The Case for Arbitrage

Steve Case has worked for the past few years promoting his thesis that investment grade companies are increasingly rising out of non-coastal markets. Through his Revolution venture firm and Rise of the Rest Fund he is putting money to work in markets that aren’t California, New York, and Massachusetts.

At the recent Greenwich Economic Forum, Case shared that investment opportunities in middle-of-the-country markets are acting as an arbitrage against the traditional economics of venture investing. According to the National Venture Capital Association (NVCA), 75% of startup investment dollars in 2018 went to California, New York, and Massachusetts. More than 50% went to California alone.

The glut of capital in coastal markets has led to a rise in valuations as money chases deals. Case and others would say the valuations have become inflated which presents an arbitrage opportunity. These areas allow an investor’s money to go further.

The reality is that most coastal-based venture firms are not going to put serious effort into sourcing and signing deals in the middle of the country. There are a few VCs that have made the move, and we are starting to see new funds cropping up in many of these nascent markets. They bring together LP capital from sources that want to take advantage of the arbitrage opportunity and locals that want to stem the brain drain from their backyards.

The most interesting shift has little to do with the venture firms at all.

Most VCs have poor fund track records. For many of the newer funds, the clock is ticking on the merits of their first efforts. Furthermore, investment marketplaces now democratize early-stage access to private investment opportunities. Sharp investors are less reliant on a venture fund serving as the middle-man to get access to this class of investment. In most cases, these marketplaces will offer access to deals with better economics than can what a Venture firm can offer.

With these new investment platforms and the continued focus on the coasts, the smart move has changed. Those looking to take advantage of the landscape should look to include better economics in non-coastal deals with access to deals with non-venture fees.

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