Article originally published in TechCrunch.

​By some counts, there are as many as 1,600 “non-traditional” investors helping to fund venture capital deals in 2021. Non-traditional investors include anyone outside of traditional VC firms investing in venture capital deals.
 
The non-traditional investment field is booming. McKinsey found that the value of co-investment deals has more than doubled to $104 billion from 2012 to 2018. That upward trajectory is likely to continue.
 
The primary motivator for non-traditional investors is seeking better returns and it’s proving successful. A recent Preqin study shows co-investing funds significantly outperform funds that don’t co-invest. Research shows that 80% found their co-investments outperforming private equity fund investments, with 46% outperforming by a margin of more than 5%. Investors also benefit from a generally lower expensive fee structure compared to traditional private equity or VC funds.
 
Co-investors can also profit by sharing the investment risk, a win for all investors that builds loyalty and trust. Because co-investing requires a hands-on approach, investors get the chance to work closely with top sponsors—the general partners (GPs)—to foster deeper relationships and gain a better understanding of the GP’s investment strategies and deal review processes. For the co-investor, building these relationships is essential for strengthening their own investment skills in the long run.
 
Why VCs love alternative investors
Alternative investors aren’t the only ones who benefit. The trend toward co-investing is also a boon for the GPs. They gain a broader array of funding options by partnering with alternative investors, and they can leverage their own capital more effectively with prospective investments.
 
There are other pluses for VCs. While co-investing LPs remain passive in the business, the VC can use that voting power to preserve investor rights and consolidate decision making. It also allows them to put more money to work in any company while staying within diversification limits.
 
What are the benefits for companies?
Companies can thrive with co-investment as well. An alternative investor infuses more funding, without bringing another VC to the table. That’s good news for founders who want to minimize the number of VCs and seats around the board table as well as time spent fundraising. Adding an additional VC inevitably often leads to too many cooks in the kitchen. And in the case of our fund, C5 Capital’s, we have brought in co-investors who have become customers.
 
How to get co-investment right
It’s clear there is significant interest in co-investing, but not everyone has the skills and resources required to successfully execute a co-investment program. At C5 Capital, we welcome co-investors and have opened up more than half our deals to outside firms. That has resulted in more than $80M in co-investments over the last three years alone.
 
We’ve found that some co-investors are well-versed in co-investing arrangements; others are just starting to co-invest and need some guidance. It’s critical that co-investors understand both the dynamics of co-investing and the range of competencies required to be successful. In addition, co-investors need a solid understanding of the terms, upsides, and potential downsides. For those new to co-investing, here are three important considerations:
 
1.     Know the deal terms
The first step is to fully understand the investment terms. Almost 50% of sponsors did not charge any management fee on co-investments in 2015. However, as a result of increased demand, the majority of LPs today pay a management fee and carried interest to the fund manager. The fees typically depend on whether the co-investor makes a direct investment or invests via a special-purpose (sidecar) vehicle.
 
2.     Choose deals wisely
When evaluating deals, keep in mind that most are not going to be the next tech unicorn so set your own realistic view on exits. Most co-investors realize that they are not likely to be investing in the next Uber and are pursuing smaller deals. According to a study from ValueWalk, 77% of LPs preferred small to mid-market buyout strategies and $2 to $10 million per co-investment.
It’s wise to ask for and review the venture team’s analysis as well as the investment data room. Co-investors can benefit from the VC’s view and extensive due diligence findings. Ask for valuation metrics, but don’t sweat the technology. Too often, investors get mired in trying to understand technology specifics, versus focusing on the fundamentals: customer demand, market size, evidence of product/market fit, business model, and sustainable differentiation.
Talk to the management team directly. Get a feel for the company’s leadership, the certainty of their forecasts, and their ability to execute. Take a hard look at the team’s resilience and their ability to anticipate and adapt. People, not technology, are typically a company’s most important asset.
 
3.     Kick the other investor’s tires
Make sure to look at investor alignment. Co-investors come in as smaller players, so make sure not to get trampled, especially by earlier investors who may have different incentives and higher voting rights or board control.
 
A final thought
Given the attractive features of co-investing, it is understandable why many institutions are pursuing it. Performance continues to be strong and investment opportunities are growing in number. That said, investors who begin co-investing without having the requisite knowledge of what it takes to be successful are likely to be disappointed with the results. Developing a full understanding of the risks and rewards of co-investing is an essential first step. With the right deal structure, deal selection, and deal investigation, co-investors can significantly increase their returns.
 
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About William Kilmer
William Kilmer is Managing Partner with C5 Capital, a venture capital fund investing in the secure data ecosystem. He currently sits on the board of five companies in the US and UK. He was formerly an Operating Partner at Mercato Growth Partners and has served as a CEO and CMO on three companies. He previously worked as the Managing Director for venture capital investor Intel Capital Europe, based in London. His new book, Transformative, will be published 2021.

Article originally published in TechCrunch.

​Just when we thought things couldn’t get worse in 2020, we received the news on the SolarWinds hack and its impact on more than 18,000 businesses and potentially dozens of US government agencies — including the departments of Commerce, Energy and Treasury. We’re just beginning to understand the extent of their infiltration, but this story brings to light what the cybersecurity industry has already known: solving the cybersecurity problem will take more time and resources than we are currently allocating.
  
