YC alum FiveStars sees explosive growth in LA, fights for the loyalty of consumers and local merchants

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Hollywood Sign LA

One of the fastest growing tech companies in LA may not even be based in the area. FiveStar, the four-year-old San Francisco-based loyalty and marketing automation company has seen its active user-base in the region grow by 90 percent in the last six weeks to more than 1 million users.

That massive uptick in adoption has made LA FiveStars’ second largest and its highest growth market. As a result the company is in the process of tripling its on-the-ground team from just four to twelve in the coming months. With mounting competition, it could prove a wise move for a number of reasons.

Surprisingly, given the geographic sprawl of the LA region, users here are even more engaged than those in the company’s other markets, according to FiveStars CEO and co-founder Victor Ho. LA has grown to 1,800 local users per active FiveStars merchant as compared to 1,700 per merchant in San Francisco, the company’s largest and second most engaged market. The most popular LA stores receive as much as 7,000 check-ins per month, Ho adds. FiveStars’ next most engaged markets are San Diego, Denver, Portland, Seattle, Dallas, and Toronto.

“Even though LA is spread out, the usage per merchant is off the charts here,” Ho says. “Maybe people there are just more comfortable driving. We don’t really have a great explanation. Maybe it’s a cultural or demographic thing. But we’re doubling down in this market based on the behavior we’re seeing.”

Density matters in the loyalty game, which is why FiveStars is focusing on signing up additional storefronts and trusting that the customer growth will drive itself as its platform becomes more ubiquitous. For the average retailer on the platform today, around 20 to 30 percent of its FiveStar-using consumers were already on the platform before the store was activated, according to Ho. But that means 70 to 80 percent are new FiveStars users, joining because a store they frequent adopted the platform. In other words, merchant acquisition is FiveStars’ best customer acquisition strategy.

For merchants, FiveStars promises to drive increased customer engagement. For example, a customer that visits a store twice per week on average may add a third or even fourth trip when they know they’re approaching their next reward – FiveStars users collect “stars” for each visit and are rewarded at various thresholds based on merchant-specific campaigns. Ho calls this “frequency compression” and explains that customer behavior gets stickier the closer to each reward they get.

FiveStars isn’t just about checkins and rewards. The company offers its merchants a comprehensive platform that includes CRM and marketing automation. These options are technically a la carte, but 95 percent of all customers choose the full-service option, Ho claims. FiveStars automates and personalizes marketing campaigns based on user behavior, including everything from re-engaging dormant customers, to incentivizing active customers to buy more frequently or spend more per visit, to rewarding customers on their birthday. All result in additional frequency compression, Ho says.

Loyalty is a hot area right now for the brick-and-mortar retail industry, which is looking to use mobile technology to drive engagement and, more broadly, to remain relevant in an increasingly ecommerce-centric world. Not surprisingly, FiveStars is not the only company to tackle this giant opportunity.

FiveStars’ biggest competitor, and arguably the largest company in the category by merchant and user adoption is Belly, a Chicago-based startup backed by Andreessen Horowitz* and Lightbank. Compared to FiveStars’ 6,000 active retailer locations, Belly is approaching 10,000. But this is hardly an apples to apples comparison given their drastically different business models. More importantly, there are some 2 million local businesses in the US that could one day adopt a mobile loyalty platform, meaning that even combined the two upstarts have acquired less than 1 percent of the addressable market. We are hardly in the first inning of this contest.

FiveStars’ approach is to integrate with merchant point of sale systems while Belly deploys standalone customer-facing tablets in-store. There are merits to each strategy and, not surprisingly, both companies think they’ve selected the winning model. The argument for FiveStars goes that by linking into the POS system, the company can collect transactional data like purchase size and composition, helping retailers learn more about their loyal customers’ buying habits and in turn deliver more personalized promotions. Belly, on the other hand, is able to deliver its merchants more personal demographic information about their customers because its tablet-based system connects with consumer social media profiles and allows the company to deliver content to the consumer at the time of check-in.

“Our promise to small businesses is that we can attach a name and demographic info to every purchase,” Ho says. “Loyalty is not actually about a rewards program. It’s more about using the underlying data for personalization. Consumers benefit when their experience is personalized. That’s the real value.”

The other major difference between FiveStars and Belly is that the former is entirely focused on small and mid-sized businesses (SMB), while the latter has signed up several nationwide brands, including 7-Eleven (which is also an investor), McDonald’s, Domino’s, and Chick-fil-A. Both markets are valuable, but the approach to winning in each is drastically different.

“We play in bottom 50 percent of the market, where merchants have one to 50 locations,” Ho says. “I don’t think we’ll ever target the top 35 percent which is your McDonaldses that work with software consultancies to do custom promotions, like Monopoly. If we expand, it will be in the middle 10 to 15 percent where you see mid-size chains like Peete’s or In-n-Out. There’s no great solution for this segment of the market and we hope to be able to address them eventually. For us the goal is really to start with small businesses. We have a heart for local. But the underlying business reason is that we can get lots of SMBs quickly, while large chains want customization.”

