Since at least the 1980s, a large, disproportionate share of venture capital investments have been made in firms located in California. When will this trend come to an end?
First, here is some background. The following animated GIF shows venture capital investments by year by state since 1995 (a link to the interactive Tableau Public data and graphs is here). The figure clearly shows the cluster of venture capital investments in certain states, chief among them California, with an estimated 52 percent of venture capital investments made in 2013 according to data gathered by Price Waterhouse Coopers.
The advantage of startup businesses located in California over businesses located in other states is large. Businesses located in Massachusetts – the state where the second most venture capital dollars flowed in 2013 – come in far behind at about 11 percent. Massachusetts is followed by businesses located in New York at about 8 percent, Texas at around 4 percent, Maryland at 3 percent, and Washington at 2 percent.
Interestingly, and perhaps surprising, the dollar value of venture capital investments have become more concentrated in certain geographic areas rather than branching out to competing businesses in other locations. For example, the share of venture capital investments made in California has increased to 52 percent compared to about 39 percent in 1995 (below; top line is California).
Another interesting observation is the mobility of venture capital money.
When Will This Cluster Bias End?
There are, of course, many potential answers to this speculative question. One potential answer is never. Venture capital money searches for firms with the highest anticipated return, and businesses located in California are tops by this characteristic – at least when measured by investments. The problem with this response is that it’s not forward looking or broad, but rather very narrow in nature.
Another potential answer is eventually, but not soon. This more honest response is based on the observation that venture capital money is largely “herd” based, meaning individuals running venture capital firms follow one another into investments rather than look for competing, perhaps better investments. As with any herd behavior, attention eventually shifts to other areas, the causes of which could be cost of doing business, better standard of living elsewhere, higher expected profitability elsewhere, and many others. The assumption behind this response is that the herd behavior stays intact, with the only difference being attention.
A third potential answer is soon – within the coming decade. This response rests on the assumption that financial mavericks are able to find more profitable venture capital investment ideas in competing geographic areas. In contrast to the herd answer, for this option to materialize, venture capital fund managers would have to shift away from the herd mentality.
Overall, venture capital investments continue to be clustered in a select few geographic areas, with investments in businesses located in California at the top. When the cluster bias will end is just speculation, but one thing is for sure: venture capital investment money is highly mobile. Eventually venture capital firms will branch out to more businesses run by bright individuals located in competing geographic areas; they just need to be convinced to broaden their perspective.
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