Local Legislation Supporting Founders Can Win the Battle for Startups

Common Sense Startup Legislation for Cities and States

By Collin West and Matt Harris

There is no question that startups and venture capital create jobs. However, there is divergent thinking on how to support these industries, including the importance of innovation policy.

This is our third paper (the other two are here and here) in collaboration with Draper Associates and Startup Genome. In this round, we look at how city and state governments can spur economic development through forward-thinking policies.

The Value of Network Effects

A network effect occurs when the utility of a service increases with the number of users. Network effects are usually discussed in the context of social networks or mobile applications. However, the same principles apply to geographic regions and their startup ecosystems.

In a city or state, the more successful businesses that move into an area will attract more talent and entrepreneurs. There is a reason why Amazon was started in Microsoft’s backyard. This positive cycle increases spending in the local economy, helping all businesses, and increasing tax revenue for city and state governments.

According to Startup Genome, an ecosystem that is 3x larger creates about 5x more economic value. The ecosystem value grows faster than the number of startups. One reason is that alumni from successful startups go off to become founders or investors themselves.

Ecosystem value increases faster as the number of startups increase. In fact, if an area loses 40% of their startups, you risk reducing the economic value of your ecosystem by over 50%.

The Current Problem

At its core, local governments are not thinking about how to create and sustain network effects. For example, 70,000 people left California on a net basis in 2020 – the first time in recent years that growth in California has been negative.

The big reason? It was not for a lack of job opportunity or desire to stay, it was cost of living. And it’s not just workers leaving the state because of the newfound ability to work remote, either. Oracle and Hewlett Packard Enterprises (HPE) both moved their headquarters from Silicon Valley to Texas.

Instead of encouraging their cities and states to continue to develop, many have taken an anti-growth stance. They do not want to see the development of new homes, offices, and commercial spaces. However, in order to solve today’s problems, we need to support entrepreneurship with the right infrastructure and promote new technology solutions.

The Local Legislation Handbook

From our point of view, there are 3 clear steps that city and state governments should take.

First, local governments should remove barriers for starting new companies and actively encourage entrepreneurship. A great example of this is Mayor Francis Suarez who has been attracting top tech talent from across the country to Miami, Florida.

The City of Miami is launching eStart, an online program to reduce the time and number of in-person visits to receive a permit to start a business. In addition, Mayor Suarez has been active in recruiting talent to the area, either through social media or making phone calls. Miami is using this period of lockdown to brand itself as a startup-friendly city.

We have seen this approach work successfully in other areas, including San Diego with its investment in Internet of Things (IoT), Denver with its smart city initiative, Raleigh with the Medical Research Triangle, and the State of Arizona with favorable self-driving car legislation.

Second, local governments should create tax incentives for building and investing in startups. The real estate industry benefits from the 1031 Exchange Rules, allowing an investor to sell one property, purchase another, and defer their capital gains taxes. The same principle should be applied to angel investors.

Angels typically make the first investment into a startup. They are putting their own money to work and add tremendous value by advising high growth startups in their earliest days. Allowing angel investors to reinvest capital from a successful startup exit into another promising company in the state (including their own companies), within 90 days, would keep the ecosystem growing.

Moreover, we see the treatment that Amazon and Tesla receive when they plan to invest time, money, and resources in a region. But what about the thousands of individual startups? It is not feasible to sign individual agreements with each startup company, but there could be a standardized tax incentive for new companies.

One option implemented by Riverton, Utah is to eliminate all license fees for all businesses. Removing barriers to entry will make it so more people start companies, and nobody is ever subjected to confusing policies and dreaded late fees. For more detail on this, you can visit Right to Start’s policies for Local Policymakers and State Policymakers.

Similarly, we would like to see a stair-step approach to corporate income tax, starting at 0% in the first year of profitability and stepping up to the full tax burden over 3-4 years.

Third, local governments need to allocate more public spending to STEM education and research for at least two reasons.

First, fast-growing startups need a consistent flow of high-quality engineering talent and game-changing ideas. You can see today that industry-leading technology companies, innovation hubs, and research parks are built near top universities and talent pools.

Second, the flywheel of innovation hinges on discovery-focused R&D and ample workers trained for these new industries. In the United States today, there are 430,000 open computer science jobs but only 71,000 comp sci graduates each year (Code.org).

Moreover, we anticipate there will be 3,500,000 STEM jobs that need to be filled by 2025 (source). A state’s educational institutions are the foundation of this local flywheel, both at the K-12 and university levels.

Cities and states need to think carefully about the second-order effects of their curriculums, education policies, and education-related spending.

Conclusion

When we look across the country, we see that tension has formed between companies and governments. The tension is that entrepreneurs, startups, and investors are thinking big while many city and state governments are thinking small.

For example, we see cities and states discouraging community expansion, keeping outdated restrictions in place, introducing more burdens on small companies, making it difficult for startup founders to even get off the ground.

This can be changed. Cities and states can think big – by incentivizing new real estate developments, encouraging immigration, creating tax incentives to new businesses, and increasing their investment in STEM education.

“Startup founders and investors want to create alignment with all of their stakeholders, it’s how the best companies succeed. But the bottom line is that local governments cannot be aligned with great companies and great investors if they are thinking small,” said Tim Draper, founder CEO of Draper Associates.

There is a once-in-a-generation opportunity for aspiring startup hubs to win the battle for startups by getting aligned with entrepreneurs and thinking big.