Gaining Critical Mass

Pittsburgh’s startup ecosystem matures
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Alfred Hunt knew a good idea when he saw it. And Charles Martin Hall had one. In 1886, the 23-​year-​old chemist had discovered a smelting process to make aluminum inexpensively while working in a lab he cobbled together in a shed behind his parent’s house in northern Ohio.

Hunt, a Pittsburgh metallurgist, realized its commercial potential and was willing to take a risk. He put up $20,000 of his own money and investments from colleagues to launch a startup that later became Alcoa, an international manufacturer of aluminum that today has $16.7 billion in assets, 14,000 employees and its headquarters on the city’s North Shore.

It’s the kind of success story that builds industries and economies and one that southwestern Pennsylvania hopes will spin out from the knowledge and expertise at its research universities and the technology companies gathering around them. And developments over the past decade provide reasons for optimism.

The key pieces that define a major technology hub have fallen into place. The region long has been fertile ground for ideas. It’s seen a robust network of entrepreneurial support evolve. Major tech companies, such as Google and Uber, have set up shop in Pittsburgh. And an increasing number of young companies are attracting venture capital on the strength of their potential.

Our total investments have grown because the quality of the investment has improved and companies are getting great ground support,” said Catherine Mott, president and CEO of the Wexford angel investor group, Blue Tree Allied Angels, and founder and CEO of Blue Tree Venture Fund.

But soft spots in the region’s tech ecosystem remain. Chief among them is that emerging tech companies needing later-​stage capital to finance their growth have to look outside the region to find it.

Gaining momentum

Total venture capital investments in a region tend to fluctuate year over year, sometimes significantly. Lately, at least, southwestern Pennsylvania companies have been on a roll.

Local companies managed to buck the national trend in 2016, the most recent year for which complete data are available. Nationally, venture capital financing fell from $77.3 billion the previous year to $52.3 billion, a 32 percent decrease. At the same time, the Pittsburgh area attracted $235 million in funding, an increase of more than 8 percent, according to a report by the professional services firm Ernst & Young and Innovation Works, a source of seed-​stage funding and business support for Pittsburgh startups.

And 2017 appears to have been another strong year. Preliminary data suggest local companies raised more than $324 million in 115 venture deals.

Recent data are incomplete, however, and don’t include several major deals. The largest is Ford Motor Co.’s five-​year, $1 billion investment in Argo AI, a local artificial intelligence company the automaker is banking on to develop a virtual driver system for future autonomous vehicles. Other deals not included are Providence Strategic Growth’s $35 million investment in Pineapple Payments, a local payment processing technology company, and a $63 million investment by Pfizer Venture and others in University of Pittsburgh spinout Complexa, a biopharmaceutical company developing novel therapies for treating inflammatory-​based and metabolic diseases.

Petuum, a Carnegie Mellon University spinout in the city’s Strip District, also grabbed headlines in 2017 when it attracted $93 million in venture capital from the investment arm of Tokyo-​based Softbank and others.

Such interest has helped the Pittsburgh Metropolitan Statistical Area move up in the rankings of Pittsburgh Today’s 15 benchmark regions to sixth best in total venture investments last year. Pittsburgh is still well shy of the $3.3 billion raised in Boston and the $1.4 billion raised in Seattle, but is nudging closer to other top-​tier regions, such as Denver and Charlotte, NC.

The number of new startups formed continues to increase, and these companies are successfully attracting investment from local and national investors,” said David Lishego, senior investment associate at Innovation Works. “This indicates that local startups are solving important problems and have potential to scale into significant businesses.”

A better greenhouse

Local tech sector growth is the result of long standing regional attributes, economic trends, the quality of emerging companies and resources to help them survive early-​stage challenges.

Carnegie Mellon and Pitt have strong research credentials and established cultures for moving ideas from the laboratory to the marketplace. Their strengths in artificial intelligence, robotics, autonomous vehicles and biomedical technologies are becoming critical to the national economy. And they attract talent ranging from top students and scholars to major tech players that thrive on them, such as Google, Amazon, Uber and Facebook.

