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Alex Lumley

Does Silicon Valley's Startup Density Really Give Them A Leg Up on Chicago-Based Startups?

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This post was already post on the Fee Fighters blog here: Feefighters blog

According to Paul Graham, startup density is what saves startups in places like Silicon Valley, as it provides:

  1. An environment that encourages startups
  2. Chance meetings with helpful people
  3. A social norm of optimism

Now, the idea that high startup density (a large number of startups relative to your city size), increases your startups’ chances of success isn’t groundbreaking.  In fact, the absolute belief in high startup density (HSD) is the reason why a lot of people leave places like Detroit and Cleveland to go to Chicago or San Francisco.  HSD is also the same reason why Brad Feld argues that Boulder is such a vibrant entrepreneurial community. The issue is though, that recent data suggests that living in a city with a higher startup density does not necessarily guarantee a higher rate of startup success.”

In order to test out the startup density idea, we used a cool website called Startup Data Trends, made by Bocoup and Atlas Ventures.  Startup Data Trends allows you to browse startups from the siteAngelList and learn more about different cities, market segments, average valuations and amounts raised- like a Yahoo Finance for startups.  Using Startup Data Trends we can take a data driven look at the idea that startup hubs are the best place to be.  (Hint, the data seems to say they aren’t).

In the series of graphs below, we compare the success of startup hubs by using two metrics, as well as compare the startup density using two different measurements.  For the success of startup hubs, we used the average valuation and average money raised per startup by city.  While, to compare the size of the startup hubs, we used two different measurements: startup density, the number of startups per 100K residents, and the number of total startups per city. We chose the cities that had at least 150 data points for valuations, so places like Boulder didn’t quite qualify (sorry Brad).  Now, if Graham and Feld were right and HSD does lead to better startup success, the average valuation and average amount raised would decrease as the startup density goes from higher to lower.   However, you don’t see this trend- the success values consistently go up and down, and in no particular order.

This data is in no way conclusive (the averages can be skewed in some cities by a couple of companies with large valuations, etc.) however the initial data seems to show that the success of startups in places like Silicon Valley, cannot necessarily be attributed to HSD.

 Success of Startup Hubs by Startup Density
The following graphs show the success of different startup hubs in terms of average valuation and amount raised by startups, measured against the startup density (startups per 100K residents).





The far left of this graph is not surprising at all, as Silicon Valley has twice the startup density of it’s nearest competitor, Boston.  What is relatively surprising though, is how New York City and Chicago rank near the bottom in terms of density.  However, it seems many great new startups are coming out of these cities (Tumblr and GroupMe in NYC, Groupon and Grubhub in Chicago to name a few), while the startup density of Chicago and New York City is really decreased by the fact that these are huge cities with other stuff going on.


This is where the data really gets interesting, as the graph doesn’t show the expected answer of higher startup density leading to higher valuation, especially when you don’t count Silicon Valley.  Since the cities are ranked from highest startup density to smallest, you might expect the highest valuation on the left and the lowest on the right, however, this is not what you see.  For example, Boston and Atlanta have very high startup density, but have relatively lower valuations, while New York City has a relatively high valuation, but a low startup density.



Startup Hub success by Number of Startups in Each City
The following graphs show the success of different startup hubs in terms of average valuation and amount raised by startups, measured against the number of startups per city.



Just to make sure that our measurement of startup density isn’t to blame for the inconclusive evidence, we took a look at the number of startups per city.  The top five is as expected though it’s a bit interesting that Boston, a much smaller city, has more startups than Chicago, but I guess that is what happens when you get a high density of top research institutions.


In this last chart you can see the cities in order of most startups to least, and the measurements of success on the two y axises, average valuation and average amount raised.  Even when we change the measure of the startup hub from startup density to straight number of startups, you still don’t see the left to right downward slope that Brad Feld and Paul Graham might expect you to see. In fact, the data seems to be very inconsistent and it doesn’t seem to show that having more startups in a city leads to more startup success.


Overall, I agree that having more entrepreneurs around you is awesome, since entrepreneurs are generally fun, intelligent, encouraging people.  However, if you take away the fun of an environment of entrepreneurs, the data doesn’t seem to support the idea that higher startup density actually leads to more startup success.  So before you pack up your bags and join the flock down the yellow brick road to Silicon Valley, take a minute to consider whether or not you actually need to surround yourself with other startups, because the data seems to suggest your startup success doesn’t necessarily depend on your proximity to other like-minded individuals.

Full dataset in google docs

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Comments

Josh Saunders

Hi Alex,

Thanks for the thoughtful response.  I agree that in many cases it doesn't matter where you are located, because customers are everywhere.  That is true for cases like FeeFighters where you are trying to capture customers everywhere in many different industries that perform credit card processing.

