Nurturing a Healthy Investment Community
In today's tough economy, entrepreneurs regularly compete for the funding of private investors. But those in certain states, such as New York, California, and Texas, find themselves with major geographic advantages. Why do some states excel and others lag behind in venture capital and angel investor networks? David Beauchamp, a corporate finance attorney in the Phoenix office of Bryan Cave, has studied that question for decades. He spoke recently to Smart Answers columnist Karen E. Klein. Edited excerpts of their conversation follow.
Certain regions—Silicon Valley, of course, comes to mind—have thriving investment communities, while others don't. Why is that?
In Northern California, there really was tremendous foresight and a certain amount of luck that brought together the perfect nexus for a true entrepreneurial business climate. You have tremendous intellectual capital there with Stanford and Berkeley and other wonderful institutions, and you have a tremendous number of graduate students who come there, love the area, and want to stay. The research facilities there have proactive policies about taking research and putting it into the marketplace so it can be capitalized.
There are also wealthy individuals in the area who were able to start as angel investors and then later got into venture capitalism or private equity financing. And then you have policies and regulations that have to be put forward. In California, the courts issued a series of rulings that began to make it very difficult for companies to enforce noncompete agreements. This meant engineers could jump out of an existing business and start a new business without having to wait two or three years. Specific research must be protected, but that has to be balanced with the need for individuals to pursue their own ideas in other areas. Many states are more restrictive, but some are following California's lead and recognizing the individual's right to make a living while still protecting the employers. You have to have a balance or nothing gets done.
These really are the key ingredients that you need to have an entrepreneurial community grow up in an area. If these parts are not in place, it's much harder for entrepreneurs to make things happen.
You've promoted entrepreneurialism in Arizona for several years. What's the situation there now?
In Arizona historically, people have made their fortunes investing in real estate, rather than in business. We had almost no government research grants. As a result, it's been hard for researchers here to take their business out of the garage and turn it into a full-fledged entity. We hope things are changing. We got an Arizona angel investor tax credit passed a few years ago that allows angels to deduct a certain portion of their capital investments from their state tax returns for three years, up to certain limits. The tax credit was modeled on similar laws in other states that have proven successful in encouraging individuals to invest in their local business community and help entrepreneurs meet their initial funding hurdles.
What can entrepreneurs in other states do to encourage those kinds of laws?
If a state doesn't have this kind of law and angel investing isn't happening there, the business community needs to approach the state legislature about it. Sometimes the business community doesn't take an advocacy role. Some chambers of commerce I've worked with—in Arizona, Michigan, California, and Texas, for instance—are very, very proactive. But I do presentations in other states and the chamber officials tell me that lobbying isn't part of their job. If that's the case in a particular state, I encourage entrepreneurs to team up and work with any groups they can to advocate for the benefit of would-be entrepreneurs and business owners who are struggling to find capital.
And then once the laws are passed, the investment community needs to be educated about them.
If there's an investment tax credit on the books but none of the potential investors knows about it, it doesn't do any good.
How do local entrepreneurs spread the word and encourage business investment?
The most basic thing is to get entrepreneurs together on a periodic basis. Entrepreneurs think outside the box and when they get together, they start to see applications and collaborations in various areas and great things happen. Totally amazing things come out of intellectual collaboration. I encourage entrepreneurs to meet up every three months or so on a local level or at an industry level. Talk about what you're doing and invite the public to hear what some of the best minds are thinking about the future.
Aren't some entrepreneurs so fearful of competition that they won't participate in public forums?
Yes, but we've found that those are a very small portion of entrepreneurs. In Arizona we tried this and we had people tell us that no one would show up. But once we encouraged entrepreneurs to get their basic ideas protected legally, they were more open to taking those ideas out and letting others shine light on them. And what resulted was they found thousands of different ways to commercialize those ideas.
Once you have some successful business owners and senior management people from the local community attending these forums, they'll get excited and involved. This feeds the next step of getting an angel investment community established, as some of the early retirees realize they can invest in ideas that will help their grandchildren some day. If entrepreneurs share what they are doing with the public, the angels will come out of hiding. Sometimes they're not even investing, but they get involved with nascent companies and they have wealthy friends they can talk to about investing. Once a trusted friend has done some vetting of a new company, it makes all the difference in the world to private investors.
Why do you feel it is so important to have thriving entrepreneurial investment across the entire country?
I'm a firm believer that the U.S. as a whole needs to develop the next round of entrepreneurs to help our economy deal with international competition. We don't want our economy to be overwhelmed by other economies, we want to grow alongside them. I've been saying this for many years, in fact.
When I was a grad student at the University of Michigan, a professor and I met with legislators to talk to them about how the state needed to diversify from the automobile industry. One of the legislators literally took out a cigar and blew smoke in my face. He said: "Son, I don't know what you smoke in Ann Arbor, but around here we deal in reality. The auto industry is going to be here for the next thousand years." A few years later, during the first energy crisis in the '70s, I ran into him on campus while I was defending my master's thesis. He saw me, and he was very glad to tell me that the Michigan economy would be strong and weather the crisis just fine. This was at the time when there was 25% or 30% unemployment in Flint.
Other than tax credits and court rulings, what are some additional public policies that can boost entrepreneurship?
Minnesota has developed a different form of angel investor community that has a long lead time but is very effective. The business community trains individuals to lead angel groups in certain parts of the state. They make investment meetings a social event for successful business owners, with the idea that this is a way to give back to the community, by working with new entrepreneurs.
We have incorporated certain elements of that model in Arizona, and we've also built on the model that San Diego implemented to encourage pharmaceutical businesses there 20 years ago. They wanted to get away from an economy built on a military and real estate base and they made excellent decisions on getting angel investors in place, drawing on the wisdom of defense contracting executives there. The work they did, collaborating for the good of the local economy and tapping into the medical research facilities nearby, has paid off huge dividends in terms of where the biotech and pharma community is in San Diego today.
It's important for the business community to support its research institutions so they can get grants and develop ideas that can be commercialized. It's a chicken/egg thing, where all the elements have to be in place in order for an entrepreneurial community to take off. Scientists won't come to your research institutions unless they see that they can get government support for their research. So states and individuals have to support the research institutions so they can entice researchers with grant money, and business organizations have to build the angel networks to do the funding once the research becomes commercial, and individuals have to develop their company's management resources. Every point of the process has to move along together, and all the parts have to be shiny, bright, and polished because that makes all the other parts look better.