Nurturing a Healthy Investment Community

It'll be hard to replicate Silicon Valley, but there are ways to encourage VCs and angel investors to invest more in the businesses in your area

by Karen E. Klein

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.