Bartlett, Joseph W.

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CAN SILICON VALLEY BE CLONED AROUND THECOUNTRY ... THE WORLD? THE METRICSJOSEPH W. BARTLETT*Venture Capital activity has historically clustered inselect regions in the U.S. and been extraordinarilyresistant to most efforts by non-favored states andregions to migrate the activity and induce it toflourish outside of the Bay area, EasternMassachusetts and a small handful of other localities.There are reasons for this phenomenon, which thefollowing article outlines and analyzes.The venture capital process, before it was so labeled, has existed forcenturies, antedating the first public venture fund: American Research &Development ("AR&D"). It is as old as commercial society itself. In theearly twentieth century, for example, Vanderbilt family interests financedJuan Trippe in the organization of Pan American Airways, Henry Ford wasfinanced by Alexander Malcolmson, and Captain Eddie Rickenbacker wasable to organize Eastern Airlines with backing from the Rockefellers.However, the era of professionally managed venture capital-pools ofmoney contributed by unrelated investors, and organized into separate legalentities, managed by experts according to stated objectives, set forth in acontract between managers and investors, describing a structured activity,which conform to definite (albeit changing) patterns and rules-is a processthat dates from the organization of AR&D.Since the most celebrated rewards in the past have generallyaccrued to investments involving advances in science and technology toexploit new markets, traditional venture-capital investment is often thoughtof as synonymous with high-tech start-ups. However, that is not anaccurate outer boundary, even in the start-up phase. For example, thetechnology of one of the great venture-capital winners-Federal Express-is as old as the Pony Express. But, whether high or low-tech, the traditionalventure capitalist thrives when the companies in which she invests have anadvantage over potential competition in a defined segment of the market,often referred to as a "niche." The product or service is as differentiated aspossible, not a "commodity." Exploitation of scientific and technologicalbreakdowns has historically been a principal way (but not the only way) for* Joseph W. Bartlett is Of Counsel with the law firm of Fish & Richardson P.C., in theNew York office.258 ENTREPRENEURIAL BUSINESS LAW [Vol. 1:2JOURNALemerging companies to differentiate themselves from their more mature andbetter-financed competitors.The good news is that opportunities for venture-backed companiesto capitalize on scientific and technological innovations are trulybreathtaking. Given only the development of therapeutics currently in thepipeline, and absent a man-made catastrophe on the planet, I confidentlypredict that my grandchildren, ranging in age from three to fifteen, areodds-on to live full and productive lives well past the century mark.Indeed, in the not-too-distant future, mankind will have the opportunity tolive just this side of immortality. Our ability to assimilate, process, analyze,and disseminate information will continue to grow in accordance with avariant of Moore's Law: quantum computing takes hold and ultimately,software catches up with the extraordinary possibilities opened by today'shardware. Further, the healthcare crisis will wind up as a footnote inhistory as drugs become available to correct substance abuse, obesity,sexually transmitted diseases, and the rest of the Seven Deadly Sins. Thiswill result in chronically sick patients-the twenty percent of the populationwhich consumes eighty percent of our healthcare dollars. Healthcare"connectivity" will finally result in huge savings and dramatically improvedoutcomes. Healthcare providers, in terms of information technology, areroughly where the banking industry was twenty-five years ago: all paper.Sooner or later, we will all possess smart cards which we can input on theway to the ER or the doctor's office; at last, the Massachusetts GeneralHospital will know as much about the patient's medical and financialhistory as Wal-Mart does about her consumption habits. Distance learningis on its way to becoming an ubiquitous reality. Consider the benefits whenand as millions of Africans earn and deploy advanced degrees in businessfrom Cornell, nursing from Johns Hopkins, and computer science from CalTech and MIT. All this would be courtesy of asynchronous andsynchronous streaming video and self paced tutorials. Even advanceddiagnostics and therapeutics are available worldwide, as U.S. hospital"brands" expand to new markets. Every Ugandan peasant will be withintwo hours drive of a diagnostic clinic staffed by Johns Hopkins.The point of this recitation, which only scratches the surface of thearray of possibilities, is to