How Silicon Valley style success can be copied

May 04, 2015 09:55
A Google office building in Mountain View, California. Silicon Valley superstar tech companies and their VC champions populate an isolated island of prosperity. Photo: Bloomberg

Once again, California's Silicon Valley is confirming its status as a mecca of high-tech entrepreneurship and wealth creation. But it is not a model for job creation and inclusive growth that policymakers and entrepreneurs elsewhere can emulate – at least not without making some fundamental adjustments.

To be sure, what is happening in Silicon Valley today is nothing short of dazzling. Venture capital (VC) investment has reached near-record highs. Overnight millionaires – even billionaires – are proliferating. Twenty-something software coders are commanding six-figure salaries.

The boom has driven California’s economic recovery. And, along with courageous political leadership, it has enabled the state to escape from a seemingly hopeless fiscal crisis.

But the Silicon Valley superstar tech companies and their VC champions populate an isolated island of prosperity.

Indeed, just 100 miles inland, in California’s Central Valley, unemployment rates remain in the double digits (11.2 percent in Fresno and 10.4 percent in Modesto), with average family income amounting to less than half of that in Palo Alto, the heart of Silicon Valley.

If the venture capitalist Tim Draper had succeeded in his misguided initiative to divide California into six states, Silicon Valley would have become the richest state in the US, and the Central Valley the poorest.

The key question, then, is how to harness Silicon Valley’s entrepreneurial and innovative prowess to the goal of inclusive economic growth in America’s heartland. To some extent, this is already happening, with visionary entrepreneurs in cities like Nashville, Cincinnati, New Orleans, Wichita, and Salt Lake City adapting Silicon Valley’s recipe for success to local conditions and opportunities – and creating much-needed middle-class jobs in the process. But more can and should be done to support this trend.

The University of Virginia's Miller Center recently created a commission to identify strategies to support the creation of middle-class jobs through entrepreneurship. The ideas proposed in the commission’s report include providing training and mentors for prospective entrepreneurs and startups, creating "ecosystems" of supporting infrastructure, and reducing regulatory barriers.

The report also highlights the importance of unlocking capital for "Main Street" entrepreneurs, who struggle to find the funding they need to launch, sustain, or scale up their operations, particularly as the recent recession drove out many of the community banks on which they had traditionally relied for credit. Silicon Valley startups, by contrast, enjoy the generous support of VC funds, having received 30-35 percent of all venture investment deployed in the US since the 1980s.

Not only is VC investment concentrated in a small part of the country; it has recently tended to support the expansion of later-stage investments, rather than the launch of startups. In other words, VC funds are not well suited to support new businesses that may generate a large number of jobs and boost prosperity locally, but that are not close to launching a billion-dollar IPO.

Before the global economic crisis, entrepreneurs often relied on personal savings, credit cards, home equity loans, and investments by friends and family for start-up capital. Since 2008, however, few aspiring entrepreneurs have been able to borrow significant amounts of money from banks. And most people do not have wealthy relatives or classmates.

Main Street entrepreneurs do, however, have two major – and underused – financing options. The first lies in the public sector. In the US, the Community Reinvestment Act (CRA) – created to ensure that banks that gather deposits in low- or middle-income communities reinvest some of their earnings in those communities – supports more than US$60 billion in community finance, compared to the US$48 billion of VC funding that was deployed last year.

Though much of that reinvestment has traditionally been channeled toward housing, a growing number of investors and banks – including the Bay Area Equity Fund, Village Capital, and the Roberts Enterprise Development Fund – are investing CRA funds in entrepreneurs.

Others – such as Bridges Ventures and Pacific Community Ventures – are using Community Development Financial Institutions and insurance-company balance sheets to expand the financing pool available to start-ups in disadvantaged communities.

A second key source of capital lies with private and community philanthropic foundations, which are required by US law to donate at least 5 percent of their assets to charitable causes annually. In 2012, such foundations distributed about US$52 billion to support their philanthropic missions. They channeled most of the rest of their US$715 billion in assets into traditional investments, in order to generate returns that would expand their capital base.

But a growing number of foundations – such as the Bill & Melinda Gates Foundation, the Rockefeller Foundation, and the Kresge Foundation – are increasing the share of assets they direct toward investments that further their philanthropy.

Such investments can help to accelerate impact investing, which aims to yield both a social and a financial return. Unfortunately, program-related spending still represents only 1 percent of capital deployed by foundations, with just 0.05 percent of that going toward equity investments.

Public and philanthropic investments in local startup businesses are already paying off, both in terms of creating jobs and generating financial returns. An early leader, the Bay Area Equity Fund, raised US$75 million from banks, insurance companies, pension funds, and individuals; created about 15,000 jobs, 2,218 of which were in low- and moderate-income neighborhoods; and generated a 24.4 percent annual return for its investors.

The government can do much to promote such investment. For starters, it should refine the rules governing which investments meet CRA requirements. Likewise, as the US taskforce on impact investing recommended, the authorities should clarify the permissible investment activity of tax-exempt foundations.

Just as Silicon Valley's dynamism should not be diminished, the rest of the country’s entrepreneurial potential should not be underestimated. With the right incentives and funding from philanthropic sources, job-creating entrepreneurs could serve as engines of more inclusive growth in communities across the US.

Copyright: Project Syndicate

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a former chair of the US President’s Council of Economic Advisers, is a professor at the Haas School of Business at the University of California, Berkeley, and a senior adviser at The Rock Creek Group.