Sisters have to do it for themselves

I just read an anonymous post on Forbes.com titled "What It's Like Raising Money As A Woman In Silicon Valley." The article details the sexist gauntlet of groping, marriage propositions and insults that the author had to run as part of the process of raising money for her company. Her experience is hardly unique; there's an ever-growing body of documentation of the sexist, racist and bigoted atmosphere that non-male, non-white founders are confronted with in Silicon Valley. My stomach churned as I read her article, partly because of her experiences, and partly because I saw some of my own past behavior reflected in the men that she dealt with.

Women have never had an easy time in Silicon Valley, whether as an employee (of which there are few) or as a C-level executive (of which there are much fewer.) Women have been concentrated in marketing, PR and HR positions, and people in those positions, male or female, rarely get an opportunity to run technology companies. Female software developers and hardware engineers have always been rare, and have had to put up with a disproportionate amount of sexism because of their rarity.

Social scientists say that it's much easier to pass laws than it is to change how people think. The proof of that is easy to see: Civil Rights legislation made segregation illegal 50 years ago, but racism is still easy to find. The first sexual harassment trial in the U.S. was 40 years ago, but there's still plenty of sexual harassment to go around. We can't legislate away racism, sexism or bigotry--but we can do an end run around them.

Women can't depend on male-dominated venture capital firms to change the way they do business--only four of the top 100 venture capitalists on Forbes's Midas List are female, and only four more made the magazine's "long list." There are a handful of seed and VC firms run by women, such as Golden Seeds and the Women's Venture Capital Fund. We need a lot more. We need women who have been successful in business and finance to step up and help other women succeed. For that matter, we need a lot more African-American-, Hispanic- and Asian-run seed and venture funds. All of these groups face discrimination from the VC community. That's not to say that every seed investor or VC partner is a sexist, racist or bigot--far from it. However, the investment community is largely an "old boys' club," and if you're not male, white and under 40, you're going to have a hard time finding funding, no matter how good your team and ideas are.

Los Angeles and New York have been making a strong push to compete with Silicon Valley for startups and technical professionals. One way that they could succeed is to help build a community of seed and venture funds in their cities to serve underserved groups, like women. Silicon Valley VCs often make it a stipulation that out-of-town startups must move to Silicon Valley in order to get funding, and the vast majority of startups offered money with that condition agree to move. Startups offered money by Los Angeles- and New York-based investors with similar stipulations are very likely to move as well, especially if they can't find funding in Silicon Valley.

As the number of investment firms targeting women, African-Americans, Hispanics and Asians increases, founders will be able to bypass investors who engage in sexual harassment, racism and bigotry. Those investors will see their deal flow diminish, and they'll be forced to either change their behavior or get out of the business, because at the end of the day, another song title describes what's most important to them: "It's Money That Matters."

Cloning Silicon Valley is a lot harder than it looks

For decades, cities and countries around the world have tried to duplicate Silicon Valley. With very few exceptions, these Silicon Valley "clones" have failed. The most common reasons given for the failures include lack of venture capital and lack of university support, but there are a number of other reasons why good intentions so often go awry:

