Navigating The 2023 VC Landscape Interview: Patrick McKenna, Comeback Capital

This article is a part of the “Navigating The 2023 VC Landscape,” which previously featured Miriam Rivera of Ulu Ventures. Click here to view the previous installment, and follow Brian Penick on Forbes.com for more expert interviews with top investors and entrepreneurs.

For the next installment of this series, Brian Penick interviews Austin-based entrepreneur and investor Patrick McKenna of Comeback Capital and Facet Financial Planning. His journey began in Silicon Valley as a founding member of LiveOps, a technology for managing distributed workers, which he scaled to 20,000 workers before it was acquired. After launching and selling two more companies, Patrick co-founded Facet, a financial planning firm for the mass affluent with 13,000 clients and 260 employees that has raised $160 million in venture capital. Patrick now serves as Facet’s Executive Chairman and General Partner of Comeback Capital, a Cleveland-based VC firm with a thesis targeting entrepreneurs in historically underserved regions.

Brian Penick: It’s obviously an interesting time, given everything happening in the market. Your investments focus on regionally specific founders–can you offer context on how you adopted this thesis?

Patrick McKenna: There are a ton of smart people in Silicon Valley, but not all smart people are in the Valley. Entrepreneurs with great ideas outside Silicon Valley, New York and Boston are typically undercapitalized. Beyond limited access to capital, they’re also under-networked, so they don’t have access to the knowledge and talent recruiting pools. Once I validated that thesis, I started specifically looking for companies based in what I define as the heartland of Salt Lake to Raleigh, Cleveland to San Antonio, kind of that interior. San Diego, Baltimore, Seattle and Tacoma also fit into that thesis, which is where I focus now as a General Partner at Comeback Capital. We have four partners: one in Cleveland, OH, another in Flint, MI, one in Chicago, IL and myself in Austin, TX. We’re set up as a Preseed early-stage rolling fund, and we deploy about a $1 million dollars or so a quarter, typically writing checks of $250,000 in up to four companies at a time. We’re looking for early-stage companies with obvious milestones to their next stage, are doing something innovative, and are also committed to building their company in the heartland city they have established themselves.

Penick: Given the market conditions, have you had to adapt your strategy?

Patrick McKenna: We’re quite disciplined in what we’re looking for in a startup, but what’s changed is more companies are now fitting into that profile. What happened in 2021 was that things got very expensive, increasing not only raises but also increasing burn rates. That’s a challenging position for an early-stage startup because companies will need capital faster, but they will burn through it quicker. We have a structure of an early-stage startup with some validation on revenue and valuations that are under $10 million, with raises in the $500,000 to $1 million range. That sweet spot allows a company to preserve enough of their cap table for founders and enough resources to hit a meaningful milestone so that they can step up their valuation and keep their costs down so that they can be more disciplined and focused and hit milestones. What we saw in late 2021 was higher valuations, bigger raises and more significant burn rates, which we didn’t invest as much in because we thought we didn’t know the market would change as much as it did. We felt it would be harder for the companies to hit meaningful milestones with the burn rates they were taking on with the money they raised. We kept our powder dry a little earlier in the cycle and were disciplined about what we were looking for. What we found this year, actually, is we’ve had more activity in the first two months of 2023, as in quality deals, than we did all last year.

Penick: Can you elaborate on what has increased your market activity this year?

McKenna: I’ve been at this for a long time. I started in tech in January 2000, right before the Dot Com Bubble. I was an investment banker at Morgan Stanley and left to join a friend’s company [Inengio; acquired by AT&T Yellow Pages in 2007] as a Head of Corporate Development. That company survived, but it was very difficult, and I learned a lot about many things that I’ve been preaching regarding my investing. I learned in 2001 and 2008 that some of the best companies are built in distressed times. The best companies have better models; talent will be distributed and more focused than the bigger companies. With fewer resources, fewer competitors will get funded against the natural winners. If you can find that company now and fund them through this challenging period, those will be the companies that will be a step ahead of the companies that went sideways or are just starting. I believe those companies will be set up for massive success when the tide comes back.

Penick: What best advice can you offer startups in this current climate?

McKenna: So I have four questions that I asked everybody: Why this? Why now? Why you? And since I’m a geographic investor, I say, ‘Why here?’ What’s the competitive advantage of you being where you are? Those are the things that you should be prepared for any investor. An example is a company I recently invested in called Jaster Athletes. It’s combining the name, image and likeness (“NIL”) market and building a new marketing agency focused on creating opportunities for the athletes not covered by the traditional agencies. They’re using generative AI to build content more cost-effectively, which is a powerful mashup. For me, it was like, ‘Why this?’ Well, there are a lot of things changing in this AI landscape. ‘Why now?’ There are these two kinds of trends that are overlapping in a market that’s undefined? ‘Why him?’ The founder was already doing marketing and had relationships with universities, working on branding and building content. ‘Why here?’ He’s sitting in Pittsburgh next to Carnegie Mellon University, which is a tech leader, and he has access to many other universities. I made that investment based on these criteria, and it was very early. Anybody reaching out to me personally or through Comeback Capital should be able to tell their story of the critical impetus that is changing now that justifies your time that comes from an entrepreneur perspective. My money is important, but your time is the most important thing. Why are you investing your time in this problem? Why do you care? I can write a check and answer the phone once a month, but you’ll grind on this for 10-12 hours a day for the next five years. I’m really interested in why you care about this; otherwise, we will waste our time, your time and my money.

Penick: Great advice; can you share thoughts for investors as well?

McKenna: The math says that you need at least 15 investments even to get a chance to start hitting a return on your portfolio. If you take $100,000 and put it into one company, your chances of failure are very high. If you take that $100,000 and spread it against at least 15, you have a much higher likelihood of success, especially with a good manager with a good thesis. You want to get diversification in your portfolio. Additionally, I found that I do the best investing in things I know the most about, like technology-enabled services and enterprise software. My three other partners have different expertise: one took a healthcare company public, and another is a Professor of Entrepreneurship at Case Western, so he understands the kind of technical entrepreneurs doing robotics and computer vision and stuff like that. We focus on the diversity of perspective and geography, which has worked well for us.

Penick: Based on your expert opinion, what will happen this year? What does your prediction mean for both entrepreneurs and investors?

McKenna: I believe the next Uber or Square-sized company is being built in the Heartland. It’s poorly understood because it’s hard to see from the outside. Some great companies started in 2020 by second or third-time entrepreneurs in Austin, Salt Lake City, Nashville or Pittsburgh. Some are getting really big, but they’re still under the radar because they haven’t raised that $200- $300 million benchmark. But they have raised $30-50 million, and a few here in Austin have raised over $100 million. Silicon Valley is still going to produce its share of Ubers. What’s changed is other places are brewing their own highly scalable companies. I predict that there will be an increase on a relative basis and investment outside of Silicon Valley. The Valley will still maintain its absolute leadership in terms of dollars. But on a relative basis of normalizing post-peak, the venture market share will be significantly higher in other areas. Austin, Salt Lake, Nashville, Miami, Pittsburgh and Columbus will get the lion’s share of this next level, and it will be a meaningful step up.

Thank you to Patrick McKenna for his time and perspective. Please stay tuned for more articles from my “Navigating The 2023 VC Landscape” series by following me on Forbes.com.

Legal Disclaimer: I am a partner at the venture capital firms LOUD Capital and Legacy Entertainment Ventures. For journalistic integrity, I have not included my perspective within my colleagues’ responses for this article to remain unbiased.