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Two ex-Sequoia VCs: the most ‘compelling emerging market’ may be America, outside of Silicon Valley

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Roughly eight years ago, investors Mark Kvamme and Chris Olsen left Silicon Valley to open a venture firm, Drive Capital, in Columbus, Ohio. It wasn’t an easy decision. Leaving California wasn’t exactly fashionable at the time. In fact, While Olsen had grown up in Cincinnati, the Yale grad had landed at Sequoia Capital a couple of years out of college — a dream job — and had no interest in going anywhere. Meanwhile, Kvamme is a California native who attended UC Berkeley, grew up immersed in the world of startups (his dad was also a VC), and cofounded four companies before himself landing at Sequoia, where among his deals, he led the firm’s investment in LinkedIn.

Even after a series of developments would lead them to take the leap, the early ride was bumpy. There was no venture community. Midwestern startups were still few and far between. More, Kvamme, first lured to Ohio by his longtime friend John Kasich to take an economic development job that he thought would be temporary, was soon deemed a little too cozy with the state’s power players.

Looking back now, it’s a wonder they stayed. Yet it’s because they did that Columbus is primed for more VCs to join them, they convincingly argue. Indeed, Drive, which now manages $650 million and features nine investors, is receiving interest from 7,000 startups each year, and some of its portfolio companies are beginning to break out. The very first company to attract a check from Drive, an eight-year-old, Columbus-based hospital software maker called Olive AI, was assigned a $1.5 billion valuation just last month in a funding round led by Tiger Global. Another investment, in the five-year-old car insurance startup Root, also appears promising. Root, which went public in November, currently boasts a market cap of $4.7 billion, and Drive owns 26.6% of the company. (Olsen says it hasn’t sold a share.)

We talked late last week with Kvamme and Olsen about what they are building — and why VCs who may be thinking about leaving California for Austin or Miami might pay more attention. You can hear that conversation in full here. In the meantime, following are some excerpts from our chat edited lightly for length and clarity.

TC: Everyone is threatening to ditch California. What’s the argument for heading to Columbus? How did Mark convince you to join him, Chris?

CO: The early case that Mark made is: there’s an enormous amount of money that’s spent on research here. In Silicon Valley, the venture dollars ratio to research dollars is massively too many VC dollars for too little research; the opposite is true here in Ohio. This is more what Silicon Valley looked like in the late 1990s.

At first, I was like, “Nope, not falling for it. There’s no way I’m believing that data. It’s a terrible idea” to move. But I was very much a numbers guy — still am — and when I started looking at the data, [I could see the] economy of Ohio is bigger than Turkey. The economy of the Midwest would be the fourth-biggest economy in the world. It’s bigger than Brazil. It’s bigger than Russia. It’s bigger than India. And it has this legacy educational infrastructure that’s been producing more engineers than any other corner of the planet. It was kind of like, wait a minute. If this thesis is right, maybe emerging markets are the most compelling place for venture capitalists to invest. But maybe the most compelling emerging market is America, just outside of Silicon Valley.

TC: I imagine that you had your pick of companies when you first launched Drive. Is that true and has that changed in this new COVID era, when everybody is striking deals online? Who is showing up that you didn’t see a few years ago?

CO: It might surprise you but we actually didn’t have our pick of the companies when we first got here, largely because it was unusual to be a venture capitalist. In Ohio, there just aren’t a lot of them. And so a lot of entrepreneurs were in non-obvious places. Unlike in Silicon Valley, where you have entrepreneurs sign up on this superhighway of capital, where you go from Y Combinator to the seed investor and then to the A investor, that infrastructure didn’t exist here. What was a little bit surprising to us was how much we ended up having to work to originate investment opportunities here in the Midwest and not because people weren’t here but because that kind of activity just hasn’t been built yet.

