Why Has LA Suddenly Gotten So Much Attention from VCs and Entrepreneurs?

“There’s something going on in LA.”

It’s the most common refrain I hear from investors and even entrepreneurs these days. I hear it right after people have decided to come by for a few days to “check out what all the fuss is about.” I hear it when I visit LPs (the people who invest in VCs) all across the country, “Yeah, I haven’t been out there for a few years but I keep hearing that something is going on there.”

Or if you ask the venerable Greg Bettinelli, he’s #LongLA

So what is actually going on in LA? Is it true that the ecosystem has changed? Has it begun to mature or is it just better marketed than in was say 5 years ago? This is the task I set out to answer with the master of analysis at Upfront Ventures Glenn Poppe who deserves the bulk of the credit for our work.

LA By The Numbers

When you begin to peel back the onion some surprising data presents itself. Let me start with the obvious baseline that most people probably know instinctively: Los Angeles is the 3rd largest technology startup ecosystem in the US. Given our city is the 2nd largest metropolitan area in the country this is hardly surprising.

But to answer the actual question “Is there something going on in LA?” in 2014 the data seems pretty conclusive because LA has now become the fastest growing tech startup region by numbers of companies being started and those of us here have noticed this pace accelerating. I know that many VCs instinctively knew this even without the chart below because I’ve noticed the frequency of high-profile VCs (Bill Gurley, John Doerr, Roelof Botha, Marc Andreessen) recently backing companies in LA, spending time throwing dinners & events and even some very experienced VCs (David Lee, Chris Sacca, Erik Rennala) have relocated to Los Angeles.

In fact, data released just yesterday (10/16/2014) in this report by the LA Economic Development Council and released by the LA Mayor’s office showed that LA now has more people employed in high-tech jobs (368,500) than any other metro region in the US, accounting for 9% of all of LA’s jobs and 17% of total wages (that obviously highlighting some other issues that need to be addressed). They estimate that high-tech work contributes $108.3 billion dollars of regional GDP. What is perhaps different from other regions is that we have large indigenous aerospace industry and a big high-tech import/export trade as opposed to a lot of software companies. But even this is changing. More on both trends later.

Given how efficient markets are when a large market like LA starts to blossom it attracts capital pretty quickly. In the last full year where we have data LA attracted $1.5 billion in venture capital to LA’s technology startups and 2014 will shatter that figure.

Over the past 4 years LA’s tech fundings have growing at a 30% compounded annual growth rate (CAGR) which is > 4 times the US average VC CAGR (7%). In the last month alone (ie not captures in the $1.5 billion 2013 figure) have been massive financings at Honest Company ($70mm), JustFab ($85mm), ZipRecruiter ($63mm) and lord only knows how much SnapChat has actually accumulated.

What Has Given Birth to This New Movement in LA?

Many people don’t realize that the majority of the monetization of the Internet originated in Los Angeles but was perfected in Silicon Valley. When my friend and the father of LA’s tech startup community Bill Gross first demonstrated his company GoTo.com (renamed Overture) on stage at a TED conference he was actually booed (True story. You can hear many other amazing stories in this 1:1 interview). What was Bill Gross’s heretical idea as portrayed to the tech elite? He presented a system where your search results would be ranked based on companies bidding for placement and where merchants would be charged on a “cost per click” basis (CPC).

Booed. So much so that if you read Ken Auletta’s wonderful book “Googled” you’ll see that Larry and Sergey had for years stated they would never do paid search results. The monetization engine of the Internet that powers the most profitable business perhaps in history was invented and perfected in Los Angeles and is what you now know as Google Ad Words. The patents Overture held became known in small circles as Google’s ’361 problem as outlined here. Yahoo! acquired Overture for $1.63 billion (Upfront Ventures was an early Overture backer).

Yes, Google won. Of course that’s not disputable. My point is that historically the ecosystem in LA has bred innovations in monetization and technologies but to date hasn’t reached the kind of scale of our major NorCal brethren.

And it wasn’t just Google Ad Words that originated in Los Angeles. Google’s Ad Sense did, too. Ad Words as you likely know are the paid results you see when you do a Google search. Google Ad Sense are the results you sometimes see on non-search pages that show you ads that are seemingly relevant to the words on the page. This method was perfected by Gil Elbaz and his team at Applied Semantics in LA and in what some have called “the most important acquisition ever made by Google” they acquired the company for $102 million before Google had even IPO’d.

What do Bill Gross and Gil Elbaz have in common that portends well for the future of LA Tech?

Both graduates of one of the most premier science institutions in the United States: Caltech. Both are massively funding other LA tech companies through what Fred Wilson once defined as “recycled capital.” Both had super talented senior executives that are now running (and funding) tech startups in their own right, like Gil’s brother Eytan Elbaz or the countless graduates of Overture. Both Bill Gross & Gil Elbaz are building their next companies in LA.

