Don’t Build Your Startup Outside of Silicon Valley
October 25, 2013 Editor 0
The entrepreneurial zeitgeist today is hard to ignore. Startup America regions have been launched in 32 states. MBAs are flocking to internet startups at an unprecedented clip — faster than during the original dot-com bubble. Even President Obama is calling our entrepreneurial job creators to arms. There’s a sense that it’s up to us to get the country back to work, and that’s driving entrepreneurs to Detroit, Baltimore, Providence, and any number of cities that have struggled with unemployment. And the numbers tell a similar story: startups are mushrooming up everywhere. From 2006 to 2011, the number of startups founded and funded outside of California, Massachusetts, and New York has grown by almost 65%.
But the reality for entrepreneurs outside of the established startup meccas is a difficult one: if you start a technology business somewhere other than the San Francisco Bay area, New York, or Boston, you’re stacking the deck against yourself.
Over the past five years, I’ve been involved with startups across the country. And while I continue to be a big believer that building new business is the key to America’s competitive advantage, it’s hard not notice the huge roadblocks in the way of entrepreneurs outside of the startup “super-hubs.” It’s generally acknowledged that it’s more difficult to find talent, raise funds, identify mentors… but the data suggests that it’s even worse than you’d imagine.
There are three pieces of data that are particularly shocking to internet, software, and biotech entrepreneurs who are on the verge of committing their firms to starting firms in secondary startup markets (and, in particular, outside of the San Francisco Bay).
It takes longer to raise money. Raising venture capital isn’t the be all and end all of entrepreneurial success. But it is an important metric. Many small businesses don’t require the sort of financing required by firms in pursuit of s-curve growth. You certainly don’t need to bang on doors on Sand Hill to start a restaurant chain or a real estate brokerage. But for an important subset of the business world — firms in pursuit of explosive growth — raising capital from angel investors or venture capitalists is an early step on a long and uncertain road to success. There is a reason venture-backed firms account for 11% of all US employment.
Against this backdrop, venture capital is aggregating. The bigger firms are raising bigger funds and institutional investors are fleeing the underperforming funds. It also happens that the best performing funds are located in San Francisco, Boston and New York. So it should be no surprise that as VC coalesces, it’s also centralizing in the startup hubs.
For startups outside of those cities, that means there is a smaller pool of locally-managed dollars to chase for your startup. (And because of the increase in entrepreneurial activity, there are also more companies chasing those dollars in secondary markets around the country). Based on my analysis of AOL’s publicly available Crunchbase data, the average Seed and Series A stage companies take about 10% longer to raise funds outside of California, New York, and Boston than super-hub counterparts. That tends to mean companies outside of California, Massachusetts, or New York will spend more than a month longer searching after Series A capital and more than two months longer searching after Series B capital.
And if you look at the time it takes from founding to raising your first (publicly announced) round, the picture gets even worse.
This doesn’t sound like long, but when runway for these fledgling businesses is often in the weeks and months, this is critical lost time. It’s time spent not building product. Not hiring new employees. Not focused on new marketing campaigns. It’s time that a competitor — perhaps in a super-hub — will have to place their full attention on building their business.
Two months spent traveling around the country to fundraise is two months falling behind.
It decreases your odds of being bought. The world is well versed in Michael Porter’s cluster theory. It’s a truly insightful mechanism for explaining why specific geographies can maintain competitive advantage despite high cost structures and other structural disadvantages. When it comes to the technology ecosystem, clusters are vital. Tech companies see engineers move to and fro frequently, integrate their products tightly, and often find themselves acquiring or merging with counterparts. All of this is made infinitely easier when you have personal relationships with the executives and engineers that you’re working with. For that reason, startup super-hubs tend to be tight-knit communities.
From an entrepreneurial perspective, the reason this matters most is that companies who are on the market to acquire competitors take on a lot of risk. There are basic risks, such as experiencing a cultural mismatch or failing to integrate technically. Those risks are minimized when the acquirer has more familiarity with the acquired company — there are fewer surprises along the integration path. So it shouldn’t be too shocking to find that our super-hubs see an oversized amount of local acquisition activity. All things being equal, it’s more likely that a tech company in New York will buy a tech company in New York than in San Francisco.
Out of 335 acquisitions captured in Crunchbase in California since 2006, 225 were of California companies. If you assume acquisitions were to be distributed across states weighted by their startup population, that number is about 39% higher than you would expect. Similar numbers exist for Massachusetts and New York. For founders thinking about launching companies outside of New York, Massachusetts, or California, that means your odds of pre-IPO success are automatically lower before you’ve even started. And if you are the clear leader and an obvious acquisition target, founders still need to consider what being located far away does for valuations. Certainly, the additional risks, the lack of exposure, and the troubling funding environment make for legitimate reasons to put less money on the table than you’d otherwise deserve.
It decreases your odds of success
The last point is a simple one. If you judge entrepreneurial success as surviving or selling (including raising follow-on funding, being bought, or successfully IPO’ing) as no doubt your investors do, then your odds of success are lower outside of the superhubs.
Since the recession began more than five years ago, early stage entrepreneurial activity (Seed and Series A deals) have risen faster for companies in secondary markets than inside the superhubs. More and more founders are taking their shot at success where they live, instead of taking that journey to the valley, the alley, or Kendall Square. But the simple truth is that by every metric surrounding follow-on funding, acquisition, or IPO, the superhubs still have a distinct edge. Despite the fact that more companies are being founded outside of our traditional areas, there are noticeably fewer success stories at every step along the way. The percentage of all companies founded in 2008, 2009, and 2010 located in California, Massachusetts, or New York who have received a second round of funding is 10-15% higher than what you’d expect based on who received an initial round of funding.
While the casualty rates aren’t quite as bad, entrepreneurs who choose to locate their businesses in secondary markets need to be aware that it’s a little like getting involved in a land war in Asia. A lot of people might have tried it out. Success stories are few and far between.
For all the reasons you can think of — talent gaps, cultural differences, funding environments, etc. — the odds just plain favor a few geographies. None more than the SF Bay area.
Every business is unique, so I would never claim to have the perfect answer for any founder trying to select his or her location. It’s not that founders outside of superhubs work any less hard, are any less talented, or have worse ideas. The reason the numbers look the way they do is because the environments are fundamentally different in start-up superhubs. And until community members acknowledge the shortcomings of secondary markets, and come up with some way of addressing them, then we should be open and honest with our entrepreneurs about the heavy toll they will pay to build their businesses where they live today.
If you’re one of those entrepreneurs or investors who is going to try to win where you live, stay tuned. The second and third articles in this series will offer some suggestions on how you can optimize your chances along the way.
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