Report: Houston needs more growth venture capital

For Houston to spur a high-growth, high-technology startup ecosystem, the city needs to attract more so-called growth venture capital investments, according to an issue brief from Rice University’s Baker Institute for Public Policy.

Credit: 123RF.com/Rice University

“Growth vs. Transactional Venture Capital in Houston, Texas” was co-authored by Ed Egan, fellow of the Baker Institute and director of the institute’s McNair Center for Entrepreneurship and Innovation, and Diana Carranza, graduate researcher at the McNair Center. It explores the extent and nature of venture capital (VC) in Houston as compared with investment at the national level and explains why growth VC is vital to Houston’s future.

“Overall, Houston’s trajectory in venture capital dollars invested is best described as flat or a weak inverted U,” the authors wrote. “The city’s trend in new deals and rounds is similar, ranging between four and eight per year. With less than 1 percent of U.S. venture capital now flowing into Houston — the fourth-largest U.S. city by population and sixth-largest metro area by gross domestic product — and with high-growth, high-tech firms driving U.S. economic growth and prosperity, Houston risks being shut out of America’s future innovation economy.”

Venture capital investments can be classified as either growth VC or transactional VC investments. Growth VC is an investment made at the seed, early or later stages of a high-growth, high-technology startup’s life cycle. This investment is made with the objective of growing a company from an idea to one capable of being listed on a stock exchange or bought by an established incumbent. New ventures capable of this kind of rapid growth are concentrated in a small number of industries, particularly information technology and biotechnology, according to the authors.

Transactional VC, in turn, is a private equity investment in companies in need of funding for expansion, new-market entry, operations restructuring or other large-scale corporate finance needs, including bridge loans before an initial public offering or investment to complete or undergo an acquisition. Many recipients of transactional VC have never received growth VC, the authors said. Transactional VC is far more dynamic and sizable in Houston than growth VC, the authors said, reaching a “staggering” $1.25 billion in 2016 (up from $260.2 million in 2006).

In 2006, Houston’s total growth venture capital investment was $83 million. By 2016, there was just $72 million in growth VC investment. “Moreover, these investment amounts are nominal dollars,” the authors wrote. “In 2016, Houston’s venture investment fell from $100 million to $72 million — a 28 percent decrease.”

Nationaly, growth venture capital increased by 81 percent between 2006 and 2016 while Houston dropped by 13 percent during that same time. Consequently, Houston ranked 39th in the McNair Center’s “The Top U.S. Startup Cities in 2016” report, down from 21st in 2006.

To address this development, Houston has set the ambitious goal of joining the nation’s top entrepreneurship ecosystems by creating 10,000 new technology jobs and luring $2 billion in venture capital investment to Houston-based startups by 2022, according to the brief. “These goals rely on growth venture capital, not transactional venture capital,” the authors wrote. “With 2016 growth VC investment standing at $72 million for the city, Houston would need to increase its nominal investment by 75 percent year-on-year over the next six years to reach its goal. This simply isn’t feasible.”

The authors said a realistic, but still aggressive, goal for Houston would be around a 15 percent year-on-year increase in growth VC. “This would allow Houston to reach around $170 million in growth VC invested, with perhaps 14 new deals and a stock of almost 80 actively funded VC-backed startup firms, by 2022,” they wrote. “Houston would then likely become a top 25 U.S. city for high-growth, high-technology startups, though its ecosystem would still be emerging and startups would remain a very small part of Houston’s economy.”

The McNair Center was founded in 2015 as the research-oriented cornerstone of a larger, nationwide consortium of Robert and Janice McNair Foundation-funded centers devoted to entrepreneurship education. The center develops and distributes data and conducts policy research to better understand and promote entrepreneurship and innovation. It also provides a forum for stakeholders throughout the entrepreneurial ecosystem to debate ideas, share understanding and effect change.