We’ve had to spend a lot of time going into the universities and putting new seed managers in business and helping them fundraise and sort of building all of this infrastructure from scratch so that the next entrepreneur is out here [versus moves away], and it works. In our first year, we had inbound interest from 1,800 [startups], then it went to about 3,000 and now it’s up to about 7,000, which is more than I’ve heard any other venture firms say that they see in California. And I don’t think it’s because we’re great. I think that’s more [a reflection of the] scale of the opportunity that’s here now. One of the things that we would love to see more of is more venture capitalists coming here, because there’s certainly more opportunity than we can invest in.

TC: You don’t worry that you’ve teed up the market for other VCs to come and steal your deals?

MW: Not at all. I’m the old guy here, so I remember when Sequoia was started in 1972; my father worked with Don Valentine and National Semiconductor, and it was then Kleiner, Perkins, NEA, [just] a couple of firms. And what happens is you create this network effect. And the more capital, the more folks [who are building stuff in close proximity to you]. Right now, if we don’t invest in a Series A, there’s a couple of local folks, but primarily, [that capital has] got to come from the coasts.

CO: My attitude is, ‘Come on [over] because the worst thing that is happening right now is that I know for sure there are multibillion-dollar investments that are not getting made still because they’re based here. The problem that we have right now is [that] a Redpoint comes in and invests in one company in Ann Arbor, or Benchmark comes into this one company in Indianapolis, or, Sequoia comes in [for a deal here or there] but they aren’t making this their primary business. And until we see more venture capitalists showing up here saying, “This is all I do every single day,” I fear that that next opportunity that we’re missing won’t get its funding. We’re just out of whack in terms of the number of opportunities versus the number of venture capitalists here . . .

[Also] some of the very best investments in Silicon Valley are done with venture firms that can partner and then entrepreneurs have access to a larger Rolodex, a larger pool of capital, more diversity of thought — all the things that they need to grow their business.

TC: You’re competing with other hotspots like Austin for attention. Make the case for Columbus specifically.

MW: If you put a circle around Columbus, a one-day car drive, you’re talking about 60% of the GDP of American, over 50% or 60% of the population, and [access to] a huge percentage of all the top customers. Columbus is in the middle of it all. What we’re able to do then is easily travel to Chicago and Indianapolis and Pittsburgh, Cleveland, Cincinnati; it’s a quick flight to Minneapolis, and so on and so forth. And the Midwest is a spectacular place to build companies.

TC: Drive’s team includes a director of engineering and several software engineers. Why?

CO: One of the things you learn very quickly that’s different about the Midwest is, it’s not a city; it’s a nation. And you have to set up your infrastructure differently if you’re going to be successful investing into that nation [because] there’s just a lot of ground cover.

One of the things that we have been able to do is to look at venture capital and say, “Look, there are a lot of rote, repetitive tasks that venture capitalists do, and what if we could eliminate those tasks, so that we don’t need to hire the boiler room of Ivy League grads to cold call the entire phone book and annoy all the entrepreneurs and do all that kind of stuff. We can do more homework in an automated fashion.” So that was kind of the idea that we had. And so we built this software platform that we’re able to use now to not only identify which entrepreneurs have the highest probability of turning into an investment but also [who are] the people for our portfolio companies who have the highest probability of joining a certain startup, or, which venture capitalists have the highest probability of investing in that follow-on round of capital.

TC: You had the chance to reinvent the VC model when you started your own firm. Are there any things that you did in setting up Drive that were different than what you’d experienced at Sequoia?

MK: We were very fortunate to have worked at Sequoia. Sequoia is by far the best firm out there, in my opinion. And we often use the phrase, What would Sequoia do? And we built a lot of things around that. But we weren’t Sequoia, so there were many things that we had to do that Sequoia had maybe done 40 or 50 years ago  but today doesn’t have to do. That includes building a lot of these capabilities Chris had mentioned before, building some of the infrastructure, helping lawyers understand how to do Series A term sheets or finding headhunters.

We’re also not in a situation where everyone is coming into the office [unlike at Sequoia]; they see a lot of wonderful companies that just ring them up. That’s why we had to be very focused on our outbound efforts. So I’d say that 60% to 70% of what we’ve done, we learned at Sequoia, but the rest we had to make specific to what we’re doing here at Drive.