highlight the life-or-death seriousness of thetopic. However, despite Tom Friedman's theorem, the earth is not flat' inthe sense that he uses the phrase. The venture capital experience in the U.S.proves it. The discipline started officially with the creation of AR&D in1 The 'flatness' Friedman discusses in his popular book, The World is Flat, refers toglobal leveling of tech-centric economic activity amongst the traditional leader, theU.S., and upstarts like India, with its sophisticated information technology industry in,e.g., Banglaore. THOMAS FRIEDMAN, THE WORLD IS FLAT (2005).2006] CAN SILICON VALLEY BE CLONED AROUND THE 259COUNTRY ... AROUND THE WORLD?Boston. A coincident phenomenon occurred in Northern California, SantaClara County, centered around the "Farm," as the Stanford Campus wasthen (and is now) called. What is extraordinary about this industry is thatby and large (and with some exceptions but such that would not falsify mygeneral proposition) the centers of this enormously productive economicactivity have remained in two areas: inside Route 495 around Boston andfrom San Jose north to San Francisco. Even when you get outside themagic circle, the activity is still selectively concentrated-with fewexceptions (e.g. Austin, Texas) entirely in and around urban areas, in theBlue States: New York, California, the East Coast from New England toFlorida, and in the interior: Denver, Minneapolis, and Ann Arbor. In thelast decade, according to a Milken Institute study, 62.5 percent of venturecapital investments went to a handful of metropolitan Standard MeanStatistical Areas ("SMSA"s). "... 25 states in the bottom half of therankings received only 3.5 percent of all venture capital investments-despite having 20.0 percent of the country's total number ofestablishments. 2The study begs the question: why does venture capital activityconsistently focus on a small number of discrete locations in the U.S.? VCstend to cluster around university towns, but there are distinguisheduniversities throughout George W. Bush country. What's holding backOklahoma, Tennessee, South Carolina, Kansas, etc.? If we can answer thatquestion, perhaps there is a tip for regions and states seeking to nucleategazelles.3If one analyzes the Silicon Valley clones, one common theme,emblematic of these venture hot spots, is cultural: the engineers of theprocess, the VCs and the entrepreneurs, are largely cosmopolitan optimists.If the recurring cultural contest amongst the tribes on this planet is betweenHeaven vs. Utopia, the typical venture capital participants are Utopians:believers in the directional momentum of the world observed by RobertWright in Non Zero.4 While conceivably a correlative versus a causative, itis likely that regions dominated by religious fundamentalists are incapableof fostering and incubating venture-backed gazelles in sufficient number toentail meaningful impact. Hostility to science 5 is an important negative.2 Brian Schmidt, Traditional Venture Capital Missing in Most of the Country, 8VENTURES, 4 (2002).3 "Nucleate" describes the process in nature which rules that the 101 " iteration of anevent or item is exponentially easier to achieve than the third; a "gazelle" is a venture-backed company opting to leap from the "embryo to the IPO."4 ROBERT WRIGHT, NON ZERO: THE LOGIC OF HUMAN DESTINY (2000)5 The Creationist vs. science "Methodists" (Mencken's label) debates focus onevolutionary "theory" (all scientific propositions are either hypotheses or theories)because they are incapable (as am I) of understanding the knockout punches science isdelivering to the Gaia Theory through the intricacies of quantum mechanics;Creationists think they understand Darwin's insights, and so they attack, all the whileignoring Einstein, Hawking, et al.260 ENTREPRENEURIAL BUSINESS LAW [Vol. 1:2JOURNALLet us express this another way, have a little fun (andparenthetically exceed the limits of my expertise)-meaning a meander intothe relationship between Claude Shannon's information theories andClausius' Second Law of Thermodynamics-a/k/a entropy. The point isthat in certain communities all information is revealed ("God said it, Ibelieve it, that settles it"), and therefore extant in a given society since itsinception 2000 years ago. There is no new input into what amounts to aclosed system. Accordingly, the information and the energy in thecommunity descend into maximum entropy, meaning that the system has:[L]ost its contrasts, its orderly arrangement, which gave ita potential for performing some definite task. It has lost itsvalue. One region of the system is the same as any otherregion, and this uniformity renders it incapable ofaccomplishing anything interesting from a human point ofview. The whirlwind of change beneath the surface doesnot produce any appreciable change at the surface itself,6 See Sharon