Who wants to be the next Silicon Valley?

The various state governments of the US all want to kick-start venture capital scenes. A recent study warns that development programmes are not all milk and honey.

Every ambitious municipality wants to be the next Silicon Valley. Even with the roller coaster ride that Menlo Park went through earlier this decade, local governments are falling over themselves to attract the next wave of venture capital. Oregon, Ohio, Michigan and Indiana are among the states that have enacted a mandate to develop local fund-of-funds programmes. These programmes are designed to invest exclusively in local firms that will in turn pour capital back into the local economy, or so the argument goes. The pension wins, the local economy wins, and a new tech centre is born.

Ross Gittell, professor of management, Whittemore School of Business & Economics

The mission statement of Indiana’s Indiana Future Fund lists off as its goals to “Foster the creation and growth of life sciences companies in Indiana; encourage the growth of a vibrant Indiana-based venture capital community; and facilitate public and private partnerships within the state.”

An admirable aim, but is Indiana, or any state that’s developing such a programme, ready for the volatility that could ensue as a result?

That’s essentially the question professors Ross Gittell and Jeffrey Sohl, of The Whittemore School of Business and Economics at the University of New Hampshire, asked in a recently published paper, “Technology centres during the economic downturn: what have we learned?”.

Gittell tells PEO, “We’re not trying to suggest that venture capital money is detrimental to economic growth.”

However, Gittell does note that contrary to popular belief, regionally focused venture capital infusion does not necessarily spur job growth, and that too much early-stage capital in a particular region can in fact – based on statistics – have negative implications.

The study also suggests that a clustering of venture capital firms in a given area can inhibit the diversification of a region’s industry. If Indiana, for example, got its way and fostered tremendous growth in life sciences, the region would be beholden to the fortunes of that sector.

Gittell cited Boston as a model of diversification, saying the city was able to weather the downturn because it wasn’t reliant on any one industry. “Boston didn’t do as poorly as most other metropolitans because it has significant exposure to other industries, such as education and state government, which are not as cyclical,” he says.

Moreover, while most VCs and private equity groups advertise how plugged into the local markets they are, Gittell and Sohl argue that those networks can actually hinder venture groups, especially in technology centres where there isn’t anyone around to offer a dissenting view.

“At the end of the boom, you could really see this herd effect and all encompassing group-think takeover,” Gittell says. “There was the feeling that there was no downside to the new economy and because of that you had a lot of good money chasing after bad deals.”

While the study issued by Gittell and Sohl (published in the journal Entrepreneurship & Regional Development) may scare some regions already headlong into their local mandate, it’s not all gloomy. Gittell notes that investing venture capital back into the region can result in prosperity during the good times. But he believes diversification is the key to prevent a downturn that could just as easily swallow all the gains a region has made.

“There’s more volatility, so the lesson to take away from the last downturn, is that if you want to focus on technology or biotech, you have to be ready for the ups and downs that may come, and plan accordingly,” Gittell concludes.