I think there is also no denying the role that Richard Rosenblatt has played in building the LA tech ecosystem and spawning great entrepreneurs who followed in his footsteps. He built & sold iMall in Internet 1.0 for $565 million to Excite. He led and sold MySpace to Fox for $650 million. He built & IPOd Demand Media. And while none has yet had the lasting power of the much bigger NorCal successes I imagine his next moves will continue to be closely watched by those in the know and the countless younger LA entrepreneurs who count Rosenblatt as a mentor may leave an even more lasting impact.

But the “monetization heart of the Internet” doesn’t stop at Overture, Applied Semantics and MySpace. Over the past decade we’ve had high-profile exits at many companies that pioneered monetization techniques now used across the web including Commission Junction, Value Click, ShopZilla, Price Grabber, LowerMyBills and a newer breed including Invoca, Burstly, Shift, Rubicon Project, Gravity, Convertro, Retention Science and so forth. Many of the early winners sold for north of a half a billion dollars.

Success begets success. The seeds planted by those who came in the 90′s have begun to blossom 15 years later literally into seed capital, blossoming new entrepreneurs and an ecosystem of experienced operators that powered LA 1.0 and are guiding LA 2.0.

But Is This Really That Surprising? Isn’t the Overall Market Just Booming Now?

Aren’t some of the recent successes in Los Angeles just emblematic of the overall long tech boom we’ve seen nationally and has led to growth in funding in NY, Boston, Seattle and San Francisco? To some extent – of course they are.

But this time there really is something happening in LA. It is different. More substantive. Lasting. Structural. This time we won’t stop at a mere half a billion but we seem destined to create the kind of tent-pole successes that have brought lasting change to markets like Seattle.

Of course most of you know SnapChat, Tinder & Whisper and many people immediately associate the success of Los Angeles under the SoLoMo banner (Social, Local, Mobile) and you wouldn’t be wrong. But many people forget that we have 2 relatively recent IPOs that are substantive companies: TrueCar (Upfront backed) & Cornerstone OnDemand. We don’t seem to get credit as a community for SpaceX or recognition as one of the fastest growing communities for commerce: Honest Company & JustFab. You probably know that Disney recently paid nearly $1 billion to acquire Maker Studios (Upfront backed) and that is really just the 1st inning for online video companies hatching out of LA.

If you throw in Oculus into the mix along with TrueCar, Rubicon, Burstly, Beats and others LA Tech has seen more than $8 billion in exits in 2014 alone. As Adam Sandler would say, “not too shabby.”

LA’s 2.0 – this time it really is different.

From Infrastructure to Applications – The Three C’s

In order to contextualize the opportunity that exists for the Internet outside of Silicon Valley these days you can take inspiration from the history of technology evolution across many markets throughout history. In her well-regarded (but boringly named) book “Technological Revolutions and Financial Capital: The Dynamics of Bubbles and Golden Ages” Carlota Perez outlines the history of many of our great leaps forward in innovation.

Each followed a predictable path of building out infrastructure followed by a bubble then a crash followed by a more rapid deployment of the technology throughout industry and society. No less than Fred Wilson has credited Carlota’s work with having a major influence on his investment strategy at USV.

At Upfront Ventures we have long argued that the same trend was underway with the Internet but when you’re in the midst of the “infrastructure phase” it can at times be harder to perceive that a separation is happening. I grew up a computer programmer, a builder of computer networks and fascinated with infrastructure so in many ways I felt like I existed at the inception of many of these great technologies.

In order to have the great companies we now know today: Uber, DropBox, Airbnb, SnapChat, Twitter, Facebook and so forth we first needed the “Internet rails” beneath us. We needed routers, switches, databases, caching software, load balancers, application servers, browsers, compression algortyhms, streaming technology, low-cost storage, management consoles, programming libraries and on and on. We saw booms & bubbles in both telecom infrastructure and Internet infrastructure and now, of course, those two things are largely the same.

Once the railways are built most countries (except for some odd reason the US) start to build better versions of their infrastructure so you get high-speed railway in Japan, Germany, China, France and now even connecting France & The UK. So I’m not arguing that the infrastructure building phase of the Internet is over – to the contrary. We see big data storage solutions and processing platforms. We see improvements in wireless transmission and in real-time programming languages.

But.

With the foundation laid the application layer has had its moment. It’s no surprise to see billion dollar companies like Honest Company & JustFab in LA. We are the largest textile and apparel center in the country and now we have a way to reach billions of people in this globally connected Internet. Deflationary Economics now favors us.

Is it any surprise to see Zulily in Seattle, Wayfair in Boston, ExactTarget in Indianapolis, TrueCar in Los Angeles, GroupOn in Chicago or BuzzFeed in NYC? I think it’s the era of the application.

