Raising money from outside the Valley: Still tough, but maybe not for long

By Hamish McKenzie , written on January 24, 2013

From The News Desk

It took Ben Milne a year of concentrated focus to raise the first round of funding for his payments startup, Dwolla. The company, which has raised $6.3 million over two rounds and is touted as one of the hottest online transactions firms, might have attracted dollars more easily had it been started in Silicon Valley. Instead, however, it was sitting in Des Moines, Iowa -- a push-pin on the prairie, a place where traditionally venture money has seldom travelled.

Eventually, Dwolla scraped together its first million from financial institutions in Iowa. "It was hard as hell," Milne says in reflection. It was probably for the best. The local investors, more risk-averse than their Silicon Valley counterparts, weren't just throwing stupid money at the Dwollla founders. They made the startup work for its money. It had to prove that its systems and software were robust down to the finest detail. "We were not treated like, 'Hey guys, you'll probably figure that out,'" says Milne.

There was no way Milne and his co-founder Shane Neuerburg, who has since left the company, were going to move Dwolla. Moving a team halfway across the country while the company was trying to solve hard problems like combatting fraud would have been a lethal distraction, he says. The margin for error was too small. Says Milne: "I think we would have single-handedly killed our company trying to move the company to the Bay at the time."

But the slow, deliberative approach ultimately paid off, Milne reckons. Advice from one shrewd investor, a local bank CEO, ended up saving Dwolla between $8 million and $10 million in regulatory costs, Milne says, a benefit that proved greater than even the seed capital. In the short term, being stuck in Des Moines definitely held the business back, he says, but in the long term, it helped it.

Even as it has become cheaper and easier to start companies and raise seed funding outside the Valley in recent years, it is still far from easy. Figures from the National Venture Capital Association show that San Francisco alone did 932 venture deals in 2011–2012, at a total value of $8.6 billion. By contrast, US cities outside California, Boston, and New York, could each claim only between 58 to 121 deals each. Investors in Silicon Valley and New York barely even have to leave their desks to get access to many deals. Entrepreneurs will go to them. For Dwolla's Series B round, Milne spent three months out of Iowa, traveling back and forth between New York and the Valley. After a long period of courting, investors eventually became interested enough to go to Des Moines. Dwolla's investors today include Union Square Ventures, Village Ventures, and Thrive Capital.

Michael Tavani, co-founder of Atlanta-based mobile deals company Scoutmob, says that being outside the Valley "absolutely hurt" the startup when it came time to raise money. But it forced the company to be scrappy and pragmatic. It couldn't afford to throw a lot of resources and developers at specific features, so it had to focus intently on what it wanted to achieve, without room for waste. It also selected New York as an early launch city so it could show investors there its potential.

As a result, Scoutmob has found some early success, forging partnerships with Foursquare and Google's FieldTrip, and launching a sideline ecommerce product: the Etsy-like Shoppe, which has been a surprise hit and now accounts for 30 to 40 percent of the company's revenue.

"The problem is it forces you to change your line of thinking," Tavani says of the regional handicap. "It would be very hard for an Instagram to ever be built outside the Valley, or maybe New York City." For Scoutmob that meant having to bring in revenue at an early stage, and to grow its customer base and a merchant base at the same time. It did not have the luxury of spending a long time developing its product without having to worry about how to pay for it.

However, being an outsider has also helped Scoutmob in other ways. There are not as many developers in Atlanta as there are in the Valley, but, he says, there are enough, and there's less competition for them. Being based in Atlanta also means that it can be overlooked by investors. That was one of the things that appealed to eventual investor Lerer Ventures – they felt Scoutmob might be an undiscovered jewel.

In fact, it seems more investors are waking up to the opportunities that lie outside the Valley. In a recent conference call for media, AOL founder Steve Case, who has a venture investment firm called Revolution Ventures, said that he thinks the "Rise of the Rest" will accelerate in the coming years as entrepreneurship spreads broadly across the country.

Technological innovation has made building startups faster, cheaper, and easier, so investments should be more networked, diversified, and distributed, Case said. Last year, Revolution embarked on a road trip across America to seek out promising opportunities. He liked what he saw.

"There's a real recognition in these different regions of the importance of entrepreneurship," he said. Consequently, Revolution will be upping its investments in non-Valley companies – considerably. "We expect 80 percent or more of Revolution's investments in the coming years and years to come to be outside of Silicon Valley."

Investors, Case believes, will start going where the opportunities are rather than forcing the entrepreneurs to go where they happen to be. Case has company. Heavyweight investors like 500 Startups' Dave McClure and Union Square Ventures' Fred Wilson are also casting their eyes further afield in the search of the next great discovery.

If, like Dwolla's Milne, you're an entrepreneur from Des Moines who's spending too much time and money in airports, that news likely couldn't be sweeter.

[Illustration by Hallie Bateman]