Tech takes a seat in Ann Arbor: Why some startups pass on Silicon Valley for the Midwest

Tuesday, January 30, 2018 - 5:49pm

Tech takes a seat in Ann Arbor

Tech takes a seat in Ann Arbor Buy this photo
Amelia Cacchione/Daily

 

In October 2017, Duo Security — an Ann Arbor-based company, launched by two University of Michigan alumni in 2009 — made national headlines when it secured a $70 million round of funding that brought it to be valued at over $1 billion dollars; the information technology startup is known for producing two-factor authentication systems.

“Ann Arbor is our home,” Dug Song, one of Duo Security’s founders, said in an October interview with TechCrunch. “With more than 350 employees based here, we’re proud of our Michigan roots and our heritage of global cybersecurity innovation in Southeastern Michigan. The region has a wellspring of talent that we will continue to invest in and hire from, and attract talent from outside the state as well.”

Duo is at the forefront of a fledgling wave of early-stage technology startups that have chosen to take root not in the San Francisco and East Coast technology hubs, but within Metro Detroit.

As of 2016, there were 49 active venture-based startups in Ann Arbor, according to the Michigan Venture Capital Association Annual Research Report. These companies represent 35 percent of startups in the state, and are are primarily split between information technology and life sciences sectors, with the remainder scattered across advanced manufacturing and energy.

In December 2017, VentureBeat described Ann Arbor as one of four emerging national tech hubs, alongside much-larger Pittsburgh, Indianapolis and Raleigh, N.C.

“Given that there are currently 112 privately held unicorn companies in the U.S., it’s impressive that Ann Arbor — with a population of just 120,000 — managed to cultivate one,” VentureBeat wrote.

What draws entrepreneurs to Ann Arbor are elements of a strong startup community: a large research institution and the fact that more than half of the venture capital firms in the state are located in the area, according to Emily Heintz, associate director at the Michigan Venture Capital Association.

“We believe the entrepreneurial investment community is made up of four things — research, capital, community and talent,” Heintz said.

These elements, combined with the city’s accessible Midwestern culture and relatively lower cost of living, have begun to make Ann Arbor an appealing alternative to the crowded Bay Area for some entrepreneurs, despite a regional dearth in capital.

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Ann Arbor’s college-town atmosphere makes it easy for entrepreneurs to connect with potential partners due to the educated local population, according to Bill Mayer, SPARK’s vice president for entrepreneurial services.

SPARK is the county’s publicly-funded economic development association, which has taken a keen interest in curating the local high-tech sector. Its downtown Liberty Street office — despite a simplistic interior — serves as an incubator housing early-stage tech-based startups.

In terms of what draws entrepreneurs to the area, Mayer explained the coasts are far more populated than the Midwest. As a result, he believes it can be very difficult to raise capital due to competition on the dense coasts. Ann Arbor, contrarily, is a “nice size” — a smaller city with 120,000 people.

“If you’re in New York or San Francisco, you can go to meetups and meet people but it’s really hard to get a meeting on Sand Hill Road,” Mayer said, referring to Silicon Valley’s arterial road known for housing the world’s marquee venture capital funds. “It sounds like everything gets funded out there, but it’s actually quite challenging to get on the radar of investors out there.”

Investors know they can hire employees in Ann Arbor that won’t get stolen by Google or Facebook, he said. They can also pay these employees a comparably lower wage than they would have to in San Francisco due to lower costs of living (although Ann Arbor is still expensive relative to its region), making Ann Arbor startups far more “capital efficient.”

Ann Arbor is also a place executives know their employees can thrive in, unlike San Francisco or Boulder, Colo.

“From an employer’s standpoint, the fact that your employees can actually buy a house is pretty amazing,” Mayer said.

Cash Butler, an Ann Arbor native, is one of many SPARK-based innovators. After spending several years in Boston, he relocated his company, ClariLegal, to Ann Arbor, drawn by the University community and lower costs. ClariLegal matches corporations and law firms with the vendors they need to ensure they get the best value for their work.