• Technology and business centers usually grow organically, as an outgrowth of existing universities or businesses. "Artificial Trees" are "Silicon Valley" clones that are built in areas with no natural growth factors. They're a lot like farms that are built in the middle of the desert: Everything they need has to be imported. As soon as the supply of any essential ingredients (talent, technology or money) tapers off, these "Artificial Trees" die off.
• In some areas, startups get funded on the basis of political clout and power, not merit. Entrepreneurs without connections don't get funded, and if they can't make the necessary connections, they go under. It becomes clear fairly quickly that the startups that got funding did so for the wrong reasons, and the available investment capital dries up.
• Some Silicon Valley "clones" get started with verbal commitments from government or private investors to make funding available. As time goes on, however, those "investors" don't actually make any investments, or the few that they do make are small and ineffectual.
• In some areas, a handful of people have designated themselves as the "go-to" people for creating and supporting the startup community. If other investors or organizers that haven't agreed to work with the "go-to" people try to offer support to the community, the established order works to push them out or minimize their influence. In addition, the startup community defines itself by the mindset of its "go-to" people and rejects ideas and participants that don't fit.
• Sometimes, the "go-to" people are well-meaning but ineffective. The head of a startup development organization I interviewed late last year in Chicago said that his group had spent seven years trying to get the city's largest investors (family foundations and investors affiliated with the Chicago Merchantile Exchange) to get involved with venture investment, especially A and B rounds, with very little success. If you try doing something for seven years and keep failing, you're doing something wrong.
• Startups struggle in areas where there's a great deal of competition for talent from established companies. For example, New York City startups have found it very difficult to compete for technical talent with investment banks and other financial companies that pay enormous salaries and bonuses.
• If entrepreneurs focus on the wrong reasons for doing startups, they're likely to fail. For example, if an entreprenur wants to start a business in order to get rich, without recognizing the high risk of failure and tremendous effort involved in building their business, they're likely to give up as soon as running their business becomes too difficult or expensive.
• If the community puts a high price on failure, either social or financial, startups aren't likely to flourish. In the U.S., 90% of all small businesses fail, and 70% of startups funded by professional venture capitalists fail, so it's essential that entrepreneurs have the ability to fail and try again without stigma or crippling personal penalties.

There are so many ways that a venture community can fail that it's amazing when one succeeds.  There's no single key to success--there are many.

Is there too much emphasis on scalable startups?

Enterpreneurs, especially technology-based ones, are encouraged to "think big" and build startups that have the potential to grow to an enormous size. Steve Blank, the father of the Customer Development process, calls these types of business "scalable startups". As he puts it, "A 'scalable startup' takes an innovative idea and searches for a scalable and repeatable business model that will turn it into a high growth, profitable company. Not just big but huge. It does that by entering a large market and taking share away from incumbents or by creating a new market and growing it rapidly."

By definition (and as Steve says in the very next paragraph), "A scalable startup typically requires external 'risk' capital to create market demand and scale." This is the very definition of the role of conventional venture capital: Invest a large amount of money in a startup, with the hope that the business will grow big enough to exit, either through an acquisition and IPO, and pay the investors a huge multiple on their original investment.

Steve calls the alternative to a scalable startup a "small business", while venture capitalists have a more derogatory name: "Lifestyle business". These businesses don't have the potential to become huge (with equally huge valuations), and are therefore bad. Or are they?

Somewhere between a "mom & pop" business like a local hardware store or restaurant and, say, Facebook, there are a lot of businesses that have the potential to grow into valuable companies that can be sold at a good multiple, but don't have the potential to be "huge". In software, there are development tools, utilities, and vertical applications that can be significant businesses. On the Internet, there are countless online services that could grow into significant businesses and be acquired by larger companies. These opportunities are right in the wheelhouse of angel investors.

Consider a startup that an angel invests $100,000 in and ends up being acquired at a 20-to-1 multiple. The angel walks away with $2 million. To a venture capital firm, that's not even worth wasting time on, but it's a good return for an angel. Compare that to a VC that puts in $1 million to get a $20 million return. The VC's financial exposure is ten times as much, and the probability of getting back $20 million is lower than that of the angel getting back $2 million.

Obviously, any angel would give their right arm to get the return that Peter Thiel got from Facebook ($500,000 invested for a $1.7 billion valuation of his share of the company as of last November, and undoubtedly, more now.) However, the odds of that kind of return are incredibly long, even for the best VCs. The new model is smaller investments in more companies at earlier stages. The larger number of investments, and their small size relative to historical VC investments, compensates for the higher risk of seed investments, as well as lower absolute rewards if and when the companies exit.

To be clear, a startup that has no hope of an exit with a 10X to 20X return to investors won't get funded by angels, let alone VCs. Those businesses have to bootstrap and/or call on "friends & family" for financing. However, there are a lot of "non-huge" startups that can still exit with a good return on investment, and dismissing them as "lifestyle businesses" means closing off a lot of good opportunities to make money.

