Where and why venture capitalists invest close to home

Jason Rowley

Public market investors have the luxury of being able to make, invest and move their money anywhere they’d like. But the same isn’t true for startup investors, who, if conventional wisdom is to be believed, tend to invest relatively close to home.

Overall, in the four main geographic regions of the U.S. we previously analyzed, a majority of investor-company relations were within the same region. In other words, much like Newton’s law of inertia: investors in the West tend to stay in the West, VCs near the ocean tend to invest near the ocean — unless they act upon outside market forces.

This regional analysis got us asking more questions about variations in where investors from different parts of the country invest. Just how close to home are they likely to invest? Does that propensity to invest within one’s own metro area, state or broader geographic region wax or wane as a function of where an investor is based? Do these differences exist on multiple levels within the broader system -- so, not just on a regional level, but on a city-by-city level, as well?

Answers to these questions could point to differences in investing “culture” or attitudes between different regions, as well as disparities in access to high-quality deal flow. Put differently, they can reveal facets of different social and market forces that drive startup investing behavior in a region.

A nation of regions, a network of cities

Using a data set of more than 82,000 investor-company relationships formed between Q1 2012 and November 1, 2017, this network spans all 50 states and 189 distinct metropolitan areas (each composed of multiple cities) and was built from Crunchbase data. With it, we’ll try to suss out the differences between different regions.

First, we’ll start with regions. The network visualization below displays intra-regional investing activity in the Midwest (colored blue), South (salmon), Northeast (light green) and Western (gold) regions of the country.


The nodes (the circles) are placed according to their corresponding metro areas’ latitude and longitude on a Mercator projection, and they’re sized based on that metro area’s level of connectedness. Bigger nodes — like Boston and NYC in the Northeast, and the SF Bay Area in the West, for example — are more connected than smaller ones.

In this diagram, thicker lines indicate more connections between investors and companies in different cities. For example, we can see strong ties between the SF Bay Area and Los Angeles, and between NYC and Boston.

But, ultimately, it’s just a pretty picture. So let’s get into some numbers. We previously looked at where investors from different regions invest, and we’ll do the same here, but with a different twist. For example, we learned that 55 percent of Midwestern investors’ company ties were with startups based in the Midwest, but we didn’t see just how close to home those intra-regional ties were. Well, that’s what we’re doing here.

In the chart below, we’ve displayed where startup investors from a particular region of the U.S. are most likely to invest.

Just like in the previous article, we found that the majority of investors invest in their own geographic region, and that investors in the West are the least likely to invest in startups from other regions of the country.

But it’s when we unpack the local investments that things get somewhat more interesting. To a first-order approximation, investors from the Midwest, Northeast and South are just as likely to invest close to home, within their own metropolitan regions. This means that an investor from Chicago is roughly as likely to invest in a Chicago-based company as an investor from Manhattan is to invest in a startup based in Brooklyn, plus or minus a few percent of variation.

In these last three regions, where investors from out of town invest may depend less on market forces and more on geography, which we’ll explore next.

In the sections below, we’ve identified the top 10 metro areas in each region, as measured by their number of investor-company connections, and showed the geographic distribution of those connections. For each metro area listed, it will help to pay close attention to how the proportion of in-metro, in-state, in-region and out-of-region ties compare to the broader regional averages depicted above.

The South and Midwest

When East Coast investors venture outside the region, they’re most likely to invest in the West, and vice-versa. Investors in the middle -- both in the South and Midwest -- have a more geographically diverse portfolio, as their home cities often lack a deep well of startup deals, at least when compared to places like San Francisco, New York and Boston.

Investors in Southern cities are not only the least likely to invest inside their own metro areas, they also are the least likely to invest in startups based in the same state but not in the same metro area as the investor in question. This might have something to do with the relatively large size of the South -- stretching from the Washington, D.C. area all the way down to the far western tip of Texas -- and a somewhat sparse distribution of major startup hubs throughout the region.

Investors in the West are the least likely to invest in startups from other regions of the country.

Below, you’ll find a chart displaying the spatial distribution of investor-company ties in the South’s top 10 metro areas. (We’re using the U.S. Census Bureau’s regional categories throughout. So, while potentially counterintuitive, we’re counting a place like Baltimore as Southern.)

Here’s how to read this chart. Of the connections between investors from Washington, D.C. and their portfolio companies, 32 percent of those connections are to startups in the D.C. metro area; 54 percent of those connections are with companies outside the broader Northeastern region.