And our belief is that consumer applications — almost all of the things consumers DO on the Internet — that ride on this Internet infrastructure layer fall into just three buckets we call “the three c’s”: content, commerce and communications. These are industries ripe to succeed in LA & NYC. These are industries that start to open up new commercial zones like Cincinnati (home to P&G & Kroger) and Chicago.

Content: It should be intuitive to most that LA is well-suited to take on the world of content meets tech as we’ve seen with Maker Studios, Fullscreen, AwesomenessTV and Big Frame. With all of those companies gobbled up the market is now focused on the next generation startups like TasteMade, MiTu Network, StyleHaul and so forth. We believe there is no denying that the future virtual reality (VR) world will be stimulated in LA where you have the great 3d special effects companies, content creators and movie studios.

Commerce: What is less known is just how important LA is as a commerce hub. Around $400 billion of imports & exports pass through the LA ports each year, which set the national high-water mark in 2012. 36% of all apparel jobs in the US are in Los Angeles. And LA is the largest retail & trade employment metropolitan zone in the country. It’s not accident we have so many great startups targeting commerce including Tradesy, DailyLook, NastyGal, Honest Co & JustFab just to name a few.

Communications: Of course comms companies are springing up globally including WhatsApp, Line, KakaoTalk, WeChat and the dominant platforms of Facebook & Twitter. But there’s no denying that we have more than our fair share of great startups in this space that have emerged recently including SnapChat, Tinder, Whisper and TextPlus (which while much smaller still has millions of monthly active users – Upfront is an investor).

And of course we have great public companies that have spanned content & communications like J2 Global whose market cap as of this writing is a cool $2.5 billion.

Stuff you may not know about LA?

There are so many misconceptions about Los Angeles and these stereotypes of course have been reinforced by tech journalist outside of LA covering our market and trying to draw simple conclusions.

So it’s probably worth pointing out that LA is a town built upon entrepreneurship even if not always underpinned by technology. We literally are a land in which people left their stable East Coast homes in search of opportunity and a chance to start fresh. LA in fact has more entrepreneurs as a percentage of its population than anywhere else in the country.

Intuitively most people know that LA isn’t just the entrepreneurial capital of the US but it is also the creative capital. LA is the largest metropolitan area in the US for people employed in art, design and media and the local creative economy of LA generates more than $140 billion in economic output – more than the GDP of many countries. In fact, 1 in 7 or nearly 15% of Angelinos are employed in a creative field.

But what about tech talent?

Yeah, we got that, too. It may surprise you to learn that LA graduates more engineers than anywhere else in the country. We also have more grad student enrollments each year in computer sciences than anywhere else in the country. So we produce them en masse and we produce them with deep knowledge.

Where do all of these engineers end up? Of course many have been employed for years in the video & music industries and a larger amount have even been pulled into aerospace and defense over the past 30 years. As a result we have a large number of locally employed engineers with video experience that will fuel the next boom of the Internet (Americans watch 5.3 hours of television per day – a number that is not declining and much of this video is now moving online) but equally important is that we are now a rich source of hardware expertise and innovation that is increasingly becoming important as the hardware markets boom.

But our best Internet software engineers have historically been exported on a net basis to the Bay Area. I’m sensing that trend reversing as companies like SnapChat have been able to import large volumes of Stanford grads lured to creating a next gen Internet powerhouse in Venice, California (which by the way, doesn’t suck GQ magazine just dubbed it “the coolest block in America.”). Nicole LaPort recently highlighted this trend for Fast Company, the so-called “SnapChat Effect” in a recent post on the topic of LA attracting great Silicon Valley talent.

You may also be surprised to know that not only does LA graduate more engineers than anywhere else in America but we also have more top 25 engineering programs than anywhere else in America with nationally acclaimed programs at Caltech, UCSD (my alma mater), USC, UCLA and Harvey Mudd.

What Do We See From the Road Ahead?

The infrastructure phase of the Internet is over. It will still garner much investment as it improves in terms of quality, speed and reach but the application layer will rise in it’s dominance. The three C’s: Content, Communications and Commerce will ride on the tracks that have been laid for us and LA has shown itself to be a prominent player in this application phase.

We have the engineers who are graduating from top engineering schools and believe me if they have the opportunity to remain in this dynamic, affordable and pleasant city many would choose to. We now have 2nd and 3rd time entrepreneurs fueled by recycled capital and mentors who have built startups to successful outcomes and have seen scale.

We have our emerging tentpole companies like SnapChat, Oculus, TrueCar and large investments and teams from Google, Facebook & Microsoft.

I also surveyed the list of local VCs and while we are slim on total available local capital I also realized just how many new funds were created over the past decade and how much more modern the skills are of this generation of local VCs are than those of the past.

With the founders, the funds, the application layer of the Internet, the attractiveness of Los Angeles in terms of cost-of-living and climate I think it’s fair to say that our moment in the sun has just begun.