Begley, U S. Science Research is in Danger of Losing Place on CuttingEdge, WALL ST. J., Aug. 12, 2005, at B1. "Allowing a minority opinion to stifleresearch is only one symptom of politics undermining science. Some appointees tofederal scientific advisory panels have been chosen for their ideology rather than theirexpertise; staffers with no research credentials after the scientific (not only the policy)content of reports on climate change. Politicians' attacks on the science of evolutioncontinue, even though 'intelligence design' may make a fascinating lesson for aphilosophy class, but is not biology." Id.The article continues:"This anti-scientism couldn't be more damaging to young peoplecontemplating devoting their life to research," says neuroscientist IraBlack, whose own stem-cell institute in New Jersey has been stalledby political red tape. "The sense of opportunity that was alwayspredominant in the U.S. now lies elsewhere."Since scientific innovation has long fueled economicgrowth, there is a danger "that the U.S. will no longer be dominant ininnovation," says G. Wayne Clough, president of the GeorgiaInstitute of Technology and a member of the President's Council ofAdvisors on Science and Technology. "A larger number ofinternational patents are being obtained overseas, R&D facilities aremoving overseas. If we are not innovating here, the economicbenefits will go elsewhere, too."An interesting battle will come when a lab in Singapore orSeoul or Britain uses embryonic stem cells to develop a therapy fordiabetes or Parkinson's or heart disease. Its use in the U.S. wouldrequire approval by the Food and Drug Administration. Willopponents of stem-cell research demand that the FDA reject it anddeprive patients of their only hope?2006] CAN SILICON VALLEY BE CLONED AROUND THE 261COUNTRY ... AROUND THE WORLD?but merely insures that there is more of the same, for aslong as someone is around to observeNote a critically important caveat. The thesis is not that economicdevelopment-any type of economic development-is a breeding groundfor the Silicon Valley experience. Take development largely dependent onlabor arbitrage and/or the exploitation of natural resources. A recent essayin Foreign Affairs cites the ability of authoritarian regimes, e.g., China andRussia, to promote economic coordination while limiting strategiccoordination, i.e., blocking the use of unapproved internet connections andother IT means around which political opposition could coalesce and buildstrength. 8 However, growth through venture capital does not occur unlessstrategic coordination flourishes. The offshore paradigms for venturemiracle are nations such as Israel, India, and Ireland-genuine, non-theocratic democracies. Many argue there is more freedom of inquiry anddebate in Israel than in, say Kansas.A significant legal point favoring California is that covenants not tocompete are unenforceable and have been throughout the period we areexamining. As Ron Gilson pointed out some years ago, the California banfreed the employees of Hewlett Packard to split off and organize firms ontheir own-Hewlett Packard as the mother ship and many of the issuethereof becoming major public venture-backed companies in their ownright. In other areas of the country, including Massachusetts, the courtswere much more sympathetic to the employers, and it was a good dealtrickier to emigrate from Digital or Data General and to find a firm in thesame line of business. Given nucleation-"them that has gits"-the alumniof Hewlett Packard and other pioneer Bay area firms produced exponentialgrowth. Hewlett Packard's alumni spread out across the region andmultiplied the uses of the Hewlett Packard's core technology by manyorders of magnitude.Next, as a first cousin of the point made earlier, entrepreneurs andventure capitalists like to set up shop in areas where many otherentrepreneurs and venture capitalists have already congregated. Again,nucleation-but expressed as a function of lifestyle preferences. Theeducational institutions in this respect are not only the major researchgenerating universities, Stanford, Berkeley, MIT, Harvard, but interestinglyenough, the public secondary and high schools. Parents, from timeimmemorial, opt to locate in areas where they feel their children will get aquality education. "Quality" in this respect being intellectually stimulating,rigorous, and supportive of the type of free inquiry which energizes the7 JEREMY CAMPBELL, GRAMMATICAL MAN: INFORMATION, ENTROPY, LANGUAGE ANDLIFE 34 (1982).8 Bruce Bueno de Mesquita & George W. Downs, Development and Democracy,FOREIGN AFFAIRS, Sept. - Oct. 2005, at 77.262 ENTREPRENEURIAL BUSINESS LAW [Vol. 1:2JOURNALtech-based businesses the parents are pushing along the trip from theembryo to the IPO. In concrete terms, this means Palo Alto High School,Wellesley High School, The