Shortage of management-savvy entrepreneurs in L.A. triggers flight of early-stage venture capitalists.

Early-stage venture capital firms have been fleeing the Southland in droves over the past eight years, according industry sources. They attributed the exodus to a local shortage of management-savvy entrepreneurs, combined with the recent recession.

Brent Rider, general partner at Pasadena-based venture capital firm El Dorado Ventures, estimated the number of early-stage venture capital firms with offices in L.A. or Orange counties has dropped from 26 or 27 firms in 1986 to only about seven today.

Rider and other sources cited a number of factors contributing to the shortage of management-savvy entrepreneurs in L.A. and Orange counties. One of the most important factors has been the downsizing of the defense industry. The high-tech sector tends to spawn a large percentage of the dynamic start-up companies often targeted by early-stage venture capital firms. But the Southland's high-tech sector had placed a heavy emphasis on defense-related work. So venture capital firms left the Southland for more dynamic areas during the recession.

Lee Petillon, partner at Petillon & Hansen, a Torrance-based law firm specializing in raising start-up capital, explained that many of L.A.'s high-tech workers subsisted in the 1970s and 1980s on lucrative government defense contracts.

"Northern California got away from (defense contract work) a while ago, but Los Angeles companies never got out of that military defense mode. They were never weaned away from government business," he said.

No marketing know-how

Jim Gauer, general partner at the Brentwood office of Newport Beach-based venture capital firm Enterprise Partners, said the defense industry does not typically produce entrepreneurial managers with the marketing and small-business skills necessary to launch a successful start-up company.

Rider of El Dorado Ventures went a step further, saying L.A. has been referred to by sources from the venture capital industry as a county full of "Arizona companies."

"You have the production there, but you don't have the thinkers, the developers," he said.

Gauer of Enterprise Partners explained that early-round venture capital firms typically look for solid, business-savvy management teams in the start-up companies they fund.

"The dynamic in Southern California has been, you find companies that don't tend to have as complete management teams as you see in Northern California. In places like Northern California and Boston, for example, you see teams that go from one successful start-up to the next," he said, noting that a typical successful management team may spin off as many one new company every five years.

In stark comparison, Gauer said, there are scarcely any examples of strong management teams coming from the aerospace industry in Southern California.

"The main problem we see in most teams coming out of aerospace is a lack of marketing savvy. (Ex-aerospace workers) don't know how to select a market niche, exploit it, and protect their franchise within the niche," he said.

Randy Lunn, managing partner of Costa Mesa-based venture capital firm TVM Techno Venture Management, echoed Gauer's sentiments.

"Nothing scares money more than engineers that have no business experience. They can build the product, but they don't always know how to position it and sell it," he said.

Paradox of success

Lunn said the shortage of early-round venture capitalists in L.A. is also due in part to the inherent nature of the venture capital business.

He explained that successful venture capitalists who start out specializing in start-up companies must often abandon those very same start-ups as their careers advance.

"You need to be a good (venture capital) firm for investment funds to give you money. But if you become successful, you can't afford to spend your time and energy doing quarter-million-dollar (start-up) deals," he said.

While sources generally agreed that strong management teams and early-stage venture capital firms are currently in short supply in L.A., most also expressed optimism that the situation would change and may even be changing already.

Gauer said the shortage of strong start-up companies in L.A. would likely improve in the future, though he stressed the process would be slow.

"I think it will change, but these things take time. It took 20 years to build the current situation (of entrepreneurial culture) in Northern California," he said.

Jones of Brentwood Associates said the dynamic multimedia and software industries in L.A. could produce a growing number of new investment opportunities for early-round venture capitalists in the future.

Rider concurred that a growing alliance between the entertainment and electronics industries may provide venture capital firms with a pool of strong start-up L.A.-based companies in the future. As cases in point, he said, El Dorado Ventures recently funded two early-stage video game companies, including one in Santa Monica.