TC: How big a net are you casting geographically?

CO: At this point, it’s massive. If you were to look at our portfolio, we have companies in Denver, Washington, Atlanta, Toronto, Austin. I think what we’re finding is that this opportunity is a broader phenomenon that we’re investing in.

Before we will invest into any of these cities, we’ve had to go in the same way we did into Columbus. And we’ve had to meet with the landlords, because landlords out here are not built for startups. They’re built for legacy companies, and they want to see five years of trailing financials, and they want a massive security deposit. And it’s like, “Well, I don’t have that.” So too with the headhunters. There are phenomenal headhunters in Ohio. They’re totally different than the ones who are successful in Denver or in Atlanta because those talent networks are very localized.

But now that done that and we’ve been invested in an infrastructure and we’ve got a density of companies in a lot of the cities that I just mentioned, now we can help and we can be very different from a venture firm that’s just going to zoom in for quarterly board meetings. We’ve got a partnership now that’s expanded where we’re investing people resources, and we’re in the cities on a weekly basis.

Lyron Foster is a Hawaii based African American Musician, Author, Actor, Blogger, Filmmaker, Philanthropist and Multinational Serial Tech Entrepreneur.

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Daily Crunch: A huge fintech exit as the week ends

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To get a roundup of TechCrunch’s biggest and most important stories delivered to your inbox every day at 3 p.m. PDT, subscribe here.

Our thanks to everyone who wrote in this week about the format changes to the newsletter! Feedback largely sorted into two themes: Some people really like the more narrative format, and some folks really want a more link-list styled missive. What follows is an attempt to balance both perspectives.

Starting today we’ll bold company names, so that you can more quickly pick out startups, add more bulleted points to sections, and, per a different piece of feedback, include more regular descriptors of companies that are not household names.

That said, we’re not going to abandon chatting with you every day, as TechCrunch is nothing if not full of things to say. So here’s a blend of what the new, updated Daily Crunch team had in mind, and your notes. A big thanks to everyone who wrote in!

Alex @alex on Twitter

A mega-exit for American fintech

The news that public fintech company Bill.com will buy Divvy, a Utah-based startup that helps small and midsized businesses manage their spend, was perhaps the biggest startup story of the week. Breaking late Thursday, the $2.5 billion transaction was long expected. Divvy had raised more than $400 million from PayPal Ventures, New Enterprise Associates, Insight Partners and Pelion Venture Partners.

TechCrunch covered the impending sale, rumors of which sprung up before Bill.com reported its Q1 earnings. To see the company drop the news at the same time as its earnings was not a surprise. For the burgeoning corporate payment space (more here on startups in the space like Ramp, Airbase and Brex).

I got to noodle on the financial results that Bill.com detailed regarding Divvy — they are pretty key metrics to help us value the startups that are competing to go public or find a similarly feathered corporate nest. In short, the corporate spend startup cohort is doing great. It’s even spawning new startups like Latin American-focused Clara, which raised $3.5 million earlier this year.

Broadly, the fintech market had a huge Q1 and is blasting its way toward a record venture capital year, like AI startups and the rest of the VC world.

Startups and venture capital

5 investors discuss the future of RPA after UiPath’s IPO

Much ink (erm, pixels) has been spilled about robotic process automation (RPA) recently, particularly in the wake of UiPath’s IPO last month.

But while some of the individuals Ron interviewed about the future of RPA believe the technology is in its “early infancy,” the pandemic increased attention toward things we can let robots handle for us. And it’s hard to argue that repetitive tasks like billing and spreadsheeting and paper-pushing should not be outsourced to robots.

“RPA allows companies to automate a group of highly mundane tasks and have a machine do the work instead of a human,” Ron writes. “Think of finding an invoice amount in an email, placing the figure in a spreadsheet and sending a Slack message to accounts payable. You could have humans do that, or you could do it more quickly and efficiently with a machine. We’re talking mind-numbing work that is well suited to automation.”

Although RPA is the fastest-growing category in enterprise software, the market remains surprisingly small. Ron spoke to five investors about where the sector is headed, where there are opportunities and the biggest threats to the RPA startup ecosystem.

