The Seattle region is rated the second-best tech market in the nation after the Bay Area, according to real estate services company CBRE. But when it comes to launching startups, the region resides in a “second tier” of venture capital ecosystems, suggests the 2017 Venture Ecosystem Factbook from Seattle-based PitchBook Data.
That evaluation creates a long-term concern: The Kauffman Foundation, which tracks startup activity, reports that venture-backed companies account for roughly half of the nation’s new jobs and much of its new wealth. Erstwhile startups Amazon and Facebook are together worth close to $1 trillion.
But thanks to a rapidly evolving network that includes startup weekends where teams create mock-ups of new products in just 54 hours, an active angel investing community and a number of innovative new local institutions, there’s more diversity in the process by which creative business ideas germinate and grow in the Seattle area.
Those ideas, in turn, change our approaches to education. The Global Innovation Exchange — a partnership between the University of Washington and China’s Tsinghua University with substantial support from Microsoft — has students working in teams to solve “real-world challenges.” The final launch project, which requires the teams to turn a concept into a market-ready product, has the goal of providing graduates with the skills to launch their own startups.
Startup financing, too, is going through rapid evolution. While venture capital remains the primary source of financing for high-risk projects, today’s VC firms are reducing risk by putting their money into later-stage companies. This strategy has created demand for more organizations to provide early-stage financing. Angel investors have established vertical niches in areas where they can apply their expertise to select promising companies. Seattle-based Wings invests in medical technology companies, for example, while Element 8, another Seattle angel investor, focuses on clean tech.
Large corporations such as Microsoft and Amazon support startups that promote their respective ecosystems. Amazon, for instance, has put money into Sensible Object to help it develop games that use the kind of voice artificial intelligence used by Alexa on its Echo product.
Some investors have been forced to adapt. Seattle’s 9Mile Labs, which had put its startups through a rigorous, nine-step program before investing in those that hit its milestones, recently dropped the approach after it had too few successes to justify the program’s cost. It now invests in startups screened by other accelerators.
Since it is so difficult to predict which startups will succeed, says Vikram Jandhyala, VP for innovation strategy at the University of Washington, it’s important to encourage lots of new early-stage companies, an approach the UW has started to take.
Not all agree, however. Garrett James Black, author of PitchBook’s Venture Ecosystem Factbook, worries that “people underrate the importance of long-term, quality support for the right idea and the right team.” Black says it’s important for startups to continue to have access to capital as they go through the tough process of gaining traction with customers. “You miss out on some of that,” he argues, “if you go to higher volumes.”
The good news is that startups can survive longer, thanks to such services as Amazon Web Services’ cloud computing offerings, which reduce fixed costs.
“When you build on top of AWS, you only pay for what you use,” says Ed Lazowska, the Bill & Melinda Gates chair in Computer Science and Engineering at the UW. “This has had a truly remarkable impact on costs, allowing companies to be bootstrapped far less expensively.”
The maturation of our homegrown companies and the creation here of nearly 100 engineering offices of companies headquartered elsewhere has also created a rich source of talent from which promising startups can draw, Lazowska notes. One result is that companies are now much farther along by the time they approach venture capital firms for support.
Entrepreneurs used to seek funding with a business plan and a PowerPoint presentation but no product, customers or revenue, says Scott Jacobson, managing director at the Seattle VC firm Madrona Venture Group. Now, he adds, “They usually have, at minimum, an early prototype and sometimes even customers and revenue.”
As the startup ecosystem in the Seattle area flourishes, we are seeing local innovations speeding the change. Here are three institutions taking fresh approaches.
Most investment ideas come prepackaged with entrepreneurs passionate to pursue them. Pioneer Square Labs’ novel approach is to search out great ideas, create and test prototypes and, if they show promise, recruit an executive team to build the business.
“We want to be able to figure out in four months whether the idea works or not,” says cofounder Greg Gottesman, who is also a venture partner at Madrona Venture Group in Seattle.
Pioneer avoids projects in such areas as life sciences or deep enterprise software that would require a longer time frame to prove out.
Success depends on recruiting the most talented CEOs and CTOs, Gottesman says. “To the extent we are bad at that, we will lose all our money, no matter how great the ideas are.”
Pioneer pays its executives to make it easier for promising candidates, particularly people with families, to walk away from a high-paying job and try their hand at a new venture.
“There’s a fallacy in the tech world that the person who comes up with the idea is the best person to run that company,” says Gottesman, citing himself as an example. Gottesman came up with the concept for Rover.com, which he describes as a sort of Airbnb for pet owners who need someone to care for their dogs. But he brought in Aaron Easterly as CEO. “If there’s a better person than Aaron Easterly to run the company, I don’t know who it is,” Gottesman declares.
Of Pioneer’s 35 projects last year, 33 withered. Gottesman expects more will survive this year because Pioneer is bringing in entrepreneurs earlier in the process, where their expertise can help guide the vetting of the idea.
