Is distance an obstacle to venture capital?

Is it possible to get business financing from top investors if you have a business plan focussed on a venture outside Silicon Valley? If you land venture or angel investments from remote investors, expect to go back to investors often with an updated business plan for more rounds of cash. A recent study by  Indiana University finance professor Xuan Tian found that entrepreneurs who raised capital from investors located more than 25 miles away were forced to raise smaller amounts, with a shorter duration between each fundraising round, than those with nearby investors.

Comparing 28,000 venture-backed companies who raised funds between 1980 and 2006, Tian studied whether venture firms could use technology to monitor investments just as well from a distance. “We saw that visiting a company day to day made a real difference, and investors were willing to write bigger checks if they could do that,” he says. From Tian’s research, venture firms don’t necessarily abide by the so-called 20 minute rule, where venture capital firms typically want to invest in startups located within a 20 minute drive of their office, but a greater distance does make a VC hold on tighter to its purse strings. On average during this time period, firms raised 3.6 rounds of financing with 20 months in between rounds and $72.7 million in total.

Fundraising clearly takes a significant amount of time and money in fees, so Tian was surprised to see that firms with remote backers actually performed somewhat better overall when they raised more rounds of financing. To calculate performance, Tian looked at whether firms would go public and if they did, whether or not they delisted within three years. For entrepreneurs with investors more than 25 miles away, one extra round of financing meant they were 5% more likely to go public and 0.1% more likely to remain public three years later. Though Tian’s research stopped as of 2006, from perusing more recent data, he says he would expect the same trends to to continue now.

Tian studies entrepreneurs who successfully landed remote funding. How likely are entrepreneurs outside of major venture hubs to get VC and angel investments in the first place? The majority of venture funding, roughly 63% of $5.4 billion in the third quarter of 2010, was funneled into California, New York and Massachusetts, according to research firm CB Insights.  That’s down from 65% of second quarter 2010 deals and 70% of 2Q funding.

This week on his blog, Fred Wilson, a partner at Union Square Ventures, a New York early-stage venture firm, outlined the number of startup he’s invested in outside of New York, San Francisco, Europe or Chicago: ZERO out of 37 investments since 2004.

“We are focused on one thing, internet services of scale, and are wiling to travel to find them,” writes Wilson, whose startup investment lineup includes Foursquare, Meetup, Tumblr, and Zynga. Still, he admits that he only has a certain amount of time and generally traverses pre-ordained routes to find and see his startups. Wilson hasn’t counted out going elsewhere, noting that he goes to Boulder and Austin regularly and sees “opportunity in Seattle, LA, Boston, DC, Chicago, Toronto, and elsewhere.

Still, since venture capital returns aren’t giving too many managing directors private jets, most angels and VC can only go so many places so often so proximity to investors or at least proximity to an easily traveled route helps.