New unicorns, new funds, and new real estate priorities, but where are the mega exits?

Two years ago, I spent my New Years Eve writing a recap of all that had happened in SoCal tech that year. It was an exciting time, with a slate of major exits (Cylance, Ring, and Sonos, among others), and Bird scooters were taking LA and San Diego by storm. That momentum carried nicely into 2019, though I missed doing a year-end review as I spent the final days of December on a surf trip in Nicaragua, thinking some nice time off would be a great way to ring in a fantastic 2020. Of course, it turned out that the best laid plans for 2020 were all for naught. After a flurry of work travel in January and February, an early March breakfast with another LA-based VC would unknowingly be my last in-person meeting before lockdown.

In March and April, there was certainly a sense of trepidation in the tech world as we grappled with the implications of the COVID-19 pandemic. Companies scrambled to reduce their cash burn or wrap up fundraises. Venture firms debated if and how they could invest in new companies without meeting founders face to face. Everybody wrestled with remote work. And nobody in startup land knew how to predict what the coming year would mean for revenue and customer retention, let alone growth.

As it turns out, much of tech managed to resume pace by the summer. Remote work forced companies to accelerate their cloud adoption and digital transformation strategies, and many turned to startups to plug holes in their infrastructure. Stimulus programs around the world helped prop up many industry sectors. Unfortunately, those programs mostly failed to adequately support mom & pop businesses. However, for those tech companies and investment firms that did have access to the capital markets, 2020 saw a torrent of fundraising, and the Southern California tech ecosystem was no exception.

Unicorn formation continued — but with caveats

 

According to CB Insights, seven Southern California companies reached “unicorn” status of private valuations of $1B or more in 2020. This is up from four companies in 2019 (Scopely, Dave, Anduril, and TuSimple), but still only on par with the seven unicorns minted in 2018 (Bird, Fair, ServiceTitan, LegalZoom, ZipRecruiter, GoodRx, and Seismic). In terms of raw unicorn generation, Southern California is still in a very distant third place after the Bay Area and New York. It is also not yet showing the long term signs of growth that one would expect given the hype the region has received in the past few years. It is has arguably underperformed in 2020 given the meteoric rise in valuations that we have seen during the year.

Southern California’s 2020 unicorns do represent a diverse range of industries. Relativity Space (rockets) and Apeel Sciences (materials) join the list of deep tech unicorns such as SpaceX and Anduril that call SoCal home. ClickUp marks the one entrant of enterprise software, capitalizing on the remote work trend that the COVID-19 pandemic has catalyzed. GOAT and Zwift have leveraged technology to build impressive communities in fast growing consumer market segments. However, KKW Beauty and Skydance Media arguably are not tech companies, and will likely do more to catalyze their respective CPG and media sectors than SoCal’s tech sector. As for those outsized 2020 valuations, we tended to see them most prominently in sectors like data science/engineering and fintech — areas where Southern California still lags behind in new company formation.

As I highlighted earlier this year, enterprise startups are generally better at recycling capital and talent through an ecosystem than consumer startups are, and thus form an important part of a growing regional tech sector. In 2021, Southern California’s overall unicorn list needs to grow at a faster pace than it has historically, and it would benefit from more representation of enterprise software.

Local venture firms grew larger

For many years a common lament among local founders and investors has been that while there has probably been sufficient seed money available in Southern California, companies that were looking for larger fundraises needed to turn to Silicon Valley to find the capital. 2020 may be the year when that finally changed. In 2020, six local firms publicly announced new fund groups (main fund + growth funds, specialty funds, or sidecar funds) over $400m:

 

In addition to the above, a number of other local firms, including Mucker, Upfront, Fifth Wall, Sound, 3L, Bonfire, Wavemaker, Sound, and others, have all either recently raised a notable new fund (>$100m), or are currently in process. The region is starting to reach the point where a local company could conceivably complete its entire fundraising journey from seed through late stage pre-IPO rounds entirely with local capital.