“I came back because there was a vibrant community of innovative thinkers and a wonderful level of talent at (the University of) Michigan, Eastern Michigan, Washtenaw Community College that I could staff my company with,” he said.

Butler said he has taken advantage of hiring University students as interns and been extremely happy with the results. He also pointed to the relatively lower cost of living in addition to easier travel compared to the coasts.

In the future, he hopes to collaborate more with the University, particularly with alumni, to bring in people who are interested in software innovation for the legal industry.

“My biggest marketing thing is flying people in and taking them to a University of Michigan football game,” he joked.

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Inside the offices at Clinc.

Inside the offices at Clinc. Buy this photo
Amelia Cacchione/Daily

 

However, the Midwest still lacks the critical entrepreneurial infrastructure that coastal tech hubs have, namely venture capital to fund early-stage companies.  

Michigan startups in particular face a “capital gap” in raising their necessary investors, according to Heintz. Most of the country’s venture capital funds are based around San Francisco and the financial hubs of New York and Boston. As a result, many new Midwestern tech companies need to leave their geographic home to raise funding.

As associate director of the MVCA, Heintz represents the 33 venture capital funds in Michigan, 18 of which are based in Ann Arbor as of 2016, according to the MVCA report.

Of the 49 active venture-backed startups in Ann Arbor in 2016, 25 received more than $101 million from venture capital firms in 2016, according to the MVCA report. Of course, this is a tiny slice compared to the $69 billion raised in funding across the U.S. in 2016.

Midwestern investors also tend to be more conservative than those on the West Coast, according to Mayer. This makes it more difficult for an early-stage company to raise funds; however, this means the Midwestern startups that ultimately receive a vote of confidence are generally lower-risk than something that would get funded in California.

“The good news about that is that the companies that do get funded here tend to have a higher survival rate,” Mayer said. “On the other hand, from an entrepreneur’s standpoint, sometimes it can be harder to raise capital, because investors typically look for more achieved milestones, more business results, versus just kind of pitching a concept.”

Heintz said it is crucial to have a robust foundation of capital in Michigan — which currently the overwhelming majority comes from out-of-state —  in order to fund new companies. According to the MVCA report, every dollar invested in a Michigan startup by a Michigan venture capital firm attracts $4.61 of investment from outside of Michigan.

“On one hand that’s good because it’s more money coming into the state, but on the other hand it’s something that you do want to worry about because you want CEOs and founders to be able to focus on their companies and not have to always fly around the country looking for capital,” Heintz said.

Recently, more startups are choosing to remain in the area, Mayer explained. He said 15 years ago, people would be able to raise money in Ann Arbor, but then when it was time for them to raise follow-on capital, they would find an out-of-state investor that would often stipulate they would need to relocate to California.

Today, this doesn’t happen as much, largely because San Francisco has become so costly, competitive and overcrowded.

“There’s so much competition for all of the employees (in San Francisco),” he said. “There are people paying over $100 per square foot for office space. You can pay $15 or $20 per square foot here. So investors do the math.”

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The University of Michigan’s research and human capital contribute heavily to the entreprenurial appeal of Ann Arbor. When Mayer began working at SPARK, he was surprised to learn only about 20 to 30 percent of the companies SPARK works with originate from the University of Michigan.

Nonetheless, he said the University serves as a key catalyst to successful entrepreneurial activity — conducting $1.5 billion of federally-funded research each year, the largest research funding budget of any public university in the nation. Some of this research translates into commercial application and can be licensed directly to industry — that, or a startup can sometimes spin off.

“The good news about the University companies is that the potential of those companies tends to be very high, because almost always they have some kind of high (intellectual property), they have patents, they have millions and millions of dollars of federal research already done,” he said.

In the private sector, startups launch outside of large research institutions and depend on competitions and grants; student startups often fall into this category. In general, one advantage to starting up in Ann Arbor, Mayer explained, is the close proximity to University experts and departments available for collaboration.

Clinc, located in downtown Ann Arbor, builds conversational AI software that was based on the work of the University’s Clarity Lab. Their work builds on the research conducted in Clarity Lab, directed by Jason Mars and Lingjia Tang, assistant professor of computer science at the University. Hauswald and alum Michael Laurenzano worked with Mars and Tang as doctoral students, and all four are co-founders of the company. Clinc raised at least $7.5 million in a funding round as of early 2017, according to Crain’s Detroit Business.