The Kickstarter Revolution

Anyone who's run the gauntlet of trying to get funding for a creative project from foundations, or investments from angel investors or venture capitalists, knows how grinding the process can be. Kickstarter was started in April, 2009 as a service that helps writers, artists, musicians, filmmakers and entrepreneurs to get funding for their projects from individuals, rather than from foundations, corporations or professional investors. Kickstarter has two important provisions: Every project has to set a funding target and a deadline. If the project reaches the funding target on or before the deadline date, the project gets funded and the sponsors have to live up to their commitments. If the project doesn't meet the funding target by the deadline date, the funding commitments are canceled and no money changes hands.

When Kickstarter launched, it was far from certain that enough interesting projects would surface to fund, or enough people would provide funding to make it work. However, word spread about the service very quickly. There are no official statistics on the number of projects that have been funded or the number of people who have participated, but hundreds, if not thousands, of projects have been funded in the 18 months that Kickstarter has been operating.

One of the things that makes Kickstarter unique is that sponsors aren't investing in a business--they're buying a product or service. For entrepreneurs, that means that they don't have to give up equity in their company to get funding. There's no problem with securities sales. In addition, the risk to sponsors is dramatically limited, since unpopular projects don't get funded and the sponsors never have to pay.

I've purchased a set of prototyping icons and a tripod mount for my iPhone 4 through Kickstarter. The iPhone 4 tripod mount project is still underway, and it's impressive to see the effort being made by the two developers to manufacture the mounts. Many of the projects submitted to Kickstarter will be one-off efforts, and the artists and entrepreneurs will go off to do other things, but some of the projects will result in long-term businesses and artistic efforts.

Kickstarter is already taking over the role of book publishers by paying author advances and the costs of editing, designing and printing books, record companies by paying musicians' advances for recording, producing and mastering music, and angel investors by paying design and manufacturing costs for hardware, software and services. It represents a true revolution in the way that individuals and businesses can raise money to work on projects that they care deeply about.

There are already a number of other groups following the Kickstarter model, and more are sure to come, especially considering that Kickstarter's transaction partner, Amazon, only works with creators and sponsors with U.S. bank accounts. The Kickstarter model could work very well in Europe, Asia, Africa, South America and Australia--anywhere where some people have creative ideas and others have the money to fund them.

Consider the source when you ask for advice

Y Combinator held its Startup School yesterday on the campus of Stanford University, and the entire event was streamed live on Justin.tv. (The sessions have been archived for viewing here.) Some of the most interesting information came in the question and answer sessions, where many of the speakers were asked variations on two questions:

• Are you funding the type of products/services that I'm working on?
• What do I have to do in order to get funding from you?

It's natural to ask "people with money" about your ideas to see if they might be interested in investing, but it's also very easy to draw the wrong conclusions about their answers. For example, if they say that they're not funding projects in the area that you're working on, but they're very excited about another market or technology, it's natural to consider dropping your idea or modifying it to match the investor's interests. Before you do that, however, consider whether or not the investor is really in a position to judge your idea.

Most angel investors and at least some VCs started as entrepreneurs themselves; most of the angels got their initial bankroll for making investments from their startups. Many of them don't have a lot of experience beyond their own businesses and the few investments that they've made. If you ask them about a business idea that's outside their "comfort zone", they'll often give you their opinion, even if it's nothing more than a semi-educated guess.

Investors usually specialize in particular markets or technologies. It's always a good idea to know what an investor specializes in before you ask them to evaluate your business. You'll get better feedback, and you'll be better equipped to evaluate their answer.

Some investors will dismiss an idea, not because it's bad, but because they already have some investments in that area and are uninterested in making more. If they reject you, it doesn't mean that there's anything wrong with your idea, team or business plan--in fact, you might actually be potentially stronger than an investment that they've already made. (The risk in this case is that they'll tell their existing investment what you're doing.)

Finally, some investors will engage in "counterintelligence", and will deliberately mislead you because they already have a stealth investment in the area that you're working on. They may dismiss your idea or business, only to announce a few months later that they've funded a startup working on the same thing that you're doing, or something very similar.

For all these reasons, it's important to consider the source when you ask for advice, request funding or get feedback. Dig a little more deeply to understand the basis for what you've been told before you act on it.