Whether it’s more valuable to know a customer’s age and gender, or their purchase history is an open debate, and one that may not have a singular answer. But while FiveStars and Belly are the two dominant startups in this category, it appears they will soon be getting some company from more established challengers. CurrentC (by MCX), a forthcoming mobile payment offering led by WalMart and adopted by retail giants like CVS and RiteAid, is being geared heavily toward collecting consumer purchase data (for better or worse) and powering in-store loyalty and rewards.

At the same time, there are credible reports that Apple will eventually add a loyalty component to its recently launched (and wildly popular) Apple Pay payments platform. When CurrentC and Apple Pay-Loyalty enter the market, the question for FiveStars and Belly may be less Tablet vs POS-integration, and more about how to compete with these deep pocketed giants with hundreds of millions of existing consumer relationships.

Across the board, these loyalty competitors will all be looking to adopt new technologies to make customer engagement more seamless. At the top of that list are beacons, or small, low-energy Bluetooth transmitters that automatically communicate with nearby mobile devices to deliver messages or prompt desired behaviors, like checkins. FiveStars is actively working on a beacons offering, Ho says, and you can bet that Belly and its incumbent competitors are thinking the same.

FiveStars is a Y Combinator alumni and has raised a total of $ 42.7 million from backers that include Menlo Ventures, Rogers Communications Inc., DCM, Lightspeed Venture Partners, Mayfield Fund, and several angels, most recently via a $ 26 million Series B round in September.

The company was founded by a pair of former McKinsey consultants who, in that role, helped build the popular loyalty programs for Starbucks and Macy’s. Now they’ve moved downstream and are taking that knowledge and a more entrepreneurial approach and targeting SMBs. With fresh cash in its pocket and momentum in the market, expect to see FiveStars spending aggressively over the next year to claim as much market share as possible. Judging by the last few weeks, LA could be one of the company’s strongholds.

“In the past, our posture has been ‘grow slowly and focus on delivering merchant volume,’” Ho says. “Now it’s just about growing really freaking quickly, and becoming be truly top of mind among consumers and merchants. Our mission is to turn every transaction into a relationship.”

(Disclosure: Andreessen Horowitz partners Marc Andreessen, Jeff Jordan, and Chris Dixon are individual investors in Pando.)

[Image via Justin Lai]

  1. FiveStars is the fastest growing company in customer loyalty and marketing automation for local businesses. Launched out of Y-Combinator three years ago to democratize Fortune 500-level loyalty technology, we now drive two million customer visits per month across our network of over five thousand businesses and have raised a total of $ 45 million in funding from top-tier investors like Menlo Ventures, Lightspeed Venture Partners, and DCM.

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Report: LA’s on the rise as its tech ecosystem sees both deals and dollars swell

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Los Angeles

Late last week, CB Insights released a report on the “booming” Los Angeles tech ecosystem. It’s the kind of analysis the research house does so frequently that it’s easy for it to be lost among the noise. But the report’s data was telling in a number of ways, revealing several macro trends that are unique to the LA region and others that have played out similarly on a national basis.

CB Insights looks at the maturation of the LA tech ecosystem over the last five years, from 2009 through 2013, concluding that investment dollars have risen 163 percent over that time from $ 590 million to $ 1.55 billion in angel and venture cash flowing into the region annually. Over the same period, the number of completed deals have skyrocketed 180 percent from 108 to 302 per year. Notably, 2013 was the most active year in both categories within the region.

While we are still mid-year, 2014 seems to be following a similar growth trend with Q2 representing the most active quarter in a deals and dollars since the beginning of the five year period. The headline deals during the period were Swagbucks’ $ 60 million growth round (its first ever outside financing) led by Technology Crossover Ventures, and TeleSign’s Adams Street Partners and Summit Partners co-led $ 40 million Series B.

The narrative around LA has long been that the region is under-capitalized, particularly in the later stages. But with 24 percent, 32 percent, and 21 percent of all capital raised in the region in 2013 going to Series A, B, and C rounds respectively, it’s hard to argue that capital isn’t flowing into the region. (Where that cash is coming from, is another matter, but more on that later.)

The percentage of dollars going to seed deals peaked in 2012 at eight percent of all deal flow, up from just two percent in 2009, and falling only slightly in 2013 to seven percent. In gross dollars, however, the story looks different, with Seed investment continuing to rise, growing from just $ 11.8 million in 2009 to more than $ 108 million in 2013. A similar arc is visible in the deal-share, as seed deals grew from just 17 percent of all transactions in 2009 to a peak of 57 percent in 2012, before falling slightly to 47 percent in 2013.