The presence of such companies tends to attract more talent, broaden the support network, and generate entrepreneurs and angel investors. The founders of Argo AI, for example, had worked for Google and Uber and have ties to CMU. And a large concentration of well-​paid talent is a defining characteristic of the tech ecosystem in the Silicon Valley, where venture capitalists invested $16.5 billion last year.

But bright ideas and talent don’t guarantee success in an industry where the failure of startups is common. For early-​stage tech companies, mentorship, networks, seed funding, office space and free or discounted support services are critical to avoiding the pitfalls of business development.

Growth in those resources over the past decade is a key reason the region’s tech industry has enjoyed recent success in attracting investors, those familiar with the industry say. About 30 business accelerators and incubators tailored to the tech industry have sprung up with names such as Blast Furnace, Ascender and Alloy26.

Some are university-​based, such as Pitt’s Innovation Institute, which offers services ranging from mentoring to protecting intellectual property. CMU’s Project Olympus incubator offers startups advice, small grants and faculty connections. Innovation Works, the region’s state-​funded Ben Franklin Technology partner, runs two Alpha Lab accelerators.

We’re seeing them bear fruit,” Mott said. “Startups can be three people in a garage who say, ‘We have a great idea, let’s build a company and see what we can do.’ What they find is they don’t know what they don’t know. These resources help them understand what they don’t know, avoid obvious mistakes and navigate obstacles. For them, that’s critical.”

Local money

Attracting growth capital becomes a top priority as companies mature. But later-​stage funding is scarce in southwestern Pennsylvania, which lacks venture funds large enough to provide it.

The health of the venture capital environment in the Pittsburgh area continues to improve. The amount of uncommitted capital at Pittsburgh-​based venture firms rose for a fifth straight year in 2016 to nearly $141 million, a 14-​year high, according to an Innovation Works survey.

But available funding in the region still only slightly exceeds the median venture capital fund in the United States. and Pittsburgh lacks local growth-​stage investors,Innovation Works’ Lishego said.

Local venture capital is mostly limited to seed and Series-​A funding rounds. Series A funding supports new companies for a year or two as they develop their products, workforce, marketing and other early business operations. When companies reach a stage when they need tens of millions of dollars or more, they have to look elsewhere. Last year, the major deals involving Argo, Petuum and Complexa were all made with out-​of-​state or overseas investors.

For growing companies, that means working long distance with investors. And local companies looking for growth capital have to compete for the attention of investors concentrated on the west and east coasts to get noticed, when a local fund would already have them on its radar.

But local venture capital funds find it difficult to get traction. When trying to raise a fund from traditional sources, such as pensions, they’re often competing with large established firms with a national reach and a resume of solid returns on investment.

Investing in startups is different from investing in publicly traded companies. There is no public market to buy and sell stocks. Investors usually don’t realize a return until the company reaches an “exit,” which comes as an initial public offering or merger/​acquisition. But big, splashy exits don’t come often in Pittsburgh.

You have to have an outstanding track record if you are going to attract institutional money,” said Blue Tree’s Mott, whose company raised its venture fund from individual investors instead. “It’s been a long time since Pittsburgh has had a home run.”

In some cities, corporations have raised joint venture funds to support local entrepreneurs and growing companies. Pittsburgh is not one of those cities. Cincinnati is. Its $57 million Cintrifuse venture fund was created five years ago with 15 partners including Procter & Gamble, Kroger and the University of Cincinnati.

We need our own VC funds, and not small ones — funds that know the local people, know who the next smart person is with a great idea, and the ability to build a team and create a company,” Mott said. “I think with the companies we have, we’re going to see some big exits in the next 510 years that will help quite a bit.”

Jeffery Fraser

Jeffery is a Pittsburgh-​based freelance writer and frequent contributor to Pittsburgh Quarterly. In his past life, he was a reporter and editor for newpapers large and small, only one of which is still in business. His magazine and newspaper reporting has won numerous awards.

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