Adding to the challenge, COVID-19 has created ground fertile ground for the acceleration of cyberattacks that are more sophisticated, dangerous, and prevalent. In this dire setting, cybersecurity has become even more of a competitive and a national security imperative and created higher demand for new solutions. This is something we all, enterprises, startups, government, and investors, need to work together to solve. So, from the venture capital perspective, where are cybersecurity investments being made, and where is the talent coming from to help stem the onslaught of hacks?
 
California’s Silicon Valley has traditionally been the epicenter of cybersecurity innovation. It’s home to some of the largest cybersecurity companies including MacAfee, Palo Alto Networks, and FireEye, as well as more recent highflyers such as CrowdStrike and Okta, providing a robust talent base for many willing venture investors.
 
However, that’s rapidly changing. Cybersecurity expertise is now budding in new regions where there is talent and a hands-on recognition of the need for innovative solutions. In particular we are seeing growth in areas such as the East Coast of the US and in Europe, led by the United Kingdom. Investment in Silicon Valley cybersecurity startups remained flat in 2020 as we are seeing record venture funding of cybersecurity companies in these emerging regions. And the reasons why may mean better solutions to solve current and future cyber needs.
 
The Emergence of a New Cybersecurity Ecosystem
 
A new generation of cyber-experienced practitioners coming from government and financial services are becoming the next generation of entrepreneurs. Fueling new innovation, this newest breed of cybersecurity startups in emerging in cities like New York, Washington DC, and London, and away from Silicon Valley. East Coast businesses like IronNet, founded by former NSA director General Keith Alexander, is one example of this growing trend of new leaders coming from federal government backgrounds.
 
These new cybersecurity leaders with front-line experience are developing solutions that fix the problems they faced as customers and, thanks to COVID-19, are hiring the best talent to join them regardless of their location. The pandemic has accelerated remote working trends, increasing more flexible location working opportunities in the cybersecurity industry. These companies are creating advantages over their West Coast counterparts in the ability to recruit better talent, lower costs, and closer proximity to customers and prospects.
 
As this expansion continues, it will inevitably dilute Silicon Valley’s domination of the cybersecurity sector. Now, new security companies flush with incredible talent and potential are attracting investors from around the world. To accurately understand this changing landscape, we scrutinized data on how the East Coast and Europe are currently shaping up against California, and the results clearly demonstrate a shifting landscape.
 
US - East Coast vs West Coast
 
Venture capital’s relentless search for alpha is shifting focus from California to other traditional venture-rich areas such as New York, Boston and the greater Baltimore - Washington DC area. However venture investment is also growing in new emerging tech areas such as Ohio and Illinois. Several large investments have driven East Coast funding to record levels in 2020, including a $150M fundraise by Snyk, a developer of security analysis tools located in Boston and a $83M fundraise from Dragos, a Maryland-based rising industrial cybersecurity company. In 2020 YTD, there was a total of $849M in venture capital investments across 53 companies on the East Coast, a 289% increase over 2019.
 
The East Coast is closing the gap on California in the number of early-stage cybersecurity companies being funded, with $1.14B invested into the Series A venture rounds of 101 companies vs. $1.5B invested into 135 companies in California over the last five years. One reason is the region’s advantage in access to talent coming from the headquarters of multiple intelligence organizations and the most prestigious educational institutions providing cybersecurity education.
 
UK/Europe Growing with Government Support
 
Although smaller, the UK and Europe’s cybersecurity venture ecosystem is also rapidly growing as venture investors join government innovation programs across the continent initiatives, form startup hubs, and attract funding from investors. Cybersecurity venture funding has increased in recent years, and is showing even more potential for future growth with stronger growth in early-stage deals.
 
With only a few US-based firms investing in Europe, growth has been largely driven by European-based venture capitalists or cross-regional funds like C5 Capital. Over the past five years, Europe has reported increasing numbers of Series A and Series B rounds, showing promise to be a new epicenter for cybersecurity innovation. Fueled by important financial hubs in Luxembourg and Switzerland, Europe received $391M in funding across 20 deals in 2020, an increase of nearly 20% over 2019.
 
London has taken a significant lead in venture funding over other European cities, but other notable hubs include Berlin, Paris, Amsterdam, Barcelona, Madrid, and Stockholm.
 
Delivering on the Next Generation of Cyber Innovation
 
Silicon Valley has been successful in making the big bets in later venture rounds to help startups rapidly scale once they have locked in their product-market fit. In other regions, especially in the UK and continental Europe, startups have often exited or reached a plateau without taking additional growth funding. This may be due, in part, to a founder’s lack of commercialization experience, or the availability of capital.
 
What has been missing in these regions is smart growth stage capital to drive further innovation and scale. Late-stage cybersecurity investments, such as Series C funding rounds, pay off for both companies and investors, with annualized returns nearly as high as riskier Series A rounds. With better access to capital and worldwide talent, there will be further opportunities outside Silicon Valley to scale and create a new wave of solutions to solve today’s cybersecurity problems. In 2021, expect to see an increase in cybersecurity funding for companies in these new regions that have strong, innovative and unique offering to help ensure a much-needed, secure digital future.
 
About William Kilmer
William Kilmer is managing partner with C5 Capital, a venture capital fund investing in the secure data ecosystem. He was formerly an Operating Partner at Mercato Growth Partners and served as CEO and Chairman of PublicEngines (Acquired by Motorola), and Avinti (merged with M86 Security) and serviced as Chief Marketing Officer / Chief Strategy Officer of M86 Security (Acquired by Trustwave). He previously worked as the Managing Director of Intel Capital Europe, based in London.