Government can help startups bridge the 'valley of death'

Government can help startups bridge the 'valley of death'
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Economic incentives offered by U.S. states to attract established companies grab headlines. The pursuit of Amazon by various cities and states, for example, captured the public interest and also created strong sentiments for and against such investment.

Amazon was on the front page, but leaders in some states are continually and quietly seeking to cultivate the next Amazon. They do this by providing early-stage funding and resources to promising startups. These forward-thinking programs set the stage for a bright entrepreneurial future but also cost public dollars.

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Skeptics focus on the cost. Optimists hone in on future growth. What is clear is that blue-collar manufacturing jobs are not coming back in droves. Instead, innovation attracts global talent and creates new products and industries.

Startups play an inimitable role in innovation. They also face a unique funding pitfall known as the “valley of death.” The very early stages of a startup’s development are funded by entrepreneurs themselves and "the 3 F's" — family, friends and fools. 

But soon, expenses grow beyond self-funding as a startup spends money on developing a viable product. Early-stage startups have minimal, if any, cash-flow, and they are too underdeveloped to attract investment from traditional venture capitalists. The valley of death then swallows them: Access to funds bottoms out while expenses keep mounting.

This is where investment at the state-level is such a great tool. Take Alabama and Michigan as examples. Red-state Alabama and blue-state Michigan are different in many ways, but leaders in both states see the wisdom in helping early-stage startups cross the valley of death. 

Alabama Launchpad is operated by the Economic Development Partnership of Alabama (EDPA), a nonprofit that partners with government agencies to foster economic growth. This may be the best of both worlds — investing in a public good but generally not with tax dollars, albeit in concert with government agencies.

EDPA is probably best known for the recruitment of a $1.6 billion Mazda-Toyota joint venture slated to open in 2021. However, since 2009, Alabama Launchpad has invested more than $4 million to fund 84 startups whose collective current valuation exceeds $210 million.

Wyndy is one of these startups. The “Uber of babysitters” received Launchpad funding to develop its app that connects parents with thoroughly-vetted college students. This funding helped sustain Wyndy until it raised $1 million from private investors. 

In Michigan, the counterpart to Alabama Launchpad is orchestrated by the Michigan Economic Development Corporation (MEDC) — a public-private funded entity. Early-stage funding for startups can be sought from MEDC’s Entrepreneurial and Innovation Initiative that also involve Invest Michigan, Invest Detroit and Small Business Development Centers. 

Like Wyndy in Alabama, Fifth Eye in Michigan found success by receiving state support in 2014 to help in development. In 2019, the Ann Arbor-based medical software startup raised $11.5 million in investment capital.

Assisting startups like Wyndy and Fifth Eye is critical to the lifeblood of the American economy. It is very unlikely Fifth Eye would be here today without such funding five years ago.

Given that thriving startups create jobs and fuel economic activity, states should help these innovative entrepreneurial ventures survive the valley of death. Importantly, policymakers in Washington, D.C. need to explore how these state-level success stories can be replicated at the federal level. 

The U.S. Small Business Administration’s Small Business Innovation Research Program (SBIR) has helped many startups, but significant gaps exist for early-stage startups. SBIR grants are open to companies with 500 or fewer employees, leaving small startups at a competitive disadvantage.

Most SBIR dollars go to 10 states, including the tech hotbeds of California, Texas and Massachusetts that may not need the support as much as other locations. Supporting embryonic, early-stage startups across all 50 states needs to become a core focus, or the country will lose out.

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Globally, considerable centers of venture-capital investment have grown outside of the U.S. in recent years.

Yes, the United States is the world’s dominant center for startup investment in general, accounting for 68.6 percent of total global venture capital (Asia is next at 14.4 percent and then Europe at 13.5 percent), but the numbers are rapidly changing, and the support is not necessarily at the early-stage level.

In the evolving situation, economic-development leaders now face increased pressure from international locations. State and federal infrastructure can provide a bridge over the entrepreneurial valley of death before global investors opportunistically drag away the lifeblood of the American economy.

David Ketchen is a professor and Harbert Eminent scholar in the Raymond J. Harbert College of Business at Auburn University. In 2018, he received Auburn University’s Southeastern Conference Faculty Achievement Award as well as its Creative Research and Scholarship Award.

Tomas Hult is a professor and Byington Endowed chair at Michigan State University and executive director of the Academy of International Business. Hult was selected as Academy of Marketing Science’s Distinguished Marketing Educator in 2016 and he received MSU’s Beal Outstanding Faculty Award in 2019. Follow him on Twitter: @tomashult.