(Extra Crunch is our membership program, which helps founders and startup teams get ahead. You can sign up here.)

The tech giants

It was a quieter day from the tech giants, who made plenty of news earlier in the week. The good news is that their relative calm means we can take a look at news from other Big Tech companies, those that don’t quite crack the $1 trillion market cap threshold yet:

Community

Some of us are mourning the shutdown of Nuzzel, so we asked … would you pay for it (and why)? Let us know what you think!

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Tesla refutes Elon Musk’s timeline on ‘full self-driving’

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What Tesla CEO Elon Musk says publicly about the company’s progress on a fully autonomous driving system doesn’t match up with “engineering reality,” according to a memo that summarizes a meeting between California regulators and employees at the automaker.

The memo, which transparency site Plainsite obtained via a Freedom of Information Act request and subsequently released, shows that Musk has inflated the capabilities of the Autopilot advanced driver assistance system in Tesla vehicles, as well the company’s ability to deliver fully autonomous features by the end of the year. 

Tesla vehicles come standard with a driver assistance system branded as Autopilot. For an additional $10,000, owners can buy “full self-driving,” or FSD — a feature that Musk promises will one day deliver full autonomous driving capabilities. FSD, which has steadily increased in price and capability, has been available as an option for years. However, Tesla vehicles are not self-driving. FSD includes the parking feature Summon as well as Navigate on Autopilot, an active guidance system that navigates a car from a highway on-ramp to off-ramp, including interchanges and making lane changes. Once drivers enter a destination into the navigation system, they can enable “Navigate on Autopilot” for that trip.

Tesla vehicles are far from reaching that level of autonomy, a fact confirmed by statements made by the company’s director of Autopilot software CJ Moore to California regulators, the memo shows.

“Elon’s tweet does not match engineering reality per CJ,” according to the memo summarizing the conversation between regulators with the California Department of Motor Vehicles’ autonomous vehicles branch and four Tesla employees, including Moore.

The memo, which was written by California DMV’s Miguel Acosta, states that Moore described Autopilot — and the new features being tested — as a Level 2 system. That description matters in the world of automated driving.

There are five levels of automation under standards created by SAE International. Level 2 means two primary functions — like adaptive cruise and lane keeping — are automated and still have a human driver in the loop at all times. Level 2 is an advanced driver assistance system, and has become increasingly available in new vehicles, including those produced by Tesla, GM, Volvo and Mercedes. Tesla’s Autopilot and its more capable FSD were considered the most advanced systems available to consumers. However, other automakers have started to catch up.

Level 4 means the vehicle can handle all aspects of driving in certain conditions without human intervention and is what companies like Argo AI, Aurora, Cruise, Motional, Waymo and Zoox are working on. Level 5, which is widely viewed as a distant goal, would handle all driving in all environments and conditions.

Here is an important bit via Acosta’s summarization:

DMV asked CJ to address from an engineering perspective, Elon’s messaging about L5 capability by the end of the year. Elon’s tweet does not match engineering reality per CJ. Tesla is at Level 2 currently. The ratio of driver interaction would need to be in the magnitude of 1 or 2 million miles per driver interaction to move into higher levels of automation. Tesla indicated that Elon is extrapolating on the rates of improvement when speaking about L5 capabilities. Tesla couldn’t say if the rate of improvement would make it to L5 by end of calendar year.

Portions of this commentary were redacted. However, Plainsite was able to copy and paste the redacted part, which shows up as white space on a PDF, into another document.

The comments in the memo are contrary to what Musk has said repeatedly in the public sphere.

Musk is frequently asked on Twitter and in quarterly earnings calls for progress reports on FSD, including questions about when it will be rolled out via software updates to owners who have purchased the option. In a January earnings call, Musk said he was “highly confident the car will be able to drive itself with reliability in excess of a human this year.” In April 2021, during the company’s first quarter earnings call, Musk said “it’s really quite, quite tricky. But I am highly confident that we will get this done.”