Related articles

• Lessons from Startup School from the Founders of Facebook, Groupon, GitHub and More (readwriteweb.com)
• My 9 Favorite Startup Lessons From Startup School (gigaom.com)

AngelGate: Send in the clowns

If you haven't been following the increasingly comical affair being called AngelGate, I'll run it down for you. First, a few definitions:

• A venture capitalist (VC) is an individual or firm who invests in start-ups and small private companies with the hope of selling their stock for a large profit, either on the public market or to a larger company that acquires a company that they've invested in.
• Angel investors are individual venture capitalists who invest their own money in start-ups, usually very early in the companies' lives (typically seed or first rounds).
• Superangels are individuals or small groups of investors that invest in a larger number of start-ups than an individual angel would normally invest in, but still focus on very early rounds.
• Conventional Venture Capital firms invest in a lot of different companies at many stages of development. They have a lot more money to invest than the angels or superangels, and usually invest in later rounds.

Last Tuesday, Mike Arrington, the publisher of TechCrunch, learned about a secret meeting of superangels being held at a restaurant in San Francisco called Bin 38. He was told that he wouldn't be welcome at the meeting if he attended, but he went anyway, and in a private meeting room, he found "ten or so" of the largest superangel investors in Silicon Valley. They basically went into a silent stupor when they realized that he was in the room, and he left shortly afterward. Later, "sources", which Arrington says were three people who attended the meeting, told him that the following subjects were discussed (I'm going to quote directly from the TechCrunch article:):

• Complaints about Y Combinator’s growing power, and how to counteract competitiveness in Y Combinator deals
• Complaints about rising deal valuations and they can act as a group to reduce those valuations
• How the group can act together to keep traditional venture capitalists out of deals entirely
• How the group can act together to keep out new angel investors invading the market and driving up valuations.
• More mundane things, like agreeing as a group not to accept convertible notes in deals (an entrepreneur-friendly type of deal).
• One source has also said that there is a wiki of some sort that the group has that explicitly talks about how the group should act as one to keep deal valuations down.

Venture capitalists, whether large firms, angels or superangels, are competitors. They do work together at times on deals, but generally, they compete with each other to make investments. There are U.S. Federal laws that deal with collusion between competitors to fix prices, terms and conditions, and to keep out or limit the activities of other competitors, and they have nothing to do with monopolies or market share. The very act of competitors conspiring secretly as Arrington says they did could be interpreted as illegal.

The best thing for the participants to do would have been to say nothing and refuse to comment if asked by the press, but that's not what happened. The day after the TechCrunch article was posted, Dave McClure, a superangel, claimed that Arringon's charges were a "bullshit superangel consipracy theory", admitted that he attended the meeting, gave his take on what was discussed, and then finished his screed with this line (and this is a direct quote: "(sic)i'm here to Disrupt, motherfucker. (sic)so go right ahead & Hate On Me."

Yesterday, Ron Conway, founder of the Silicon Valley Angels and one of the earliest angel investors, wrote a long email to attendees of the Bin 38 meeting to say that:

• He didn't attend either meeting (apparently there were two meetings), although one of his partners did
• He didn't agree with the agenda or process of the meetings
• He'd really appreciate it if the other superangels not talk to him again
• His only interest is the entrepreneurs that he funds
• And by the way, Dave McClure, don't write or say anything about this email

One of the most endearing things about Dave McClure is that he's incapable of keeping his mouth shut, so almost immediately after Conway sent his email, McClure demonstrated his mastery of Twitter by sending the entire world a message that he had intended to send only to another attendee of the dinners. In it, he confirmed that there were two meetings, said that he and other attendees were being "thrown under the bus" by Conway, and confirmed the identity of another person, David Lee, Conway's partner, who attended both meetings. McClure deleted the errant tweet, but not before it had been copied and widely distributed, including to TechCrunch.

TechCrunch ran McClure's tweet, and then they received a copy of Conway's email and ran that. McClure is continuing to respond to other postings around the web that agree with his point of view, when the best thing he could do right now is visit a foreign country with no Internet connectivity.

