Thoughts On Comparing Venture Capital In Different Geographies

In a prior comment, Kisalaya asked if I would share some thoughts about US venture capital in a way that might provide some insights as to where one might look for macroeconomic levers in how venture funded companies develop within other geographies (e.g., in India).

Let me preface this by saying that I am not a venture capitalist, although I tend to be about small businesses, privately-held companies, venture capital- and angel-financed businesses as a matter of appetite.

From my experience at business school at the University of Chicago as related to the distribution of venture capital and entrepreneurial activities, the first thing that jumps out at me in the United States is that Silicon Valley and Route 128 (Boston) have the highest concentrations of venture capital and venture financed businesses. Areas like my former hometown of Chicago and current hometown in Dallas have sometimes been referred to as the desert wasteland of venture capital. Fewer early-stage venture firms, more mezzanine firms, etc. … this tends to be the makeup in the Midwest.

Yet focusing a little deeper on one phenomena may be instructive, and it has been researched a bit in universities at a more rigorous and statistical level (I cannot find the studies offhand, so this is off the top of my head – if anyone can confirm, great). The phenomena is this: Silicon Valley tends to swamp Route 128 in terms of the amount of capital and venture financed businesses. 

On the surface, this is perplexing as to why this is so. Both of the areas have large talent pools. They also both have good universities (e.g., Harvard, MIT, Stanford, Berkeley) very proximate to the center of activity. Both areas also have partnerships between industry and academia. Both also have capital investment infrastructure.

The way this discrepancy has been explained to me is that the employee-friendly laws of California over Boston have some of the biggest effects on the difference (in addition to the more litigious stances in Massachusetts). Non-competition clauses as part of employment agreements are much, much harder to enforce in California. As net result of legal differences, the network effects of a much more mobile workforce creates an environment that may be much more "entrepreneurial-friendly" in a sense.

Anecdotally from my own experiences with start-ups, when considering legal infrastructure documents (e.g., stock option plans) for areas like California, Illinois, and Germany, the California forms of agreements seem to be much more employee-friendly as a general rule too. Things like employee-friendly stock repurchase agreement and accelerated vesting clauses come to mind as being things that have become norms in California, but not necessarily in other parts of the country and perhaps not other areas of the world. While stock options did lose a lot of weight in the bubble, and thus leveling the playing field from a stock option differential perspective, things will start to open up again as the IPO and capital markets open up.

California is a very employee-friendly place (perhaps aside from housing costs …) from my perspective. Although this may be shooting a little low, if the unemployment security filing regulations for employers is any example, I’ve found the filings for CA employees to be the most burdensome of any of the states I’ve filed for. That type of structure protects the employee as well at the cost of higher administration for the employers.

Stepping back a bit, I suppose other things to look at that could influence venture capital activity:

• how do the venture capitalists get liquid (what are the mechanics of getting to the public markets)
• industry variations due to local geography (e.g., Chicago does not have as much high-tech)
• talent pool for management (aside from just line workers)
• proximity of capital to ventures (VC have historically invested closer to where they are located than farther away [because of deal management and deal sourcing concerns])
• exchange rates (can the VCs both make enough money and invest enough money relative to the pre-money valuations of the companies and size of fund they are working)

Other than the fourth bullet point above, I’ve not seen any academic research on the topics. Not to say it isn’t there or that it couldn’t be researched more rigorously, I just haven’t seen it.

Internationally, other areas to study that come to mind may be Japan and some of its protectionist policies in the past surrounding electronics. China, in terms of of the recent transfer of wealth to entrepreneurs by the giving away of state property, is also noteworthy.

Other areas to look at may be New York and Colorado in terms of venture capital (especially since Fred Wilson and Brad Feld are prominent VC bloggers in those respective geographies). I’m less familiar with those areas of the US, but what comes to my mind readily is that Colorado made some good telecom modernization investments in the mid- to late-90s. New York is the home of a lot of publishers, advertising, etc. firms. New York City doesn’t have much in the way of financial markets though, right?

Update (Sept. 2005): Venture capitalist Fred Wilson focuses in on a special area of this post.