2022 Is The Year Emerging Markets VC Comes of Age. Here’s Why:

Listed #12 on the Most Free Economics List by Heritage Foundation, Georgia is fast becoming a dominant tech hub for the Caucasus region.

In Catapult’s last monthly update to investors, we offered recent market data evidencing three important venture trends:

(1) a dramatic acceleration in the amount of capital being deployed into smaller ecosystems outside the ‘big three’ US tech hubs of Silicon Valley, NYC and Boston;

(2) a ten-year low in the percentage of all U.S. venture funding deployed going into Silicon Valley companies; and,

(3) a boom of newly formed venture funds that have a defined geographic focus.

In response to these trends, we ask the overriding question that these data points suggest: Is 2022 the year Emerging Markets-focused VC funds come of age? We believe the answer is yes. Here are reasons why:

1. The Pandemic-fueled Dispersion of Talent is Here to Stay

As capital for credible founders became more accessible in recent years, the battlefield shifted. The fiercest competition between startups today is over talent, not capital. Over the past decade, engineers and operators led a not-so-quiet exodus out of high-priced tech hubs and repotted themselves in smaller markets — the Nashvilles and Miamis of the world — where they could ostensibly enjoy big city salaries while living in low tax (or no tax) states and in housing markets 30–50% less expensive. Pandemic took hold in the spring of 2020 and only accelerated that exodus by an order of magnitude.

While some of that tech talent may indeed return to the high priced, established tech hubs from whence they came, the majority of these new transplants are expected to stay put, thus enriching the tech talent pool in these smaller hubs both now and for years to come.

2. ‘Centers of Excellence’ are manifesting in smaller geos now

Beyond seeding smaller hubs with a deeper bench of talent with which local startups can build teams and achieve scale, this talent dispersion creates another phenomenon that we, at Catapult, call Centers of Excellence. In our nomenclature, a ‘Center of Excellence’ refers to a competitive advantage that a tech hub develops over time around a specific sector.

This competency arises for several reasons. One could be an inherent advantage that that hub has due to its long history in and association with a certain industry. (Think the Midwest and the Consumer Packaged Goods (CPG) industry, or Los Angeles and entertainment.) A second reason could be the presence of university programs with a excellent reputation in a specific technical discipline. (Think Artificial Intelligence and Carnegie-Mellon University in Pittsburgh.) A third reason could be a hub’s history of successful companies focused on a specific domain that then created a diaspora that launched other startups focused on that same domain. Think data storage and Salt Lake City. A quick story about Fusion-io illustrates this third point well.

Fusion-io was one of the biggest tech successes to come out of Salt Lake City. After Fusion-io exited, many employees left to pursue other data storage-related ventures. Having spent years in the community and often with children enrolled in local schools, many ex-Fusion-io employees opted to stay in the area. After all, the cost of living in Utah was so much lower than doing so in the Bay Area, and there was already a robust talent pool of people with the idiosyncratic skills and expertise germane to data storage right there in Salt Lake City.

In short order, new data storage startups founded by the Fusion-io diaspora (i.e., Primary Data, Isilon, Qumulo, et al) emerged from the Salt Lake City ecosystem. Over time, it became widely believed that the brightest minds around data storage were probably living and working in and around Salt Lake City.

3. Domain expertise within tech hubs creates a flywheel effect

This phenomenon becomes self-fulfilling. As more startups focused on a certain sector see positive outcomes, the diaspora from those exited startups tend to settle in the local community, buy property, start families, launch startups of their own, start angel investing or forming VC funds, and re-enforcing that ecosystem’s inherent advantage in developing startups focusing on that domain. We are now seeing this phenomenon in a host of other geos that are not one of the big three U.S. hubs.

Given its association with Wall Street, New York was long considered the best place to launch a FinTech startup. Today, however, it’s facing stiff competition from smaller, less expensive hubs that are known for having robust FinTech ecosystems of their own. Think Frankfurt, Atlanta, Charlotte, and of course, London.

Oh, and the Wall Street as we knew it doesn’t really exist on Wall Street any longer either. It, too, has become distributed. The famed brokerage houses of Wall Street lore are now scattered across the greater New York Tri-State area, some even settling in Hoboken, New Jersey.

4. Having remote-first, distributed teams is now a competitive advantage

What all this talent dispersion means is that the world’s best data storage engineers, or FinTech experts, or AI specialists are more likely to be in places like Salt Lake City, Pittsburgh, or Toronto than in Silicon Valley today. Founders have already realized this. Many VCs are just now catching on.

This is transformative. And paired with the plethora of workplace collaboration platforms like Trello, Zoom and Slack, which did not exist a decade ago, it means talented teams can be spun up anywhere in the world almost overnight. Time zones be damned.

This means speed to market. This means teams can be collaborating 24/7. This means when developers are shutting down their laptops in San Francisco, their colleagues in Tbilisi are just booting up theirs.

In the fiercely competitive and increasingly global tech marketplace, this might not only be a nice advantage; indeed, it might be an existential threat to organizations not structured in this way.