Whose story of what happened at the meetings is right, Arrington's or McClure's? Arrington didn't name any of his sources and didn't go into any specifics about what action(s) the group agreed to undertake (if in fact it agreed to do anything.) For his part, McClure didn't mention the fact that there were two meetings, not just one, in his response to Arrington's story, which certainly detracts from the authenticity of his account. Also, his tweet in response to Conway's email didn't say that Conway's or Arrington's charges were wrong, only that he (McClure) and other attendees were being thrown under a bus by Conway.

What conclusions can we draw from this mess (so far)? In the song "If I Was a Rich Man" from "Fiddler on the Roof", Tevye sings:

The most important men in town would come to fawn on me!
They would ask me to advise them,
Like a Solomon the Wise.
"If you please, Reb Tevye..."
"Pardon me, Reb Tevye..."
Posing problems that would cross a rabbi's eyes!

And it won't make one bit of difference if I answer right or wrong.
When you're rich, they think you really know!

Now we know: Being rich doesn't make you smart or give you common sense.

It takes successful startups to build more startups

There's a number of elements that are generally accepted as essential for a city or region to have a successful startup culture:

• Good colleges and universities, preferably with strong engineering programs, in order to provide an ongoing supply of qualified young talent
• A good quality of life that encourages graduates to stay in the area rather than relocate after graduation
• Availability of venture capital

There's another element that's less-discussed, but possibly the most important of all: Local, successful startups that get big enough to spin off other startups. This is one of the reasons that Silicon Valley has been able to maintain its lead for several generations now. Shockley Semiconductor begat Fairchild Semiconductor, which begat Intel, National Semi, Signetics and others. Those companies spun off other semiconductor companies, and the chain continues today. Hewlett-Packard employees founded Apple, Tandem and many other companies, and those companies have spun off countless other startups. Yahoo and Google have each spun off many startups. eBay acquired PayPal, and now the ex-PayPal team has built a new generation of startups. Twitter (which spun off from Google) has already sprouted Square, and many other companies will bud off over time. Facebook will have the same effect.

It takes a big success to first recruit and then spin off the founders of future startups. In Chicago, where I'm located, Groupon looks like it has the potential to spin off more startups. It's too early to tell whether that will be the start of a sustainable startup culture in Chicago, but it's a big move in the right direction.

For startups, it's money that matters (in different ways, at different times)

So you're thinking, "Of course money matters! Isn't that the point?" For startups. money means different things at different stages of development, and using it for the wrong things can be very dangerous. At inception, seed and early stages, money means investment in development and growth. The purpose of capital raised early on should be to develop the startup's products and services, do customer development, find a good product/market fit and have the means to pivot if you have to in order to find a good fit. However, for a good number of startups, especially in the dot-com boom days, early-stage money went for big offices, lavish furnishings, expensive cars and other unproductive uses. The goal of money in this stage is to invest in order to generate revenue.

At later stages, money can be used to invest in the business for rapid growth or, as Ben Horowitz puts it, to "crush your competition." It's also at these later stages that the emphasis shifts from plowing money back into the company to compensating investors for their investments and employees for their hard work. As I've written previously, successful startups have lots of exit strategies. If the company goes IPO, that provides the liquidity event for everyone. If the company is acquired, that may provide a decent return for the investors and something for the employees--it depends on the acquisition price. However, even if the company remains private and independent, it still has to put money back into the hands of its investors and employees.

It's at this stage where it's okay to start thinking about paying competitive salaries, creature comforts, and the other niceties of having money. If a startup continues to skimp on salaries, benefits and the like at this point, and if it refuses give investors a decent return, even if through dividends, it will lose key employees, increase employee turnover (which always increases cost and decreases efficiency) and tick off investors. Those startups that start cheap and stay cheap end up paying for it, sooner or later.

So money means different things, and should be used for different things, at different stages of a startup's development. Early on, use money to invest in the business; later on, use money as a reward.

Jack Sprat and the semantics of startups

"Jack Sprat could eat no fat.
His wife could eat no lean.
And between the both of them, you see
They licked the platter clean."