The fail-fast philosophy has a better chance of working because Pioneer Square Labs begins with 100 percent of the equity in the companies it forms and can retain a “meaningful portion” of the equity with a limited expenditure of capital. If even one startup is a winner, there’s a big upside for the startup studio and its investors.
Pioneer Square Labs had its first spinout when it raised a $2 million funding round for LumaTax, which automates sales tax reporting for small businesses.
Pioneer’s cofounders include Voyager Capital venture partner Geoff Entress and Madrona Venture Labs cofounder Ben Gilbert. More than 50 angel investors and 13 venture capital firms participated in Pioneer Square Labs’ initial $12.5 million funding round in October 2015.
Locally, backers include Bezos Expeditions and serial entrepreneur Rich Barton, who founded Zillow and Expedia.
Greg Gottesman, a partner at Madrona Venture Group, cofounded Pioneer Square Labs as a platform for “getting from nothing to something — fast.”
PIONEER LABS CASE STUDY
One of Pioneer Square Labs’ more promising ventures is Boundless, which helps immigrants apply for visas. It is the brainchild of Xiao Wang, a former senior product manager at Amazon Go. He emigrated from China to the United States when he was 3 years old. This startup’s first product is the spousal visa. The Boundless website gathers information from visa applicants, fills out their immigration forms for them, then tracks the applications to notify applicants of progress through the system. In April, the Pioneer Square Labs spinout obtained $3.5 million in seed funding from Bellevue-based Trilogy Equity Partners, Seattle’s Founders’ Co-op and other investors.
Intellectual ventures, the Bellevue intellectual property company cofounded by Microsoft veteran Nathan Myhrvold, has spun off many startup companies with such exotic names as Terra Power, Kymeta and Echodyne. Last September, it launched Xinova to help startups and corporations with new product development. The Seattle-based firm taps a global network of inventors to help clients develop and market new products. Investors in Xinova’s investment fund include university endowment funds in the United States as well as several foreign multinationals.
Xinova’s 50 employees, 30 of whom are based in Seattle, include business analysts and experts in intellectual property, product development and commercialization. The company also draws on an “innovation network” of more than 10,000 experts in companies, institutions and universities worldwide.
Xinova tackles problems for clients in a variety of fields, from agriculture and food technology to transportation and manufacturing. “In the early days, it was difficult to convince companies that this was something they needed,” says Nicholas Gibson, SVP and head of marketing at Xinova.
But Xinova provides perspectives that can be invaluable. For example, ENN, a Chinese energy company, tapped Xinova to help it figure out how to contain a gas so corrosive that it ate through any metal storage container in which it was placed. Xinova’s solution came from an audiologist who suggested the gas could be contained inside a sound wave that would keep it from coming into contact with the wall of the storage unit.
If Xinova chooses to work with an inventor, it pays the inventor an up-front fee of tens of thousands of dollars for the right to work on the idea, put together a patent, build a prototype and commercialize it with a customer who can turn the idea into a product.
Xinova splits the royalties with the customer and shares its portion of the royalties with the inventor. Xinova owns the license and the patent but the inventor and customer hold a license to use the product. If the product then sells to other businesses, the inventor, the original customer and Xinova share the revenue from those sales. Clients include PepsiCo and Honda.
XINOVA CASE STUDY
Vancouver, B.C.-based CoffeeFlour sells a flour that has a citrusy, dried-fruit flavor and is made from the fruit of the coffee cherry. Normally thrown out as waste by coffee producers, the cherry can be made into a gluten-free, highly nutritious flour. CoffeeFlour founder and CEO Dan Belliveau previously was a Starbucks engineer who designed and built roasting facilities. Xinova helped the startup find customers overseas as well as a new market for the absorbent, high-fiber flour: using it as an environmentally friendly way to soak up waste from oil spills.
In 2012, some prominent local investors led by the Washington Research Foundation, an organization first established to capture and enhance the value of intellectual property from the state’s research institutions, came together to establish the W Fund. Its goal was to speed the commercialization of university research by investing in companies working on promising technologies developed at state universities. It invested roughly $20 million in 19 startups, ranging from medical devices and life sciences firms to clean tech and software.
Now, in a significant shift in strategy, the university has decided not to raise a new W Fund and instead put far smaller sums of money into a far larger number of startups. Small dollars can make a big difference in the “valley of death” between the end of a research grant and formation of a startup company with the level of product development needed to attract seed capital, says the UW’s Vikram Jandhyala.
The new approach is reflected in the CoMotion Innovation Fund, which awards grants of up to $40,000 per project, with an additional $10,000 to startups for reaching business development milestones. The UW and the Washington Research Foundation provide up to $1 million annually to support the UW’s commercialization program.
The fund came about as part of a rebranding and restructuring of the UW’s commercialization program in 2015 to better encourage innovation. CoMotion goes beyond simply helping UW staff and students obtain licenses and patents by coaching them how to be entrepreneurs and providing initial financial support.
“We try to figure out the best way to get an idea out in the real world,” Jandhyala says.