For the most part, these firms are relatively new. Of the top 6 above, only Greycroft and Lead Edge have been in existence for more than about five years. A new firm’s third fund is often considered the “make it or break it” fund — LPs start to get a more clear picture of early performance, and the firm has had sufficient time to institutionalize its operations. So many of these firms will soon be facing a real test as to whether or not it is viable to base a large venture firm in Southern California.

One thing to note about all of these large firms is that they are not exclusively investors in Southern California. B Capital invests globally, with additional offices in San Francisco, New York, and Singapore. Greycroft also has an office in New York and invests across the US. Lead Edge, Sinai, March, and Westlake are all active players in the Bay Area and other geographies as well. Southern California’s ecosystem still does not have sufficient scale for large firms to focus exclusively on the region. We will need the unicorn list, and more importantly, the list of exits, to become much larger in order to sustain locally-focused firms.

COVID-19 redraws the map

In the 2018 recap, I wrote that Southern California needed to diversify the geographic range of its startup community beyond the Westside of LA in order to escape the worst effects of the housing crisis. Of course, as has been written many times by now, nothing has reshuffled the deck of “location, location, location” more than COVID-19.

As we end the year, most of the buzz in the tech world has been around mass migrations from the Bay Area to Texas and Florida. Austin is scoring major corporate relocations and already prompting cries that the growth is too much. Meanwhile Miami’s Mayor Francis Suarez is putting on a masterclass in using Twitter to woo and capture influential newcomers. Mayor Suarez’s moves to draw tech talent are somewhat reminiscent of Los Angeles Mayor Garcetti’s call to action for tech early in his term. Unfortunately, his activity on that front seems to have settled down as he has jockeyed for a larger national presence and has grappled with growing crises at home around homelessness, housing affordability, and COVID-19.

So has Southern California been a net recipient of COVID-19 migrations, or have its citizens joined the caravans heading to lower income tax, better governance pastures? Early in the pandemic, it certainly did feel like the entire East Coast was coming here to spend at least a few weeks in Malibu or Palm Springs. However, a quick look at rental data from Zumper would seem to suggest that LA is suffering from the same mass exodus as the Bay Area and New York, causing falling rents. Meanwhile “hot” cities like Miami and Austin have continued to see year over year increases in rental costs:

However, a deeper look at different cities within Southern California reveals a slightly more complex situation:

While rental prices have indeed fallen in Los Angeles, they have remained steady or even risen in other parts of Southern California. And when we look at home sales prices rather than rentals, it appears that prices not only continued their rise in 2020, but actually accelerated compared to previous years:

So the overall picture for Southern California remains mixed. Perhaps there has not been a mass exodus in the same way that some other cities have experienced, but there certainly has been a reshuffling, as people look for more space to work from home, and as the amenities of city living don’t seem quite as attractive under lockdown. But the allure of the Southern California way of life seems to be mostly intact, despite all the challenges facing the state.

Looking ahead to 2021

The one topic that I have not touched upon yet is exits, which form the backbone of any healthy ecosystem. Outside of life sciences, this was a relatively quiet year for Southern California. Yes, a number of local players in electric vehicles like Karma, Fisker, Cazoo, and Nuuve were swept up in the SPAC craze. But after the blockbuster acquisition of Honey by PayPal at the end of last year, things have remained fairly slow on the more traditional M&A and IPO fronts. Perhaps the most notable acquisition of the year was Fastly’s purchase of cybersecurity firm Signal Sciences for $775m, which added momentum to the growing cybersecurity cluster in Southern California.

However, that one large acquisition was not enough, especially in a year when the IPO window seemed wide open. Southern California needs to find a way to increase its pace of unicorn formation, especially outside of the consumer sector. More importantly it needs to generate more than the one or two major exits per year that it has steadily realized over the past decade. Now there is plenty of local capital available, and the trend towards remote work means that Southern California companies should have an easier time finding top talent as well. So we must find ways to build larger companies.

As we head into 2021, Southern California is at a crossroads. Despite some early vaccine distribution and lockdowns, the region is arguably the epicenter of the COVID-19 crisis across the nation, creating significant uncertainly around when life can return to normal. But the tech world must march on, and Southern California founders have never had better access to capital and talent. 2021 will be a year to capitalize on these strengths and build a new post-COVID generation of meaningful companies.