Boston Latin School, Roxbury Latin, andBronx Science. If (and again I am picking on Kansas) there is a ragingdebate in the public school system in a given region about intelligent designversus evolution, it is (fortunately or unfortunately depending on how youlook at it) a signal to the parents to find some other area of the country inwhich their children are scheduled to be educated. I do not mean to suggestthat venture capitalists are any more or less religious in the broad sense ofthe word than the Kansas School Board; however, the overwhelmingmajority of the VCs deem themselves liberated from cant and catechisms.If there is a philosopher on religious issues admired by the VCs, it isSpinoza. If the issue has to do with the lessons in the Christian Bible, thepreference is for the Jefferson Bible.Parenthetically, a quick mention of government support. Manyregions of this country-most with less than outstanding success-haveattempted to use government assistance to incubate the Silicon Valley typephenomenon with dollars. To be sure, government assistance (and moreimportantly enlightened government regulation) are critical to the ventureenvironment and its growth. Thus, on the federal level (and it is the federallevel that counts) we have been extraordinarily lucky to have the benefit ofgovernment actions which are obscure to those outside the inner circle buthave been critically important in fostering venture-backed companies. Thisincludes the lowering of the capital gains tax in 1973; the Bayh Dolelegislation; the Plan Asset Regulation; and Rev. Proc. 97-23. Howeverthese are federal policies, and they are neutral vis-A-vis one region versusanother in the United States. What then accounts for the regional disparity Iam talking about?It is not, interestingly enough, low state and municipal taxes. Theventure hot spots-Massachusetts, California, and New York-imposerelatively high tax rates on income and gains. One would think that thatfact alone would drive tech-based industries away. Although county andmunicipal taxes have attracted heavy industry-for example, automobileplants, paper companies, and machine tools-to low tax jurisdictions, theeffect on venture-backed, tech-based companies has been largelyimperceptible. To be sure, direct government assistance can be important.Thus, Small Business Innovation Research ("SBIR") grants often prove tobe critical elements in the growth curve of those companies which arefavored. However, my understanding is SBIR grants are generallyclustered in those zip codes where venture activity already exists. In otherwords, the rich get richer in the government grant game-again nucleation.If you get venture private activity going, then SBIR grants are frosting onthe cake. If you do not, you are unlikely to attract eligible recipients of thesame.2006] CAN SILICON VALLEY BE CLONED AROUND THE 263COUNTRY ... AROUND THE WORLD?Another factor which favors the coastal states as a potential homefor "Silicon Valley Lite" is curiously enough, expensive residential realestate. Home prices in the suburbs of Boston, the Peninsula, WestchesterCounty, Southern Connecticut, and Northern New Jersey would seem toinhibit the entrepreneurial population; however, in my view the reverse istrue. Expensive pieces of real estate make available a source of equitycapital to the garage entrepreneur-the first player in the trip from theembryo to the IPO and obviously, a necessary (although not sufficient)player. A lot of start ups, some quite successful, have been funded by asecond mortgage on the founder's home; unsecured bank loans do not workvery well for that purpose. They tend to require the payment at a time whenthe founder is still tinkering with the Beta test.Yet another element favoring the coastal states is the presence ofeducated immigrants. In my venture capital classes at NYU, the censusedged up well over the 80 percent mark in terms of non-residents of theUnited States: Chinese, Indian, Central European, Russian, and Turk.Many of the same are able to stay in the U.S. at the end of their schooling,and they add enormous impetus to the entrepreneurial process. Asuccessful immigrant is by definition a risk taker. She is accustomed tostarting out on a new journey, often with limited resources, and workingdoubly hard to make a successful life. What role could be more logical forbudding founders and VCs?Where does all this lead? I suggest it is not hard to do the math. Ifthe regional policy is to attract a Silicon Valley epiphany, all the metricshave to be aligned. If so, nucleation is possible. If not, status quo.

Can Silicon Valley Be Cloned Around the Country ... The World? The Metrics

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Can Silicon Valley Be Cloned Around the Country ... The World? The Metrics

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