It looks like we've got yet another semantic dustup going on in Startup City. A couple of weeks ago it was about ridding the world of the term "fail fast", and last week, a battle broke out between Lean and "fat" startups. The breaker-outer was Ben Horowitz of Andreessen Horowitz, who wrote an op-ed piece for the Wall Street Journal's All Things Digital website titled  "The Case For the Fat Startup." In his article, Horowitz reviewed the history of Loudcloud and Opsware, the companies that he and Marc Andreessen co-founded, and argued, in his words, 'The best companies can raise money even in this market. If you are one of those, you should consider raising enough to wipe out your competition."

Fred Wilson, a well-known New York-based VC, argued in his blog post titled "Being Fat Is Not Healthy" that "I have never been involved in a successful software-based web service that raised and spent boatloads of money before it found it's (sic) sweet spot." He points out that Loudcloud and Opsware raised $350MM in four rounds of financing, including an IPO, in the space of 15 months. The only reason that they were able to do that was because the companies had been co-founded by Marc Andreessen, and Netscape made a bunch of people rich.

If Loudcloud and Opsware had been founded by two different people, even if their resulting services and products were exactly the same, they would have had a dramatically different outcome, because they would have only been able to raise a fraction of the capital. In statistics, we call something that is so far outside the realm of normal occurence an "outlier". Loudcloud and Opsware were outliers, and using an outlier as proof of the validity of a concept is like saying "I won $10 million in the lottery, so anyone can do it." Technically, yes, "anyone" can do it, but the odds against it are astronomical.

Wilson argues that once you've got your product/market fit right and you're sure that you're pursuing a real market and not a mirage, then go ahead and raise all the money that you can. Loudcloud didn't do that. It raised and spent an enormous amount of money only to learn that it didn't have a good product/market fit. (Horowitz claims that Loudcloud had, in fact, found a viable product/market fit, but then why did he decide to sell it off and focus on software?) It could have learned that it had an insufficiently appealing product/market fit by spending only a fraction as much as it did, and then put its resources into the real market opportunity that it finally identified. And it's true that reaching a product/market fit isn't a binary decision; it takes time. However, I'd argue that you want to floor the accelerator when you've found the right fit, not the first fit.

I worked with Ben at Netscape, and I consider him a friend, but the approach he advocates smacks of both "Ready, Fire, Aim" thinking and the now-discredited "get big fast" philosophy of the dot-com boom. I'd argue that Loudcloud spent the money because it had access to the money. If it hadn't had access to so much money, it would have been run very differently.

When you know that what you're doing is right, by all means raise the money you need to "crush your competition." There are also businesses where the capital investment required to even figure out if you're going in the right direction is so high that there's no alternative to being a fat startup. But for most software companies, being fat won't be a winning strategy for either entrepreneurs or investors.

Why the term "Exit Strategy" should be kicked to the curb

Mark Suster, a respected Los Angeles-based VC, has been taking a lot of flak for a blog post he wrote suggesting that the saying "fail fast" should be discarded. Many people took Suster's comments as a rebuke of Lean Startup principles, but they were in fact highly supportive of Agile and Lean concepts. Suster was targeting entrepreneurs who use "fail fast" as an excuse to fail using someone else's money: "If at first you don't succeed, quit and make someone else pay for it."

Recognizing that misery loves company, I want to take on another popular phrase that should be kicked to the curb: "Exit strategy", specifically when it's used in the following sentence: "What's your exit strategy?"

If a company is successful, there are lots of possible exit strategies:

• Sell the company to a bigger acquirer for a lot of money
• Merge with another company
• Go IPO

You can also continue to run the company successfully and grow from internal growth, or acquire other companies.  A successful company doesn't have to worry about exit strategies.

An unsuccessful company, on the other hand, needs to worry about exit strategies a lot. The options for an unsuccessful company include:

• Selling the company, usually for a fraction of the amount put in by investors
• Liquidating the assets of the company in the hope that something (a product, patents, etc) will fetch a good price
• Using available cash reserves to pay off creditors and shut the company down
• Going bankrupt

None of those are appealing options.

Moreover, the startups that are asked about their exit strategies are usually the ones at an early enough stage of their development that it's impossible to say what an appropriate exit strategy should be. So, the founders or managers make up an exit strategy that they think VCs will want to hear. If the IPO market is vibrant, that will be the first choice; in a period like today where few IPOs are launched, they'll emphasize acquisition or merger.

