Is VC Becoming More or Less Concentrated Among States?

SSTI Gives Readers Closer Look at the Data
With U.S. venture capital (VC) investment reaching its highest level since 2000, many are excited about the potential growth of investments in states that have received historically smaller amounts of VC. In the March 19, 2008 issue of the Digest, SSTI covered analysis from the National Venture Capital Association (NVCA) and PricewaterhouseCoopers that highlighted the five U.S. regions that have experienced the greatest growth since 1997. These regions, including the state of New Mexico and Pittsburgh metro area, have posted remarkable gains.
 
Others, looking at the data from different perspectives, disagreed with the NVCA conclusion and argued national trends do not appear to be especially favorable to nontraditional venture regions or select states.
 
Understanding trends in the VC industry from various angles is important to ensure state policymakers propose and support the most appropriate interventions for the specific goals to be accomplished. In some cases, no public intervention may be necessary. In others, perhaps programs should be targeted to specific sectors or geographic areas. In still other cases, broad policies may be required.
 
The March 19 Digest article tried to present a balanced view of both arguments for several reasons. First, reporting errors, omissions and the quirks of individual deals can paint a distorted picture of overall patterns when viewed in isolation or in single year “snap shots.” Also, rapid growth in the national VC industry as a whole or in certain regional markets could mask trends on another scale, such as the state level. Finally, the number of dollars invested in a state is important, but as an increasing number of firms turn to later-stage, high dollar investments, early-stage companies may still be left without access to private equity financing.  
 
The SSTI State Venture Capital Dashboard
To make a case for whether or not VC is more or less concentrated, one needs to look at the trends in the data over time and through several lenses. As an aid for everyone in this effort, SSTI has developed a new Web tool designed to help practitioners and academics look at the level and distribution of U.S VC investment since 1997. The SSTI State Venture Capital Dashboard provides 52 profiles (50 states plus the District of Columbia and Puerto Rico) connected by a simple interface that will allow users to easily navigate to state investment data. Users can view state investment levels, deal flow, and the share of overall U.S. investment received by each state on the basis of annual and quarterly reporting. This information has been derived with permission from the PricewaterhouseCoopers/National Venture Capital Association MoneyTreeTM Report with data from Thomson Financial.
 
Using State Share of Total U.S. Investment to Facilitate Comparisons
VC investment experienced remarkable variance over the 10 years, most notably with the exuberance of 2000 and 2001 and the post dot-com crash lows immediately following. That variance presents challenges for studying trends among states. To overcome this, SSTI looked at changes in each state’s share of the total U.S. investment over the years.
 
Using state share of total VC investment as a standardizing measure, however, has its own drawbacks when looking the VC industry. For example, it presumes that all VC is the same, or, in other words, that any deal could take place anywhere but just happens to occur in one particular place over another. A second presumption is that there have been no changes in the types of deals made or the preferences of investors for certain “hot” industries or sectors.
 
A more rigorous model is required to really understand the nature and differences of VC investment among states. Since the question is whether VC is more or less concentrated geographically, however, share of total provides a good launching point.
 
The California Phenomenon/Problem
On the national, 50-state level, the most striking trend in venture capital distribution over the past 12 years has been the increasing prominence of California. As George Lipper noted for the National Association of Seed and Venture Funds, California claimed about 40 percent of national venture investment in 1995, a figure which had grown to about 47 percent by the end of 2007. Second-place Massachusetts captured almost 12 percent of the total pot last year. While approximately only one-fourth of California’s investment, Massachusetts does significantly outdistance the other states; third, fourth and fifth places come in between 4 percent and 5 percent. The balance of the top 10 states were around 2 percent and 3 percent each in 2007.
 
The data clearly show the Golden State has been consolidating its dominant position in the market over the past few years, dramatically skewing the data about each state's share of venture investment. So what to do about California in comparisons? And should California, as such an obvious outlier, even be included in the comparisons?
 
One cannot argue that California is capturing “more than its share” of VC. The issue is not one of fairness, as money follows the deals VC firms believe will yield the best returns for their investors. There may, however, be good deals that go lacking for funds in other areas of the country.
 
Since many state and local TBED initiatives are built on the premise that access to early-stage, risk capital is critical for growing technology-related companies, seeing positive trends in growth for VC invested within a state is a useful indicator to monitor or adjust public policy interventions. Removing California from the analysis makes it easier to see the trends in the rest of the states.
 
In 1995, the top 10 states for VC investment, sans California, were Massachusetts, Texas, Colorado, Washington, Virginia, New York, New Jersey, Florida, North Carolina and Illinois, respectively. During the past 12 years, several states changed relative rankings in the top 10 list. In addition, Pennsylvania and Maryland moved up to join the top 10; Virginia and Illinois dropped out.
 
To address the question of whether VC has become more concentrated, SSTI developed a graph (available on the SSTI Venture Capital Dashboard site) comparing the shares of the top 10 states in 2007, after California back through to 1995. The graph shows the share of VC activity in these states has gradually grown over the period, beginning at  64 percent in 1995 and climbing to 72 percent by 2007.
 
Two conclusions seem to be apparent:

• Any increased concentration of total VC activity is being borne by above average growth of California’s investments.
• Throughout the rest of the country, though the overall dollars invested have grown substantially, there has been a less pronounced increase in the percentage of venture investment concentrated in the top states, at least at the state level.

If these conclusions are correct, then it would seem prudent to omit California from future investigations into the geographic distribution of investment. It also suggests the share of U.S. venture investments is not the most useful or accurate measure for evaluating the effectiveness of programs intended to increase a state’s risk equity activity.
 
On the Dashboard site, you can download a visualization of the percent of non-California U.S. venture activity experienced by each state since 1995. The chart provides little evidence that the U.S. venture capital market is becoming more or less concentrated around a few states.
 
SSTI will take a closer look at the distribution of VC deals and the stage of those deals in a future issue, but in the total number of deals, California's position appears to be dominant as well. Between 1995 and 2007, the state's share of national deals crept from 36 percent to 41 percent.