Just Add Balls

Yesterday the Xconomy blog shared an email interview they conducted with Paul Graham.  The prominent early-stage investor posits that Silicon Valley is a more nurturing environment for startups than Boston because startups put the Valley on the map.  Paul also states that he thinks entrepreneurs and investors should spend more time trying to understand why the Valley is a better place for startups.  That got me thinking about the U.S. as a whole being better than most other countries at fostering a startup culture.

In order for a startup culture to be successful there needs to be a whole ecosystem in place to support it, and the U.S. is founded on such an ecosystem.  In my opinion, the five main components of a startup-friendly environment are: 1) access to knowlege, 2) ease of incorporation, 3) funding sources, 4) viable execution, and 5) exit opportunities.

Spawning entrepreneurial activity requires access to knowledge.  Whether it be via a formal education or information resources such as publications, lectures and the internet, entrepreneurs need to know as much as possible about the space they intend to enter.  This is obvious.  And the U.S. is wrought with educational opportunities.  Of American adults over the age of 25, more than 85% have completed high-school and 27% have a college degree.  The U.S. government encourages advanced education via its numerous financial aid programs and tax deductions for interest on education loans.  Even without a formal education, though, entrepreneurs can tap into books, magazines, conferences and contacts with domain expertise.

Nobody would want to start a company if it was a nightmare process to get incorporated.  The U.S. makes the incorporation process incredibly easy.  In Delaware this can be done by filing one simple form and paying $89.  To illustrate the system in other countries, a potential entrepreneur in Mexico must file 8 forms in different government offices, and the process takes about one month.  The U.S. also offers a variety of incorporation types, such as C-corp, S-corp, LLC and Partnership.

A huge reason for the existence of a startup culture in the U.S. is access to moderately cheap capital and established bankruptcy proceedings.  Other than the turbulent economic times we are in today, the historically stable U.S. economy has limited systemic risk to both debt financing and equity financing. Our economy has also not been characterized by highly volatile inflation rates (again, present circumstances excluded). This stability, when combined with the aforementioned limited systemic risk lead to low interest rates levied on debt and moderate returns demanded from equity.  These forces have engendered entire industries of venture financing such as venture funds, seed funds and SBA loans.  Most startups in the US first get seeded by individuals with enough net worth to afford an angel investment. Due to the more even distribution of wealth in the U.S. relative to other countries, angel investors can be found in every corner of America.

Bankruptcy workouts are also more efficient in the U.S. than other countries. For example, in much of Latin America, secured creditors typically do not have priority to their collateral, and the judicial system that governs bankruptcy proceedings is weak and slow. On the contrary, the U.S. has an established Bankruptcy Code that determines the pecking order of different classes of creditors. This introduces additional confidence in financing a startup. Consideration must also be given to the standards of corporate governance that govern a Board of Directors. In the U.S. these principles have arisen from decades of legal precedence and shareholder activism. Most countries in the world do not benefit from a rich history of legal precedence and government involvement.

A critical success factor of any enterprise is a strong team to execute the company’s vision. Even in the U.S., where there is a large universe of talent, finding the right people to fill key positions is one of the biggest challenges for any entrepreneur. This challenge is magnified tremendously in foreign countries where there is only a small pool of highly-educated workers, and where many of the most qualified workers seek opportunities elsewhere, leading to a “brain drain” in local economies. Attracting strong team members in the early days of a venture is usually accomplished with stock options that are only worth something in the presence of healthy exit markets, which leads to the final point.

Just about the entire value harvested from a startup’s efforts lies in the amount of money generated in a liquidity event (or “exit”). The two main exit opportunities for a company are public offering and acquisition. Market conditions are paramount to reaping the greatest possible value from an exit, even if the company has impressive performance and growth potential. An IPO will mainly only be considered when the public markets are stable in order to minimize the risk of an offering trading at or below its issue bid, which would in turn lead to the perception of an undesirable offering and further selling. Acquisitions are also dependent on market forces such as high equity prices and cheap sources of debt financing.  Both of these exit markets have been robust for most of recent history in the U.S.  Though they are not palpable at the moment, they too shall rise again.

So there it is.  The recipe for creating a startup culture.  We should feel blessed to live in a country that fosters capitalism and an entrepreneurial spirit.  The foundation is there.  Now for the most important ingredient of all:  balls!

(Please be aware that the use of the term “balls” is a colloquial reference to taking big risks and in no way suggests a bias towards gender)

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