Messaging app’s IPO expected to lead to spin-offs that will boost growing tech hub

Financial Times
February 10, 2017
by Hannah Kuchler

On a quiet street leading to the Venice boardwalk in Los Angeles, behind stalls selling henna tattoos and hemp clothing, Snap employees are busy at work.

Three security guards in black bomber jackets and a small wooden plaque reading “Snap” are the only signs that this patchwork of small office buildings houses the owner of Snapchat, set to be one of the largest US technology initial public offerings in recent years.

Snap’s IPO is expected to value the social media company at up to $25bn, making it one of the biggest tech companies ever to be based in LA. When Evan Spiegel, Snap’s co-founder and chief executive, chose to avoid Silicon Valley and base the company closer to his family home in southern California, he lured software developers south. Now many in this city are hoping the Snap IPO could help replicate Silicon Valley — on the beach.

Tianxiang Zhuo, a partner at Fika Ventures, started the early-stage VC firm last year partly in anticipation of a boom of young LA start-ups, many of which may be founded by Snap employees leaving the company to become entrepreneurs.

“Snap will be one of the anchor tenants,” he said. “Their valuation shows you can build and scale in LA. Even if they don’t get $25bn, even if they get $15bn, it will be an awesome success story for the city.”

Mr Spiegel wants to differentiate Snap from its Silicon Valley rivals: the discreet offices contrast with the large, colourful campuses of Google and Facebook, and he has distanced himself from other purveyors of digital ads, declaring many “creepy”. But Snap has grown to be a size comparable with the large private tech companies in northern California, such as Uber and Airbnb.

Jim Armstrong, managing director at March Capital, which has offices in Santa Monica and Silicon Valley, says it is great to see an LA entrepreneur who is not about selling the company early.

“Snap has that crazy Bay Area attitude that started with them turning down $3bn,” he says, referring to its rejection of an offer from Facebook in 2013. “They are out to change the market, they are not about flipping early.”

Until Snap gained traction, entrepreneurs who chose to base their companies in LA had either grown up in the city, or were older former employees of large industries such as entertainment or shipping, finally quitting their jobs for a good idea and building medium-sized companies.

Kashif Sheikh, investment analyst at PrivCo, a private company financial intelligence platform, says LA has never had any “sizeable” exits, acquisitions or IPOs, making Snap’s debut “particularly insane”. The largest “exit” for a start-up was the $3bn IPO of ecommerce site in the last dotcom boom. More recently, content company Demand Media went public at $1.4bn in 2011 and Cornerstone on Demand, the HR software maker, listed at $600m the same year.

One start-up that provided earlier hope of an LA tech renaissance was Beverly Hills-based MySpace, the social network that once rivalled Facebook. But its popularity rapidly waned in the years after it sold itself to Rupert Murdoch’s News Corp for $580m in 2005.

Adam Miller, Cornerstone’s chief executive, says that in the early days of his company, there was no one in tech to look to for mentorship. “It was very lonely to be in tech in LA, it was not a well understood industry in LA and it wasn’t really even socially acceptable to be working in technology in LA,” he says.

But, in the past couple of years, the LA tech industry has started to see some success. Now other start-ups compete with Snap for space in Venice and Santa Monica. Large Silicon Valley tech companies and digital advertising agencies are opening offices 20 minutes’ drive away in Playa Vista, on the old industrial site where aviation pioneer Howard Hughes built the Spruce Goose plane. Snap is planning to rent 300,000 square feet near Santa Monica airport.

As the entertainment industry moved into online video, multichannel networks such as Fullscreen and Maker Studios appeared to provide a home for YouTube creators, with their growth supported by investment from large media companies. Video games companies, such as Santa Monica-based Activision, have also begun spawning start-ups, especially in gaming or virtual reality.

The proximity to two major ports, Los Angeles and Long Beach, has been an advantage for ecommerce companies receiving products from manufacturers abroad. The Honest Company, the baby and personal care online shop, and the Dollar Shave Club, the razor delivery service bought last year by Unilever, are both based in LA.

LA now has the talent and is in the early stages of attracting more capital. Universities in and around LA train more software engineers than in any other major metropolitan area in the US, including Silicon Valley and Boston. But traditionally, they have either moved to work at big tech companies in the San Francisco Bay Area or entered banking, says Mr Zhuo.

He thinks LA is still underserved by venture capitalists, estimating that in active funds, there is only about $1bn available for investment at any one time — the same amount as just one large fund among the dozens that can be tapped in Silicon Valley.

“There is this crazy talent pool that is underserved,” he says.

Venture investment is increasing: up 25 per cent year on year in 2016 to a total of $3.5bn, according to research firm CB Insights. The deals are bigger, with the capital spread across 160 companies in 2016, compared with 219 in 2015, and less focused at the earliest stage, with seed rounds falling from almost half of all fundraising in 2012 to 29 per cent last year. Firms in the global centre of VC — Silicon Valley’s Sand Hill Road — now often send a partner down to check out LA start-ups for one week a month.

But the funding is still far less than in Silicon Valley and other tech hubs in the US. The Valley saw $3.9bn in VC funding in just the fourth quarter of 2016, compared with $2bn in New York, $1.4bn in the Washington DC Area and $1.3bn in New England. According to PwC and CB Insights, LA received just $900m in funding in the fourth quarter.

Five years ago in Los Angeles, Michael Heywood founded Whisper, the app for sharing secrets that has grown into a content business. He says it is easier than ever to start a company away from Silicon Valley, because you do not need the racks of servers and the people who know how to look after them. Start-ups can just plug into Amazon Web Services and tick boxes for extra services such as machine learning.

“The conventional wisdom is the smartest people in the world are in the Valley. That’s not a false statement. If you want oranges, you go to Florida, if you want software, you go to Silicon Valley,” he said. “But you don’t need thousands and thousands and thousands of employees. You can get 50 or even 100 absolutely brilliant people anywhere.”

Nodding over his shoulder in the direction of Snap’s offices two streets away, he says: “Once your business trajectory needs thousands of employees, then you become your own mecca, like Snapchat.”

Snap is unlikely to turn LA into a mecca the size of Silicon Valley by itself. It may also take time for employees to start leaving Snap to found their own companies.

James Montgomery, co-founder of March Capital and founder of LA-based investment bank Montgomery & Co, says LA is 10 years into the 25 it took Silicon Valley to get where it is today. “If you go back 25 years in the Bay Area, there were more jobs in aerospace [such as at Lockheed Martin] than in Silicon Valley; that’s one generation,” he says. “It shows you what is possible.”

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