The appropriate question isn't "What's your exit strategy?", it's "What's your business model?" and "How will you make this into a successful business?". The answer to those questions will determine whether the startup will even get to the point where a positive exit strategy is possible.

Reaching critical mass for encouraging startups

An article in today's New York Times talks about the revival of New York's startup community, which is focusing primarily on consumer Internet services. The article points out that New York is number three behind Silicon Valley and Boston in VC investments, but is growing rapidly.

Most people forget that before there was Silicon Valley, there was Route 128, named for the freeway that circles the Boston area. Route 128 was where the venture capital business was born, funding companies like Digital Equipment, Data General and Lotus. Polaroid was also a huge part of the tech community. The mantle of startup hotbed moved to Northern California in the late 1970s, and has stayed there ever since. New York blossomed for a time in the dot-com boom, and then collapsed as a startup center until its rebirth in the last few years.

There is absolutely no reason why startups have to concentrate in one area. Silicon Valley has Stanford and UC Berkeley, two of the top universities in the U.S. if not the world, and it also has the biggest concentration of venture capitalists anywhere in the world. However, Boston has Harvard and MIT. New York has Columbia and NYU. Chicago has Northwestern, the University of Chicago and IIT. Pittsburgh has Carnegie Mellon and Pitt. Los Angeles has UCLA and USC.

You can see where I'm going here. The educational resources needed to spawn successful startups can be found across the U.S., not to mention in cities around the world. Venture capital is far more concentrated, but there are large communities of VCs in Boston and New York as well as Silicon Valley. Chicago, Pittsburgh and Los Angeles are no more than a two-hour plane ride from one of the three VC centers.

Geographic location is no longer as important as culture. Boston and Silicon Valley have strong entrepreneurial cultures developed over decades. In those areas, people challenge the existing order, question how things are done, look for their own opportunities and seize them.

By comparison, finance has been so lucrative in New York that there wasn't much motivation for people graduating from college to start their own businesses. That all changed with the Great Recession and the collapse of the financial sector. Very little hiring is going on, so entrepreneurship now looks much more attractive to new graduates.

The other cities, Chicago, Pittsburgh and Los Angeles, have largely served as talent feeders to Silicon Valley. There hasn't been a strong startup culture in any of those cities for some time, and new graduates interested in startups either moved somewhere else right away or had their locally-based startups acquired and then moved. However, all three cities are showing signs of nearing critical mass: Chicago has Groupon, 37signals and Threadless. Google has a very large presence in Pittsburgh (and for that matter, Carnegie Mellon has opened a branch campus next to the Googleplex in Mountain View). Los Angeles (and San Diego) have Hulu, Divx, Buy.com and a large Yahoo contingent, among others.

As Caterina Fake says in the New York Times article, what New York (and, by extension these other cities) needs is a PayPal--a big, successful startup that spins off a lot of other startups. PayPal has spun off startups including YouTube, Tesla, Slide, LinkedIn and Yelp, and the founders of those companies are investing in a new generation of startups. (Fairchild Semiconductor and HP performed the same roles for previous generations in Silicon Valley.)

Perhaps that's the "secret ingredient" to creating a sustainable startup culture--you need a successful startup that spawns off others and educates the community that you can not only survive but thrive on your own. Groupon is the most likely candidate to perform that function in Chicago, while Google is the prime suspect in Pittsburgh, and there are a number of candidates in Southern California.

Thus, two final points:

1. No startup center lives forever: Route 128 around Boston lost its lead to Silicon Valley, and now Silicon Valley is declining in strength as other centers around the world are gaining.
2. Culture and the presence of a large, successful startup are as important to establishing a strong startup community as the proximity of top universities and venture capitalists.

Why "Pay-to-Pitch" makes no sense for anyone

Over the last few months, a firestorm has erupted over angel venture funding groups and "deal-finders" that charge startups to pitch to their investors. The battle has been led by Jason Calacanis, who's declared war on pay-to-pitch. The most recent pay-to-pitch scheme to come under the spotlight is from New York Angels, led by David Rose (not the one with the orchestra.) New York Angels charges $150 as an application fee for a chance to pitch to whichever members of his group decide to show up that night. That's a lot less than some other groups and finders who charge thousands of dollars, but it's still pay-to-pitch.

