Austin Ventures’ $900 million VC fund was supposed to make the city the next startup hub. But it wasn’t until the fund folded that Austin’s tech scene flourished.

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Austin Ventures had become too big to fail, but it was failing nonetheless.

The Texas capital's eponymous venture fund was largely regarded as the city's premier venture firm — the equivalent of Silicon Valley's renown Sequoia Capital — during its heights in the 1980s and 1990s. But eventually the investment firm began to outgrow its hometown reputation, and Austin's promising startup scene was stunted.

"The reason there was no community in 1996, and the reason there was no community in 2010, is because of Austin Ventures," angel investor and Osano founder Arlo Gilbert told Business Insider.

Austin Ventures, commonly referred to as AV by the city's investor community, was the only game in town, several investors told Business Insider. The problem was, it wanted to keep it that way. The investment firm largely focused on venture investing, but it kept raising larger funds that weren't suited for the city's smaller startups. At one point, the firm had upwards of $900 million in assets under management, one investor estimated, and was forced to focus on investing in later stage companies to get the kinds of returns a fund of that size needed.

Today, Austin Ventures, the venture capital investor, is no more. The partners scattered and the firm has switched to the private equity business. But Austin's startup scene is stronger than ever.

The lessons of Austin Ventures' rise and fall provide a framework that other cities with tech ambitions would be wise to pay heed to. It's a story of how a local powerhouse, with deep pockets and industry ties, can provide a vital foundation for building a startup scene. But eventually, that powerhouse — whether a VC firm or a company — becomes a constraint that must be disrupted or replaced for a healthy and innovative startup economy to flourish.

"AV was, you know, described as the 800-pound gorilla. It's good when you're the 800-pound gorilla, if you're the 800 pounds gorilla, right? Like there's a good life," former Austin Ventures general partner Tom Ball told Business Insider.

A big fish in a small pond

Both Gilbert and Ball credit Austin Ventures with kickstarting Austin's reputation as a tech hub, but its caché with Silicon Valley investors hampered the region's explosive growth, they said. As the major VC in town, Austin Ventures referred many of its portfolio companies to Silicon Valley investors for later-stage funding rounds. Without AV on its balance sheet, any Austin-based startup faced an uphill battle once they made the trek out to court Menlo Park's biggest check-writers.

"They were hunting in their own pond, and if you went to California to raise money and Austin Ventures had not invested in you, you may as well just go out of business now," Gilbert said. "The signaling was just like, 'Oh, well if your main backyard VC, who I would want to take a board seat, isn't investing, I'm not in.'"

According to Gilbert, that cut off many local startups at the knees. A pass from Austin Ventures was the kiss of death, and it's impossible to estimate the number of companies that never came to be because of that, he said. The ecosystem favored the AV network, and legacy tech companies prevailed while startups struggled to gain traction.

"I think we felt like we were very competitive," Ball said. "But the competition actually makes you better and stronger. And frankly, as a former entrepreneur, competition is better for the entrepreneurial side of the table."

A dose of healthy competition

By 2015, Austin Ventures had almost entirely made the transition to private equity, all but entirely ditching its venture capital practice. Ball left the firm that year to start his fund, Next Coast Ventures, which is reportedly raising its second fund. Another former Austin Ventures partner, Bill Wood, was one of the first to spin out into his own firm, Silverton Partners, in 2003 when he realized AV was leaning heavily on later-stage investments.

"We've been in the Austin early-stage ecosystem the longest and got to see a lot of the evolution of how everything has changed," Silverton partner Kip McClanahan told Business Insider. "There've been a couple of additional early-stage firms that have come into town, and we can put more capital work in Austin."

Several investors told Business Insider that the end of Austin Ventures' reign has, not coincidentally, occurred in tandem with a revival in its startup scene. Every investor that spoke with Business Insider emphasized the strength of Austin's venture community, especially as it compares with Silicon Valley's competitive and tight-lipped ecosystem.

"In Austin, the ecosystem for startups is so rich that we really don't, it's not a competitive environment," McClanahan said. "That's worth saying because I think if you look at the West Coast, it's a highly competitive environment."

Austin now boasts more than 13 hometown VC firms and hundreds of startups, developing everything from robotics to artisanal vodka. According to Pitchbook, Texas-based startups raised more than $3 billion in venture capital in 2018, the most recent year for which there was comprehensive data and a record for the state. The previous record was in 2013, when startups raised $2.83 billion, according to Pitchbook.

As that environment matures, McClanahan said, more investors will have to invest in its startups in the later stages where there aren't currently dedicated firms. And, Gilbert said, that's a good thing, because he hopes this generation of funds learned from the last doomed experiment.

"That splintering was terrible in some ways because you no longer have a billion dollars here waiting for the next unicorn," Gilbert said. "Now you got all these VCs that are friends, they know each other, and suddenly they're competing. In the last year, they've all gone to their second funds. Their second funds are bigger, bolder, they've had success, they've proven themselves. Austin's gotten on the map."

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