The university does not take an equity position in the companies, although it may get a portion of licensing or royalty fees from startups that originated as UW spinouts. This arrangement allows entrepreneurs to pursue funding via angel investors, venture capitalists or an outright acquisition by a larger company.
The coaching CoMotion provides helps the program’s entrepreneurs focus on their potential customers’ needs and the size of the market for their proposed products. CoMotion entrepreneurs also get help preparing their pitches to investors who will want to know potential competitors and whether the right team is running the startup.
Meanwhile, CoMotion Labs offers startups office and lab space on UW campuses in Seattle and Spokane. Two incubators operate on the UW’s Seattle campus, along with an accelerator operated by the international Techstars program. Currently, 82 startups participate.
To help entrepreneurs turn their ideas into products, the UW has set up a MakerSpace in Fluke Hall that provides a variety of tools for making prototypes of products, including 3-D printers, soldering stations and laser cutters and engravers. There’s also strong interest in the nearby University District becoming a hub for startups as they mature into young companies.
CoMotion has had some notable successes. Turi, a startup founded by UW professor Carlos Guestrin, helps developers build apps that leverage machine learning and artificial intelligence. It was acquired by Apple last summer for approximately $200 million.
Although the UW continues to fine tune its approach, the long-term emphasis on innovation appears to be paying off. The UW now ranks seventh among the top 10 universities in the country for commercializing its research, ahead of both MIT and Caltech, according to an April report from the Milken Institute.
That’s good news for Seattle and Washington state because a robust commercialization program creates new companies that bring jobs and revenue into the local economy. In turn, these companies may later support their alma mater through donations.
This approach also has the benefit of training a larger number of students in how to launch startups.
Meanwhile, the annual business plan competition at the UW’s Foster School of Business has awarded $1.3 million during the past 19 years to 154 student companies. The Jones + Foster Accelerator program provides student-led startups with six months of mentoring from experts and up to $25,000 in follow-on funding to take their company to the next phase.
UW CASE STUDY
University of Washington graduates Sam Tanner, above left, and Peter Keckemet used a $1,200 loan from the “Creating a Company” business class at the UW’s Foster School of Business to launch Joe Chocolates. The idea was to sell caffeinated chocolates that would help students stay up for late-night cram sessions. The Seattle startup’s Bits of Buzz are made from coffee beans roasted by Seattle’s Lighthouse Roasters. Flavorings and chocolate come from Guittard Chocolate Company in Burlingame, California. Flavors include salted caramel, honey almond and midnight coconut dark chocolate. Joe Chocolates are available at 22 retailers, including Nordstrom Ebars, Bartell Drugs, New Seasons Market and the University Book Store. The startup has repaid its loan and obtained a $25,000 grant from the Foster School of Business Jones + Foster Accelerator program, which helps student-led companies through the decisive first six months as startups.
NEW KIDS ON THE BLOCK
Two new venture capital firms in Seattle are bringing fresh sources of much-needed capital to Seattle’s swelling ranks of entrepreneurs.
Flying Fish Venture Partners, Seattle
Flying Fish is a newly formed Seattle venture capital firm providing early funding to Northwest startups in cloud computing, artificial intelligence, speech and natural language, machine learning and the Internet of Things. Flying Fish partners angel investor Heather Redman, former Amazon VP Frank Chang and former Microsoft executive Geoff Harris have raised $2.5 million with plans to raise $80 million more. Their investments so far include Seattle’s ReplyYes, which lets customers buy products via text message; Redmond-based Otto Robotics, which is developing an automated food preparation and delivery service for restaurants; Seattle-based Ad Lightning, which helps publishers and ad platforms identify disruptive ads; Seattle-based Tomorrow Ideas, whose Tomorrow app helps families make long-term financial and legal decisions; and Element Data, which makes software that provides insight into the why of human decision making.
Imagen Capital Partners, Woodinville
Imagen Capital may be only a few months old but the $150 million venture capital fund led a $9 million Series A investment round that included such notables as Google Ventures and Mark Cuban’s Radical Investments. The pick: Nimble, a Santa Monica-based customer relationship service for small businesses. Imagen’s managing partners are Chris Barrow and John Polchin, the former CEO and CFO, respectively, of Bothell-based EagleView Technologies, an aerial imaging company. Their new fund targets early-stage technology businesses. Earlier this year, Imagen invested $5 million in Bothell-based Vioguard, which makes a self-sanitizing keyboard.
POWER FROM THE PEOPLE
Online crowdfunding platforms such as Kickstarter allow firms to raise cash without surrendering equity while also getting exposure for their products.
PicoBrew, the Keurig of beer, set a goal to raise $350,000 in a Kickstarter campaign to fund its latest product, the Pico C, a small home-brewing appliance. The Seattle startup severely underestimated the public’s thirst for its countertop brewing system. In May, PicoBrew raised $1.8 million in seven hours. The smart appliance uses PicoPak ingredient kits from breweries around the world, including The Pike Brewing Company in Seattle. Consumers can also brew Kombucha.