Venture Capital: Where Will the Money Move to Next and Where Has It Been?

R.T. Young

R.T. Young, Ph.D. Business Economics

Venture capital is a world of very risky investments. In a nutshell, the venture capital world consists of a very few well-connected financial investors looking to invest in early- to late-stage startup companies and small businesses needing cash. The hope — for both the venture capitalist and the entrepreneur — is that the given startup will succeed in achieving often amazing growth rates. If the company succeeds, both the entrepreneur and the early-stage investors, which in most cases includes venture capitalists, usually make a ton of money.

With the number of potentially successful entrepreneurs spanning the globe, one would think the venture capital industry would be highly spread out over the various geographic hotspots for entrepreneurial activity. Interestingly, instead of being dispersed, the venture capital industry is highly concentrated.

Here’s a look at where the venture capital industry investments went in 2013. As mentioned, only a few geographic locations suck up all of the venture capital investment.

On top of the venture capital investment world are businesses located in California, capturing about 52 percent of the total venture capital investment dollars. Far behind in second are businesses headquartered in Massachusetts at 11 percent, New York at 8 percent, Texas at 4 percent and Maryland at about 3 percent.

Graph 1

One might ask: Well, are the 2013 investment figures just an anomaly? Perhaps investors took a shine to companies located in California because of the recent boom in the technology industry.

The following animated GIF addresses this question by showing what the figures look like from 1995 to today. (As a note, the size of the state represents the percentage of total venture capital invested in businesses in that state in a given year. If the state shows up as larger in any given year, then businesses in that state received a disproportionate share of venture capital investment dollars in that year.)

Perhaps as no surprise, the dominance of venture capital investment in California is generally consistent across the years. The lowest take for California-based businesses occurred in 1998 at 37 percent, and the highest was 53 percent in 2012.

Why such a bias on behalf of venture capital investors for startups located in California?

As with most questions of this broad magnitude, the answer lies in the multidimensional detail. Here are four reasons.

First, the venture capital industry goes through various “hot” sectors, and in the past 20 years, the technology industry has been and continues to be a “hot” sector. With the likes of Google, Apple, Amazon and many other big technology companies headquartered in and around Silicon Valley, it comes as no surprise that venture capital investments would go to companies close by.

Second, venture capital investments tend to float towards areas where professors at universities are very entrepreneurial. Located in California are such institutions as Stanford, the University of California at Berkeley and the California Institute of Technology, to name just a few. Many faculty members at these universities may be more entrepreneurial than faculty at competing institutions of higher education.

Third, industries cluster by their very nature. For instance, the investment banking industry is overly concentrated in very few cities, chief among them New York City, Chicago, Philadelphia and Omaha.

Clustering does not, of course, only occur for the various components of the financial industry. Clusters are also quite common in the industrial sector. For instance, the auto industry is heavily concentrated in the Michigan, Indiana and Ohio area; the tobacco industry has its headquarters in the mid-southern United States, including North Carolina and Virginia and the oil and gas industry is concentrated in Texas, North Dakota and certain areas in between the two.

So, the fact that the venture capital industry is heavily concentrated in California, and in particular Silicon Valley, is not all that surprising. Or is it? After all, the venture capital industry is after the most profitable investment opportunities and therefore should be very mobile. Can it really be that businesses located in California offer 52 percent of the most profitable opportunities?

Fourth, alongside clustering, the venture capital industry suffers from an oversized amount of “herd behavior.” Essentially, venture capital investors tend to follow one another into investments, rather than invest in competing companies.

It is this last point that leads some industry observers to wonder when the industry will broaden its horizons to other areas currently dominated by wealthy individual investors.

Interestingly, the answer largely depends on the above four answers to California’s dominance.

On the first, the venture capital industry may move away from California if investors start to sour on the California tech industry’s ability to produce rock star talent. Many locations are now trying to compete for the venture capital industry’s money through the technology startup channel. For instance, Skype, the king of voice-over-IP services, was not developed in Silicon Valley, but rather Estonia.

In addition, technology may lose favor with the venture capital industry as a whole. If one breaks up the data into sectors, the results look a little different. For instance, the following figure shows the venture capital investment flow in the consumer products industry. Although businesses in California have a slight advantage in 2013, that advantage is not as large, especially if one controls for population.

The same general story holds for most other sectors.

Graph 2

Another trigger for venture capital investors to widen their horizon could be the increasing desire on behalf of university administrators to get entrepreneurial talent as part of their faculty, rather than just teachers or researchers. California’s first-mover advantage won’t last forever.

Lastly, on clustering and herd behavior, the venture capital industry will eventually reach a tipping point where either entrepreneurs or investors want to live somewhere else for various reasons, such as tax policy, housing, demographics or any number of things.

Overall, contrary to what some might think, venture capital investment is highly clustered, with the vast majority of the money flowing to businesses headquartered in just a few states. Of those states, businesses located in California are king, capturing anywhere from 37 percent to 53 percent of total venture capital investment dollars across the U.S. since 1995.

The question now is how long can this go on? When will venture capital investors move away from Silicon Valley towards (perhaps) greener pastures in other highly entrepreneurial areas, such as Utah and some of the southern states? We all know it will eventually happen — the only question is when and what the trigger will be.

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About R.T. Young

R.T. Young

R.T. Young, Ph.D. Business Economics

R.T. is a business economist and angel investor. R.T. spends his days doing advanced statistical analysis and writing for businesses and elected officials across the United States, Europe and Asia. In his off-time, R.T. enjoys basketball, football, baseball and most any other sport. R.T. holds a Ph.D. in business economics and a bachelor’s degree in physics.

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One thought on “Venture Capital: Where Will the Money Move to Next and Where Has It Been?”

  1. The Venture Capital you represent is “private” venture capital, or does it include “Government” venture capital. This is a big player in certain segments sometimes the only player e.g. space for most of its history. Also, how do you choose to account for “unpublished” and “foreign sources” of venture capital? These are not disclosed in manners easily acquired because, well companies seldom give up information in investment initiatives since the information that one is investing is often a strategic insight knowledge (for your eyes only) kind of information. There is competition, alot of competition in the field of venture capital and initiatives outside of operations and normal R&D. Thanks.

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