In the South, most states have only one major hub of entrepreneurial and investing activity, so it makes sense that investors from most of these metro areas will invest in companies outside their own region and state.

This creates the opportunity for investors in these areas to develop very geographically diverse portfolios of companies. For example, investors in the broader Washington, D.C. metro area have invested in more different metro areas around the country than investors from any other metropolitan area, which is a remarkable finding. It’s especially so when you consider that the population of investors is much smaller in the DC metro area than, say, New York City or Boston.

One would think that a larger population of investors would correspond to more diverse geographic ties, so the relatively small DC community is disproportionately well-connected with the rest of the country.

This is the case for most of the country, including (and perhaps particularly) America’s Midwest.

As we’ll see throughout, metropolitan areas that have strong entrepreneurial and creative cultures -- like the cities in Ohio in the chart above, or places like Austin, Seattle and the Bay Area -- tend to produce investors with a high degree of “local loyalty.” Meaning, these investors have the luxury of being able to invest close to home because their cities have a deep and productive well of new deal opportunities.

And high-net-worth investors from certain areas without strong startup ecosystems -- say, Palm Beach, FL -- may have to look elsewhere in their state and geographic region for startups in which to invest.

The Northeast beasts

Northeastern states are physically smaller and investing activity is more geographically concentrated in just a few major hubs. Accordingly, Northeastern investors are less likely to invest elsewhere in their state, if and when they don’t invest in their local metro area. And this makes sense. By the time you leave one major metro area, you’re often in another state entirely. There’s just not enough room in most Northeastern states for more than one significant destination for startup investors.

But perhaps more importantly, the Northeast is unique in having two of the nation’s three largest entrepreneurial and investing hubs -- Boston and New York City -- situated so closely together, much like a solar system with two suns. Accordingly, most of the startup activity from satellite metro areas is often directed toward these two centers of financial gravity.

Here we can see what we’ll roughly call the “Palm Beach Effect” at play with places like Newark, Hartford and Manchester. Without a wide array of options close to home, or even in their home states, investors in these metro areas are likely to invest elsewhere in the region. An exception are those investors in the Allentown, PA area, which primarily feed capital back into startups in Philadelphia and Pittsburgh, which are both in Pennsylvania.

And now, with the South, Midwest and Northeast covered, let’s jet on over to the West, the true outlier region.

West Coast, best coast (for startup investors?)

The Western region -- which encompasses the Rocky Mountains, the desert Southwest and the Pacific coast -- stands somewhat alone among the country’s four regions for a number of reasons. But the one we’re focused on here is the tendency of investors in this region, particularly those based in California, to stay fairly loyal to their local companies.

The San Francisco Bay Area is the overwhelmingly dominant startup ecosystem in the West. Accordingly, investors based there (and a lot of them are) are treated to a seemingly endless buffet of opportunities to invest in local companies of all stages. Much to the chagrin of the rest of the country, investors in the Bay Area are among the most locally loyal -- not just to startups in their own metro area, but to the state and region as a whole. Although Nashville and Columbus investors are less likely to invest out of region, the deal volume from those cities is very, very small when compared to the Bay Area.

Although Los Angeles’s startup and investing scene isn’t comparable to San Francisco in the way that Boston’s is to New York City’s, we see several strong examples of the “Palm Beach Effect” at work here. Although places like San Diego, Santa Barbara and Anaheim have some startup activity of their own, more often than not, investors based in those metro areas are more likely to gravitate to companies based in places like LA and SF than elsewhere in the state or region.

What we’ve learned

In many ways, the above findings reinforce many of the thoughts and theories about how startup communities emerge and develop from folks like Brad Feld. In his book, Startup Communities, Feld suggests there’s a positive, self-strengthening cycle of growth and reinvestment as successful entrepreneurs become investors with a vested interest in fueling the next cycle(s) of growth in their respective communities.

It’s a compelling theory, but it presents a kind of chicken-and-egg problem akin to the law of inertia. Markets in motion tend to stay in motion. And despite all the best efforts of city, academic and other leaders to kickstart new entrepreneurship and investment in metro regions outside the incumbents, capital and connections -- like matter itself -- will gravitate toward the denser, brighter areas. At rest, these markets will tend to stay at rest until acted upon by outside market forces.