In turn, the Series A market peaked at 41 percent of all dollars invested in 2012, up from just 19 percent in 2009 before falling considerably to 24 percent in 2013, thanks to more activity at the Series C, D, and E stages. But in raw dollars, Series A deals have grown from $ 112 million in 2009 to $ 426 million in 2012, falling ever-so-slightly to $ 372 million in 2013. On a deal-share basis, Series A transactions have actually been declining from a peak of 32 percent in 2010 to a low of 26 percent in 2013. This shift, while it’s a reflection of the Series A trap, is also an indication of the changing definition and benchmarks of Seed and Series A deals.

It’s notable, given the Seed and Series A peaks, that 2012 was very much the year of the accelerator in LA with more than a half-dozen such startup building machines opening their doors for business that year. Like it has nationwide, the accelerator market in LA has contracted in the ensuing two years, as both founders and later stage investors have looked to separate those adding real value from those who were not. Predictably, this has meant fewer seed deals and dollars invested in 2013 and early into 2014, but also means that there are more companies navigating the later-stages of fundraising – hence the growth in those categories. What’s unclear is what this reversal will mean longer term with regard to the rate of company formation and capital allocation in LA. Stay tuned.

A list of the most-well-funded private companies includes some familiar faces and somenew, but perhaps not in the the order outside observers might expect. For example, Snapchat is just the fifth most-well-funded company in the area, despite its once eye-popping valuation and its successive deca-million dollar rounds. The leader in this category is fashion ecommerce juggernaut Justfab at $ 215 million raised.

The so-called Internet sector – which, I must say, is rather poorly defined – has dominated all funding activity in LA, representing between 68 percent and 74 percent in each of the five years analyzed. While not specified by CB Insights, a look at the winning companies in the region indicates that ecommerce, advertising technology, and content have been the big sectors within this larger category. The biggest change over the last five years – both locally and nationally – has been the rapid emergence of mobile, which in 2013 represents 22 percent of all deals completed in LA. This is reflected in some of the region’s hottest names like Snapchat, Whisper, and Scopely – not to mention the IAC-owned Tinder.

When looking at the most active investors in the region, it’s revealing that at the early-stage (Series A and B), the list is dominated by local firms, with Upfront Ventures leading the way and only 500 startups cracking the top ten as an out of town firm (SV Angel, at number 4, is headquartered in Silicon Valley but managing partner David Lee now lives in LA). At the mid-stage (Series B and C), however, the picture looks different. Redpoint Ventures, which hasn’t had an LA office for several years, remains the most active investor in this stage, while Benchmark Capital is tied for second with three local firms – Clearstone Venture Partners, Upfront Ventures, and Greycroft Partners. The rest of the top ten is dominated by non-LA firms. The story is even more clear at the late stage, with only Upfront Ventures cracking the top ten most active firms (T2).

In other words, LA startups may be accessing more capital than ever before, but the more mature the businesses become, the more likely it is that capital will come from outside the region. Whether this is a bad thing depends on your perspective. Worthy companies are still finding the cash they need to grow. However, there are undeniable advantages to having investors and their respective networks of resources (talent, business development and corporate development contacts, service providers, etc.) local. One possible explanation for the seeming inability for LA startups to break through that mythical $ 1 billion valuation plateau (Snapchat notwithstanding) and continue operating independently is this lack of institutional support and mentorship. Shoedazzle’s spectacular fall from grace is the classic example of an out-of-town board asleep at the wheel.

Looking into exits over the last five years, the report reveals that these transactions have increased annually since 2011, with 2013 seeing a total of 84 exits including EdgeCast Network’s $ 350 million sale to Verizon and Goodread’s $ 150M sale to Amazon. Not reflected in this report is the downright prolific first half of 2014 which saw several blockbuster deals, none bigger than Facebook’s $ 2 billion acquisition of Oculus VR.

But while the M&A market has been heating up, the IPO market for LA startups is all but non-existent. CB Insights notes that six of the ten largest exits by valuation were IPOs, but these deals have represented less than 1 percent of all exits in the last two years. As a result, LA has a relative dearth of large, stand-alone technology companies that can act as pillars of the community, drawing (and later shedding) talent and capital. This began to change somewhat in early 2014, after this report was compiled with two marquee and long anticipated IPOs in TrueCar and Rubicon Project. Others on the horizon are thought to be JustFab, OpenX, Honest Company, YP, and SpaceX.

Like any startup ecosystem outside of Silicon Valley, LA is still finding its legs and its identity. But, as the data shows, the region is rapidly maturing by every conceivable metric including company formation, access to capital, late stage company growth, and exits. Where LA can improve is by keeping more of its best companies local and independent, and by funneling more of the returns created by these winners into local investors’ coffers.

One thing that’s clear in looking at the CB Insights data, is that LA is a market that’s heading “up and to the right.” Don’t be surprised to see that trend continue. (Please just don’t call it Silicon Beach.)

[Image via Mulling it Over, Flickr]

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