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California Rules the Venture Capital Ecosystem

Posted By Scott Shane On December 22, 2010 @ 8:30 am In VC & Angel Capital | 3 Comments

California has been the number-one state for venture investing for more than 30 years. It doesn’t matter whether you measure VC activity in dollars, deals done, or capital under management. Actually, based on certain measures, California today accounts for a larger slice of the venture capital pie than it did 30 years ago.

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California’s Dominance in Venture Capital

National Venture Capital Association (NVCA) data shows that, in 2009, half of all venture capital dollars invested in the United States were deployed in California. And over the 29-year period from 1980 through 2009, the state was responsible for 44.1 percent of all venture capital investment dollars. In no year since 1980 did California account for less than 32.2 percent of the dollars that VCs put into startups.

A similar pattern can be seen from the data on deals.  In 2009, California accounted for 40.6 percent of all U.S. venture capital deals. Between 1980 and 2009, the state accounted for an average of 38.9 percent of all VC investments.  And in no year since 1980 did the state account for less than 32.2 percent of U.S. VC deals.

Among metropolitan areas, the San Francisco/San Jose axis has dominated venture capital for decades. According to a study by Henry Chen of Harvard University and his colleagues [2], the San Francisco/San Jose area accounted for 19 percent of all venture capital offices in 1985 and 24.4 percent in 2005.  By contrast, Washington D.C. only increased from 3.1 to 5.3 percent of all offices over the 20 year period studied by the researchers, and Atlanta only increased from 1.8 percent to 2.3 percent.

Why It’s Not Likely to Change

The dominance of California (and the San Francisco/San Jose metro area in particular) in venture capital is unlikely to change.  The distribution of venture capital across states has barely changed over the past two decades even though the industry has gone through remarkable changes – rate of return, amounts of money invested, and numbers of firms shifting dramatically.  If expansion and contraction of the industry did not appreciably alter the geographical distribution of venture capital, then the distribution must be very stable.

That stability is a function of a positive feedback loop between venture capitalists and entrepreneurs who need VC funding.  Venture capitalists need to find good investments, help entrepreneurs to build companies, and make sure that business founders act in accordance with investors’ interests.  All of that is easier if investors invest locally and stick to investing in places where a lot of venture capital-backable companies are already present.  In their study, Chen and his colleagues found that when venture capital firms open new offices, they tend to expand to Boston, San Francisco/San Jose, or New York, rather than places where venture capital isn’t already prevalent.

Entrepreneurs whose business models need venture capital, in turn, tend to locate near existing venture capitalists because those locations are where funding is easier to find.  As a result, venture capitalists and the entrepreneurs they finance have remained concentrated in places like Silicon Valley for the past 30 years.

Implications

Venture capital-backed companies are high performing businesses, creating more jobs, producing more innovation, and generating more wealth than other kinds of startups.  This pattern has led governors and legislatures to look for ways to build up the venture capital industry in their states.

However, policy changes, such as lowering state income taxes, have done little to increase the amount of venture capital in most states.  Instead, venture capital remains concentrated where it was most prevalent 30 years ago.

The positive feedback loop between investors and entrepreneurs keeps other states from building up their venture capital industries.  California continues to obtain the lion’s share of U.S. venture capital, making it the go-to destination for starting high tech companies in need of venture capital; and the presence of those companies in California leads venture capitalists to concentrate their efforts there.

Editor’s Note: This article was previously published at OPENForum.com under the title: “Creating Venture Capital Ecosystems [3].” It is republished here with permission.


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[1] Image: http://smallbiztrends.com/wp-content/uploads/2010/12/california-money.jpg

[2] a study by Henry Chen of Harvard University and his colleagues: http://www.hbs.edu/research/pdf/09-143.pdf

[3] Creating Venture Capital Ecosystems: http://www.openforum.com/idea-hub/topics/money/article/creating-venture-capital-ecosystems-scott-shane