The memo released this week provided other insights into Tesla’s push to test and eventually unlock greater levels of autonomy, including the number of vehicles testing a beta version of “Navigate on Autopilot on City Streets,” a feature that is meant to handle driving in urban areas and not just highways. Regulators also asked the Tesla employees if and how participants were being trained to test this feature, and how the sales team ensures that messaging about the vehicle capabilities and limitations are communicated.

As of the March meeting, there were 824 vehicles in a pilot program testing a beta version of “city streets.”  About 750 of those vehicles were being driven by employees and 71 by non-employees. Pilot participants are located across 37 states, with the majority of participants in California. As of March 2021, pilot participants have driven more than 153,000 miles using the City Streets feature, the memo states. The memo noted that Tesla planned to expand this pool of participants to approximately 1,600 later that month.

Tesla told the DMV that it is working on developing a video for the participants and that the next group of participants will include referrals from existing participants. “The new participants will be vetted by Tesla by looking at insurance telematics based on the VINs registered to that participant,” according to the memo.

Tesla also told the DMV that it is able to track when there are failures or when the feature is deactivated. Moore described these as “disengagements,” a term also used by companies testing and developing autonomous vehicle technology. The primary difference worth noting here is that these companies only use employees who are trained safety drivers, not the public.

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Betting on upcoming startup markets

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Welcome back to The TechCrunch Exchange, a weekly startups-and-markets newsletter. It’s broadly based on the daily column that appears on Extra Crunch, but free, and made for your weekend reading. Want it in your inbox every Saturday? Sign up here.

Ready? Let’s talk money, startups and spicy IPO rumors.

Betting on upcoming startup markets

This week M25, a venture capital concern focused on investing in the Midwest of the United States, announced a new fund worth $31.8 million. As the firm noted in a release that The Exchange reviewed, its new fund is about three times the size of its preceding investment vehicle.

I caught up with M25 partner Mike Asem to chat about the round. Asem joined M25 in 2016 after partner Victor Gutwein spearheaded the effort with a small $1 million fund. Asem and Gutwein have led the firm since its first material, if technically second fund.

Asem said that his team had targeted a $25 million to $30 million fund three, meaning that they came in a bit higher than anticipated in fundraising terms. That’s not a surprise in today’s venture capital market, given the pace at which capital is both invested into VC funds and startups.

The investor told The Exchange that M25 has been investing out of its third fund for some time, including CASHDROP, a startup that I’ve heard good things about regarding its growth rate. (More here on the CASHDROP round that M25 put capital into.)

All that’s fine, but what makes M25 an interesting bet is that the firm only invests in Midwest-headquartered startups. Often when I chat to a fund that has a unique geographical focus, it’s merely that, a focus. As opposed to M25’s more hard-and-fast rule. Now with more capital and plans to take part in 12-15 deals per year, the group can double down on its thesis.

Per Asem, M25 has done about a third of its deals in Chicago, where it’s based, but has put capital into startups in 24 cities thus far. TechCrunch covered one of those companies, Metafy, earlier this week when it closed more than $5 million in new capital.

Why does M25 think that the Midwest is the place to deploy capital and generate outsize returns? Asem listed a number of perspectives that underpin his team’s thesis: The Midwest’s economic might, the network that his partner and him developed in the area before founding M25, and the fact that valuations can prove to be more attractive in the region at the stage that his firm invests. They are sufficiently different, he said, that his firm can generate material returns even with exits at around the $100 million mark, a lower threshold than most VCs with larger capital vehicles might find palatable.

M25 is not alone in its bets on alternative regions. The Exchange also chatted with Somak Chattopadhyay of Armory Square Ventures on Friday, a firm that is based in upstate New York and invests in B2B software companies in what we might call post-manufacturing cities. One of its investments has gone public, and the group’s latest fund is a multiple of the size of its first. Armory now has around $60 million in AUM.

All that’s to say that the venture capital boom is not merely helping firms like a16z raise another billion here, or another billion there. But the generally hot market for startups and private capital is helping even smaller firms raise more capital to take on less traditional spaces. It’s heartening.