5. New Venture Models Are More Adaptable to Remote-First, Cross Border Investing.

We last posted on this subject in our piece, VC 3.0 And The Democratization of Venture Capital, in which we examined how the VC 1.0 and 2.0 models from the ’80s and ’00s, respectively, were being challenged by a new wave of solo capitalists, rolling funds, and other innovative approaches which we loosely characterized as VC 3.0. An inherent advantage of these 3.0 venture platforms is the speed at which they can make decisions — i.e., fewer committees and fewer partner meetings required to approve investments — and how nimbly they can adjust to meet rapidly changing times.

While there may be some notable exceptions in VC, by and large in every industry the larger and more established and hierarchical an organization, the slower it tends to move and the more risk-adverse it tends to be.

The ‘atomization’ we’re seeing in venture capital as an asset class accrues nicely to emerging managers in emerging markets because small, nimble funds can spin up local investors with domain and geographic expertise quickly — either through a scout program or other mechanism — in order to source and support the best opportunities coming out of an emerging ecosystem. And because operating costs in emerging markets are often significantly lower than those in established hubs, emerging managers can take a risk on promising but still unproven market opportunities in ways an established, monolithic fund of the VC 1.0 model simply cannot.

6. Regulatory frameworks slowly achieving parity with U.S. standards.

Finally, for decades, U.S.-based startups possessed a clear advantage when fundraising from venture investors due to their status as a U.S. based company domiciled in the U.S., typically in Delaware. Delaware law was the gold standard. It was tried and tested. Investors knew what to expect under Delaware law. Moreover, the U.S. had bankruptcy laws and other regulatory frameworks that were generally investor-friendly and flexible enough for startups to hire/fire quickly so as to give them the best chance to mount an offensive against entrenched, better-financed incumbents.

Other nations were not so fortunate. Often bedeviled by red tape, archaic regulations, and mind-numbing bureaucracies, many nations outside the U.S. and a handful of others struggled to create systems and infrastructure that would support the innovation economies they said they so desperately wanted to create. But that’s begun to change.

Innovative leaders such as France’s Macron and Germany’s Merkel made strides to modernize their regulatory frameworks and their economies to be more startup- and investor-friendly. Moreover, some of the greatest progress in this regard has been made by post-Soviet bloc countries like Georgia, Estonia, Lithuania and Ukraine that have quickly modernized their systems, done much to root out endemic corruption, and developed infrastructure to help migrate them from the unsustainable, extraction-based industries that long defined their economies (i.e., oil, mining, et al) toward knowledge-based economies that attract high-paying jobs and stem brain drain.

The net result of this rapid modernization is that these emerging hubs are beginning to achieve parity with the U.S. in terms of their regulatory frameworks and investor protections. This will further erode the built-in advantages that U.S-based startups have long held over startups based in emerging tech ecosystems across Europe, Eurasia, the Caucasus and Africa in attracting venture funding.

The Road Ahead

While there is still much work to be done to build self-sustaining tech ecosystems in these emerging market hubs, recently there has been a dramatic shift. Pandemic was the obvious catalyst. While some nations looked to examples such as Estonia as evidence that even small, former Soviet-bloc economies can rapidly reinvent themselves into prosperous tech centers, others appeared too encumbered by long-standing business cultures to make the leap. Breaking away from long-held beliefs about the ‘way things are done here’ is difficult for any nation. Additionally, there were valid reasons why some countries were complacent. Extraction-based industries were profitable. Energy prices were relatively stable; and tourism provided consistent revenues. Pandemic changed all that.

As Covid took hold in early 2020, tourism revenue plunged. So did business travel and convention industry bookings. With everyone working from home, commercial real estate values tanked. Energy prices, while remaining high, became even more volatile.

Many emerging market nations began to accept that their economic futures were likely going to be tied to how well they migrated away from being reliant on things like tourism, oil and mining, to embracing science, technology and innovation in a fulsome way. And with less friction from having to wean off legacy systems already in place, these emerging economies could start fresh. They could quickly adopt best practices from what had worked in Estonia, the Nordics and other geos to lay the infrastructure for their own vibrant, startup-friendly ecosystems.

The data is now clear: VC investing in emerging markets is no longer a fringe activity practiced only by ‘true believer’ investors willing to withstand decades of losses before exits occur. The exits are now here and valuations are surging. Smaller hubs in Europe, Central Asia and the Caucasus are now catching up quickly with those in the U.S. on a variety of key metrics. Leading accelerators like Y Combinator and USMAC are increasing their presence in these regions to identify startups and import Silicon Valley know-how and mentorship. And global VC brands like us at Catapult are launching geo-specific funds to source, fund, and mentor the best founding teams building the next generation of global tech powerhouses.

It will take commitment. It will take money. It will take cooperation with compliant, forward-thinking governments working with us to design systems that support startup innovation for the long term. And that’s how it ought to be. The opportunities are enormous and we couldn’t be more excited for what’s to come.