The dark interior of the Clinc office compliments the view of downtown Ann Arbor in the winter. On a Friday afternoon, instead of already leaving for the weekend, they were hard at work — in meetings in a glass-walled conference room and scrutinizing code while hunched over their desktops.

Johann Hauswald, co-founder and chief architect at the company, is a three-time University graduate. Hauswald is the perfect representation of his company — laid back and casual, but extremely astute — a description denotative of Silicon Valley.

One of the team’s objectives was to examine intelligent personal assistants like Siri — to find out how the technology was built and then insert it into customer-facing apps.

The team ultimately created their own intelligent personal assistant software. Now, companies can adopt the technology and personalize it to their domain so their customers can communicate with a more customized assistant.

One area the software is particularly helpful in is banking, demonstrated by Hauswald as he opened his banking app and asked his phone how much money he had spent on food in Ann Arbor in the past month. The virtual assistant responded with an amount and the screen presented a report.

Hauswald explained Mars and Tang could have moved their entire research lab to Stanford University to take advantage of the nearby investors.

“It sounds attractive, but from our perspective, we had this tight connection to the University, there’s this whole research lab of Ph.D. students that are at the University,” he said. “Ann Arbor is an awesome city, it’s cheaper. There is a lot of tech in downtown Ann Arbor, and also in Michigan in general.”

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Inside the offices at SPARK.

Inside the offices at SPARK. Buy this photo
Alec Cohen/Daily

 

Startup ventures are a risky business and not all of them are met with success, and this is no different in Michigan.

Cribspot began as a class project by University of Michigan Business undergraduates, but ultimately launched as a property management startup in late 2013. By summer 2014, the company had raised $660,000 in investment, primarily from Michigan-based venture capitalists.  

Cribspot compiles and crowdsources off-campus housing options for students, and grew to include over 100,000 users at 175 schools as of early 2018.

“It’s actually a really growing community of startups in Ann Arbor and Detroit,” Cribspot co-founder Jason Okrasinski told The Daily in 2014. “There’s maybe a handful of startups, so it’s a tightknit community and all together, it’s just a really great place to start a business and really start to grow it.”

Yet four years later, The Daily reported Cribspot is expected to quietly shutter its Ann Arbor operations.

A former Cribspot employee, who asked to remain anonymous, told The Daily in early January the company leaders couldn’t agree upon a direction for the company, suggesting this caused its operations to be economically unsustainable.  

“Essentially what happened — to the best of my knowledge — is that the company was kind of going in two different directions, one more tech-oriented and the other more concerned with the physical business of Ann Arbor housing management,” he said. “With this in mind, it was starting to look less feasible for the latter to continue functioning if the company was to follow these two separate paths.”

Meanwhile, back at the Clinc offices, Hauswald said the company has no desire to relocate from Michigan.

“Never at any point did we think we have to move to California in order to make this work,” Hauswald said. “We did get sort of hints from investors — like, ‘If you want to be a successful startup, you have to go the Valley.’”

According to Hauswald, finding talent and engineers has never been a problem for Clinc. He added, however, business executives don’t necessarily live in the area. To overcome this issue, companies needs to be able to have people working remotely, and be able to pay them.

Like Butler, Hauswald noted Clinc hires many student interns, many of whom come from West Coast schools like Stanford University and the University of California, Berkeley.

“They are coming and applying to us for internships,” he said. “They don’t necessarily think of location, they think, ‘What are the interesting problems?’”

Connor Borrego, a serial entrepreneur and 2017 LSA graduate that currently works in product marketing at a local startup, said the geographic expansion of the tech industry would be a socially beneficial long-term trend.

“I think there’s a lot of concentration of wealth and talent and education on the coasts of this country, and I think it has lead to a silo of communities across the country,” Borrego said. “By spreading the talent, spreading the wealth out across the country, I think you’ll do a much better service to democracy as a whole.”