On-demand pricing, and grokking the insurance game

This week The Exchange chatted with Twilio CFO Khozema Shipchandler about his company’s earnings report. You can read more on the hard numbers here. The short gist is that it was a good quarter. But what mattered most in our chat was Shipchandler riffing on where the center of gravity at Twilio will remain in revenue terms.

Briefly, Twilio is best known for building APIs that allow developers to leverage telecom services. Those developers and their employers pay for as much Twilio as they used. But over time Twilio has bought more and more companies, building out a diverse product set after its 2016-era IPO.

So we were curious: Where does the company stand on the on-demand versus SaaS pricing debate that is currently raging in the software world? Staunchly in the first camp, still, despite buying Segment, which is a SaaS service. Per Shipchandler, Twilio revenue is still more than 70% on-demand, and the company wants to make sure that its customers only buy more of its services as they sell more of their own.

Startups, then, probably don’t have to give up on on-demand pricing as they scale. Twilio is huge and is sticking to it!

Then there was Root’s earnings report. Again, here are the core numbers. The Exchange is keeping tabs on Root’s post-IPO performance not only because it was a company we tracked extensively during its late private life, but also because it is a bellwether of sorts for the yet-private, neoinsurane companies. Which matters for fellow neoinsurance player Hippo, as it is going public via a SPAC.

Alex Timm, Root’s CEO, said that his firm performed well in the first quarter, generating more direct written premium than anticipated, and at better loss-rates to boot. The company also remains very cash-rich post IPO, and Timm is confident that his company’s data science work has lots more room to improve Root’s underwriting models.

So, faster-than-expected growth, lots of cash, improving economics and a bullish technology take — Root’s stock is flying, right? No, it is not. Instead Root has taken a bit of a public-market pounding in recent months. The Exchange asked Timm about the disparity between how he views his company’s performance and future, and how it is being valued. He said that the insurance folks don’t always get its technology work and that tech folks don’t always grok Root’s insurance business.

That’s tough. But with years and years of cash at its current burn rate, Root has more than enough space to prove its critics wrong, provided that its modeling holds up over the next dozen quarters or so. Its share price can’t be great for the yet-private neoinsurance companies, however. Even if Next Insurance did just raise another grip of cash at another new, higher valuation.

Corporate spend’s big week

As you’ve read by now, Bill.com is buying corporate-spend unicorn Divvy for $2.5 billion. I dug into the numbers behind the deal here, if that’s your sort of thing.

But after collecting notes from the CEOs of Divvy competitors Ramp and Brex here, another bit of commentary came in that I wanted to share. Thejo Kote, the corporate spend startup Airbase’s CEO and founder did some math on Divvy’s results that Bill.com shared with its own investors, arguing that the company’s March payment volume and active customer account implies that the company’s “average spend volume per customer was $44,400 per month.”

Is that good or bad? Kote is not impressed, saying that Airbase’s “average spend volume per customer is almost 10 [times] that of Divvy,” or around “$375,000 per month.” What’s driving that difference? A focus on larger customers, and the fact that Airbase covers more ground, in Kote’s view, than Divvy by encompassing software work that Bill.com itself and Expensify manage.

I bring you all of this as the war in managing spend for companies large and small is heating up in software terms. With Divvy off the table, Ramp is now perhaps the largest player in the space not charging for the software it wraps around corporate cards. Brex recently launched a software product that it charges for on a recurring basis. (More on Brex at this link, if you are into it.)

Various and sundry

Two final notes for you, things that should make you either laugh, grimace, or howl:

  1. The Wall Street Journal’s Eliot Brown tweeted some data this week from the Financial Times, namely that amongst the roughly 40 SPACs that completed deals last year, a dozen and a half have lost more than half their value. And that the average drop amongst the combined entities is 38%. Woof.
  2. And, finally, welcome to peak everything.

More to come next week, including notes on the return of the Kaltura and Procore IPOs, and whatever it is we can suss out from the Krispy Kreme S-1 filing, as donuts are life.

Alex

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