. Investing early gives us the opportunity to connect the core technology team to resources, potential customers and team members that might not be in their region.

Connect regional strengths with global resources. Prior to making an investment, we map out a startup’s regional and strategic partner needs. Regional needs can be everything from capital to service providers to talent. To execute this strategy, we’ve developed not only close relationships with the ecosystem participants mentioned above, but also other regional funds who, like us, perform a lot of heavy lifting early in a company’s lifecycle. We have also partnered with the DFJ Network, allowing us to access a global network of resources and relationships. Strategic partner needs are met by making early introductions to the tech platform partners of the West Coast – both for partnering opportunities and to begin identifying a startup’s potential exit partners. Seed investing is difficult enough, but startups in Middle America need to be well-equipped at launch in order to compete with companies coming out of the well-established ecosystems of the West and East coasts.

Build capital efficient businesses. Our fund is focused on building capital efficient businesses. Companies that operate with a capital efficient mindset attract entrepreneurs who are inherently resourceful, efficient and tenacious. These companies also provide greater investor flexibility potentially taking advantage of early exit opportunities while still allowing high potential returns on invested capital.

So why don’t more funds take advantage of the underfunded Midcontinent? Because it takes a lot of time. Identifying deals is only a small part of the equation. Once a deal has been identified, you need to access the local resources, ecosystem participants and talent that are crucial to a startup’s success. The good news is that we are seeing more funds exploring these opportunities in the early-stage. But, for now, there are only a handful of very active funds in Middle America.

There is a huge untapped venture opportunity in the Midcontinent. If non-obvious venture deals drive the largest returns, isn’t it also possible that non-obvious regions could produce some of the most novel innovation, successful entrepreneurs and strongest returns? Absolutely.

Blair Garrou is a Managing Director with DFJ Mercury. Opinions expressed here are entirely his own. He tweets here.