In defense of why his group charges an application fee, Rose said the following: "The reason we charge a fee is because we're between a rock and a hard place. The unfortunate but accurate fact is that 90% of all companies requesting funding are simply not fundable, by anyone, anywhere...no matter how earnest the entrepreneur might be. The larger VC funds get upwards of 10,000 plans each year, but that's ok for them because they either completely ignore over-the-transom submissions, or have them read by a paid associate." (Click here for a link to his complete response.)

The problem with this logic is that $150 isn't going to spell the difference between a fundable startup and one that's not, and New York Angels is taking money from all of them. Assuming that Rose and his team only actually present the plans that they think are fundable to investors, they're effectively collecting $1,500 for every startup that gets to pitch. On the other hand, if they're letting startups pitch that they know aren't fundable, they're misleading the startups and wasting their investors' time.

If I were an angel, I'd want to screen my own deals, rather than let someone else tell me what's good and what's not. I wouldn't put any more trust in Mr. Rose than into a stockbroker or investment banker who's trying to get me to make an investment.

I don't begrudge Mr. Rose or his logic; I just think that it's wrong. Pay-to-pitch doesn't open up any real funding opportunities for startups. Investors involved in pay-to-pitch schemes either a) could do better by screening their own deals, or b) are motivated by the money they make from pitching fees, which means that they're not serious investors.

Where should you locate your startup?

I monitor the Lean Startup Circle group on Google, and a member asked for some suggestions on how and where to find a contract development team. The discussion quickly turned to relocating to where the team is (the member who asked for advice was in Denver); Silicon Valley came up a few times, and one person even suggested relocating to India. My suggestion was to stay right where he was, find a qualified developer locally to run development (I found some good resources in the Boulder area, and other members in the area offered their help), and go from there.

So, where should you locate your startup? (I'm assuming that your business will be technology-based.) If your customer base is concentrated in one geographic location, the answer is simple--go where your customers are. However, if your customers are spread out all over the place, should you stay put or move? It depends on who you (and your partners) are and what your expertise is. If you have the experience to develop at least a portion of the product or service yourself, and you're comfortable managing a development team, you can locate wherever you're comfortable and where you can find the other business and technical resources you'll need.


If you're not a developer or engineer, you need to have at least one person on your team who can run development. That person should be a full member of the team, not a contractor or consultant. No matter how good or committed a contractor is, they're always thinking about the next client and the next project. The work is always done better when the person who does it has skin in the game. It may not be as hard to find that person as you think. If you live in or near a major city, there are always developers that might be interested, or who might know someone qualified who would be interested. Search on Google with your city's name and terms like "startup" and "venture" to find local groups and events where like-minded people congregate, or use a service such as Meetup.com.

That's fine, you say, but why not move to Silicon Valley? I spent more than 25 years living and working there; I consider it my home. You'll find experts in just about every skill set you can imagine. I love the weather; not too hot, not too cold, and you're no more than a few hours from the beach or the mountains. Now for the downside: Silicon Valley is an incredibly expensive place to live, work and run a business. I would easily have to pay 50% more than I pay now for a condo comparable to the one I rent in a suburb of Chicago. If I wanted to buy a home, I'd pay at least three times as much in Silicon Valley for a home with comparable square footage and yard space. Taxes are very high, yet the quality of schools is poor, and parents pay big premiums to live in cities that have good schools, such as Los Gatos and Palo Alto.

Just about everything else is more expensive as well: Food, gasoline, utilities and so on. Office space is much more expensive. People have to earn more money in order to have a decent quality of life, so salaries are much higher. It all adds up to a much higher burn rate than in other, less expensive places to live.

I've never understood why venture capitalists push their investments to move from lower-cost areas such as Texas and Chicago to Silicon Valley. Yes, investors can keep closer tabs on their investments if they can drive over to them, but airfare is truly not that expensive, and teleconferencing is effectively free. If I could run my business successfully at a 30% to 50% lower burn rate simply by staying right where I am, why would I move?