A2B Consulting Group

Blog

Announcements and Updates

Why Silicon Valley Startups Are Not Leaving? Part One...Burn Rate Does Not Matter!

I live in the Sacramento region where  a major effort is underway to recruit companies out of the high cost Silicon Valley to  lower cost, fill-in the blank communities.  While this has been going on for a several years, less than a handful of companies have actually moved by my count.  Similar efforts are being employed by other communities looking to bring innovation and the potential next Amazon to their towns,  all with similarly dismal results. This begs the question: Why aren’t startups jumping at the chance to come to a lower cost environment?  We hear a non-stop stream of crazy Silicon Valley cost issues from high housing cost to ridiculous commercial and industrial space rent rates and yet there is no mass exodus.  Why aren’t startups leaving in droves given this costly environment?

I have spent the better part of the past two years meeting with Silicon Valley based startups, accelerators and innovation hub operators, and investors and three reasons for a lack of interest in startup relocation have become clear to me:

  1. Cost reduction is not important
  2. Capital is abundant and chasing yield regardless
  3. Exit strategy

Cost Reduction ~ Not Important. The recruitment point I see promoted THE MOST is cost reduction.  This makes total sense in response to the ever recurring Silicon Valley cost story.  Savvy communities often phrase it in VC terms like “Come and lower your burn rate”. Seems logical right? Business seeks a lower cost environment. This is a fundamental in an economic development recruitment pitch to industry, “we have a cost advantage”.  But the lower cost proposition is flawed when it comes to startups funded by Angels & VCs.  

One core tenant of the startup world is “fail fast”; finding out if this product, app or tech is or is not viable sooner rather than later. Eric Reis author of The Lean Startup; serial entrepreneur and founder of  Stanford’s LeanLaunch Pad Steve Blank; and Brad Feld, author of “Startup Communities” are some better known tech influencers who promote the concept of fail fast.  Brad Feld phrases this as

“..the notion of continually trying new things, measuring the results, and either modifying the approach or doubling down, depending on the outcome

Startup Communities, page 100

And an even more telling viewpoint from Eric Reis

What if we found ourselves building something that nobody wanted? In that case what did it matter if we did it on time and on budget?

Eric Reis,  The Lean Startup, page 37

Further impacting the issue is the conflict within many VC funds in terms of their investing. Aaron Harris, a partner at Y Combinator, a major accelerator in Silicon Valley stated that VC funds have “misaligned incentives” when it comes to the matter of burn rate. (Y Comb blog.Nov. 21, 2016 ) VC’s know that, while returns comes from a handful of their investments, there must be significant time invested in startups to determine potential success.  On the other side of the ledger is the pressure for the fund to produce returns quickly so the VC funds can raise more funds in the future.  In addition, many VC funds “make more money off management fees than than they do from investing well”. The result is that these two competing incentives:

“…create a situation in which it is better for a VC firm to push a company to demonstrate success or failure quickly…

Aaron Harris, Y Comb Blog

Thus, startups and their investors are focused on the product and whether that product will succeed in the marketplace.  Burn rate, particularly when it comes to location related costs, is simply NOT part of the equation…at least not yet.

In my next post, we will looking into Capital Abundance and the chilling effect it has on startups moving out.  Stay tuned!

 

Randy Starbuck