When the Revolution team hops on a bus and road trips across the country on our Rise of the Rest tours, we don’t embark on those week-long trips for the fun of it. The Rise of the Rest road trip is a direct response to the extreme disparity across the United States when it comes to the geographic distribution of venture capital investments. Over 75% of venture capital investments go to only three states: California, New York and Massachusetts. This forces the remaining 47 states — or what we call the “rest” — to compete for the remaining 25%.
However, the minimal volume of capital available isn’t the only challenge for companies that are breaking ground outside of traditional innovation hubs. The quality of the networks of capital, no matter how small or limited, also poses particular challenges in these regions. When networks of capital are not organized and the players aren’t connected, it’s practically impossible for struggling young companies to find the funding necessary to break into the next echelon of startups.
Efficient networks of capital, such as those in the Bay Area or New York City are relatively insulated to market conditions. The rewards of entrepreneurship and investment remain within the ecosystem and further propel innovation and growth in a virtuous cycle. In an efficient marketplace, investment funds are ultimately returned and recycled. As companies rise in an insular marketplace, the management, employees, and investors are able to start or invest in new businesses and continue the cycle of innovation.
A prime example of this can be found in Detroit, a city most definitely on the rise. When Quicken Loans (formerly Rock Financial) was purchased in 2000 by Intuit Inc., an enterprise software company based out of California, the Michigan-based company remained in their home state. Not only that, Quicken Loans made the deliberate choice to centralize their operations in the Motor City and today, 3,100 Quicken employees live in Detroit. One of those employees was Marc Hudson, a former software engineer at Quicken who is now the co-founder and CEO of his very own startup, Rocket Fiber, which aims to bring lighting speed internet service to Detroit. Rocket Fiber is not only providing a much needed service to the community, but it is also helping Detroit rise and become a leading tech hub. If this cycle continues to hold in Detroit, it will continue to draw new and returning sons and daughters back to the Motor City.
This sort of environment that promotes local innovation and encourages companies to continue to scale where they’re based doesn’t happen by accident. The odds are often stacked against companies that rely on venture capital and subscribe to the tremendous demand for exits. In fact, 75% of companies with venture funding exit at a $75 million valuation or less. While exits can be productive and hugely beneficial for the company, investors and, indirectly, the cities and startup ecosystems, the pressure for exits can also create tension between investors and the needs of the larger ecosystem.
When companies are prematurely driven to exits, not only can it stop a company’s progress, it can also move top talent away from the ecosystem or bury it within a larger company that is not aligned with helping the city rise. Not to mention the worst possible scenario where the acquiring company completely shuts down the business for competitive reasons. That’s why it is essential for policymakers, entrepreneurs and investors to work together to create a healthy ecosystem where companies aren’t pressured to prematurely exit, and when they eventually are ready to do so, are incentivized and able to negotiate remaining in their rising city.
Here are three ways to create a network of capital that encourages companies to remain locally and contribute to the rise of their cities:
1. Celebrate Exits as a Draw
Success begets success. By celebrating appropriately timed exits and not being shy about wins, startup ecosystems in smaller markets can encourage potential entrepreneurs or potential angel investors to get in the game. Ecosystems must take the steps to market what is unique about their cities to entrepreneurs and investors — and even major local corporations and politicians — so that everyone can share in the hometown victory.
2. Facilitate Opportunities for Early Investors
It is absolutely vital for entrepreneurial ecosystem leaders to facilitate opportunities to convene, educate, and support early investors. The ecosystem fails if it does not provide these three components. Additionally, as entrepreneurs take investment from local angels, they should look for opportunities to enable their early investors in smaller geographies to generate some liquidity, so that capital can be recycled back into the ecosystem. One option is to offer early investors opportunities to sell shares in later financings (at hopefully higher valuations).
3. Negotiate an Anchor to the City
Considering the cost advantages of operating in some of the smaller markets versus the coasts, it is occasionally possible for an acquired startup to negotiate to remain in its home city. Other approaches which have been effective for the to-be-acquired startup in M&A negotiations are touting the recruiting advantages available if the startup abuts a high quality university or assists from local governments who provide meaningful incentives for companies to keep employees local.