Money in the sun
by Cheryl Meyer Posted 08:48 EST, 9, Feb 2007

With the Oscars less than a month away, all eyes are on Los Angeles. Investors, however, have a weightier concern: Will their backing of LA startups pay off?

Last year, financiers plunked down more than $1.4 billion in LA businesses, for an average deal size of $13 million, according to a January report from Ernst & Young LLP and Dow Jones VentureOne. Roughly 30% of these were early-stage companies, a sign of confidence in startups in an area known more for entertainment than entrepreneurialism. "There's a tremendous amount of optimism in the Los Angeles market, given the diverse nature of the industries we have here," says Ernst & Young partner Michael Schoenfeld.

That influx propelled Southern California to the No. 2 spot in the U.S. last year for total dollars invested, behind Silicon Valley, surpassing New England for the first time.

"Having run a tech company in the [San Francisco] Bay Area, I can tell you that there are some remarkable things about the Los Angeles marketplace that make it particularly attractive for entrepreneurs," says Nick Grouf, chairman and CEO of Spot Runner Inc., citing quality of life, schools, restaurants and, of course, sunny weather.

A native New Yorker, Grouf and David Waxman, a longtime partner, co-founded Spot Runner in 2004 and have raised almost $60 million from investors such as CBS Corp., Battery Ventures and WPP Group plc.

But Spot Runner's latest round was a pittance compared with other LA deals. Topping the list was Amp'd Mobile Inc., a broadband mobile-phone services provider that got a $150 million third round in April from a dozen VCs. The company has raised more than $250 million to date.

One-year-old Altra Inc., an ethanol fuel plant operator, has attracted more than $200 million, including a $120 million round in August from Kleiner Perkins Caufield & Byers, buyout shop Sage Capital Partners LP and others. "We like to invest in things in our backyard," says Sage managing director Dan Gardenswartz. Sage has also backed Sherman Oaks, Calif.-based Plymouth Health, a medical center operator.

Industries attracting investors run the gamut. Kythera Biopharmaceuticals Inc., a Woodland Hills, Calif., company focused on aesthetic and restorative dermatology, raised $30 million in a Series B round in July from Prospect Venture Partners and others. Versant Ventures managing director Camille Samuels forecasts an IPO for Kythera within a few years.

Kythera chief business officer Amit Munshi says the founders lived in LA and knew they could tap a broad pool of talent, from the California Institute of Technology in Pasadena to the University of California, Los Angeles, to other biotechs.

Not everyone finds talent so easily. Numerous VCs and entrepreneurs say recruiting workers — particularly executives — is difficult. Housing costs are high, traffic is a nightmare and the area is known as an entertainment hub. "I can't tell you how many qualified CEOs we found, and they could not get their families to come here," says Frank Kline, managing partner at Kline Hawkes & Co., a Los Angeles private equity firm. Kline says investors helped lure one out-of-state CEO by buying him a house.

Peter Hovenier, vice president of finance at Santa Monica's Boingo Wireless Inc., says LA lacks Silicon Valley's small-club feel. Plus, tech companies have to compete against the likes of Google Inc. in compensation. Not that Boingo is complaining. The company received $65 million in a C round of funding in August from Mitsui & Co. Ltd., Steelpoint Capital Partners LP and others and has raised almost $100 million.

Entrepreneurs have faced other problems in LA. Ryan Magnussen, CEO of Ripe Digital Entertainment, a Hollywood, Calif.-based provider of video-on-demand digital content, says his startup met with VCs nationwide but found Los Angeles investors lacking enthusiasm. "They were lethargic. It's very LA," he says. "Northern California was competitive. New York was more private equity. Every market had its own flavor, but LA's venture community was clearly not getting it." Ripe Digital eventually picked up funding from Rho Ventures in Palo Alto, Calif., and East Coast-based Hearst-Argyle Television Inc., Time Warner Investments and Columbia Capital LLC. It announced a $32 million Series B round in October.

Investors hope for a more welcome IPO market this year. Catalytic Solutions Inc., an Oxnard, Calif.-based provider of catalytic converter optimization technology, was the only area startup to go public in 2006, E&Y reports. "Every company marches toward an IPO for the most part, and you see what happens along the way," Boingo's Hovenier says.