I think Customer Density could be important for many other B2B industries though where the customer is more targeted.  For example, if you sold a product/service where your main target was technology companies, you'd probably be more likely to be successful if you were located in the Bay Area.  Likewise, Chicagoland is a major hub for CPG, insurance, heavy equipment and manufacturing.  If one of those is your target customer, I believe you'd have a higher likelihood of success in Chicago than you would if you were in the Valley.  I've seen many, many companies in San Francisco try to target CPGs and retailers (and I worked for one also) and most of them are not successful.  Is that because they are so far away?  I'm not sure, but it is intriguing to think about.

What is also interesting is that the number of corporate venture funds continues to increase.  You are finding more traditional corporations either starting their own funds or becoming LPs in VC funds.  This could be a ripe opportunity for Chicago with so many Fortune 500 companies here, because not only do these corporations invest their money, they are also making investments for strategic reasons and are eager to be early customers for startups' products.  I'm not sure if any of the VCs in Chicago are specifically focusing their attention on bringing in corporations as LPs, but I believe if they did, it could have a big impact on their portfolio companies and on the success of Chicago startups as a whole.

At a previous startup I was at, Pepsi and Unilever were both LPs in a fund of one of our VCs.  It helped greatly that those companies had a material interest in our success and our technology.   Not only does working with large companies get you great feedback and possibly some revenue, often times it also gives you instant credibility within your market and a beachhead to make inroads at other large corporations.  As a result, I believe  being in an area where a large number of your target customers are, has the potential to increase the likelihood of success for a startup.

Lastly, I strongly agree with your last comment as well - that founders are the critical piece that leads to success or failure for a startup.  It isn't the investors, the mentors, the advisors, or even the employees.  They all play a role, sure, but the founder is the leader and the success or failure of the company falls mostly on their shoulders.  Of course, as much as we try, there is no magical formula to tell you what the ideal founder is or where to find them.  In Illinois founders tend to be older, more experienced, come from the corporate world and have a business background.  In SF, they tend to be younger, have much less experience, and are often developers.  I'm not sure which type of founder is more successful... but then again, it depends how you define success.

Josh

Alex Lumley

Josh,

Thanks for reading the post and commenting.

I very much agree with your argument that funding does not = validation/success, it just means that you owe somebody money.  Your argument on "Customer Density" though is a really tough one because now a days, your customers don't have to be where you are located.  Take for example Fee Fighters, who has customers all over the country (and including customers who wish that Fee Fighters worked internationally), Feefighters really could get their customers from anywhere.  So while the extra customers don't hurt Chicago and Feefighters, I can't imagine it helping THAT much.

So all this being said, what really drives startups success?  I tend to agree with Paul Graham when he says that really you should frame the argument in terms of 'what keeps startups alive'?  Because startups are meant to die, but something has to happen for them to survive.  My personal, belief (which I have absolutely no back up for) is the founders themselves are the ones that are the antidote to the startup death, so whereever you can get better founders, or produce better founders, that is where you will have less startups that die (aka that are successful).  What do you think?

Thanks again!

Alex

Josh Saunders

Nice post Alex and FeeFighters - I really enjoyed reading it.  I'm going to make a controversial comment though that I've been pondering for some time.  One of the fundamental flaws I have with the post is that it uses fundraising and valuations as a proxy for successful businesses.  This is a very common proxy that people use and is being increasingly used in Chicago as early stage investments here continue to grow.  The problem I have is that just because a company raises money, doesn't mean that they are a success (they generally still have a long way to go before being successful).  In fact the common number thrown around is that only 1-2 VC-funded startups out of 10 are ever really successful.  Does that make this a vanity metric?

The key assumption made also is that the money flows to where there are successful startups.  But I don't believe that is 100% accurate either (although partly true).  In many cases, entrepreneurs go to where the money is. Many founders and developers move to Silicon Valley because they know that is where they are most likely to get funded.

I agree with your statement at the end, that having more entrepreneurs around is awesome and is certainly helpful as they provide advice, mentorship, etc...  More so than having a large density of startups, I think Chicago's greatest advantage is having a large density of customers.  Unless you are selling to other startups or technology companies, there aren't nearly as many customers in the Bay Area as some other parts of the country.  If you are working in B2B, there is no better place to be than Chicago.  In Illinois alone, you have hundreds of major corporations that can serve as key customers, not to mention a short trip to places like Minneapolis which also has a large density of Fortune 500 companies.  Plus, you're between both coasts for day trips to meet with customers.

I think it is great that more money is flowing into Chicago as our startup density grows, or perhaps our startup density is growing as a result of the increased capital.  But I think it would be interesting to look at "Customer Density" and it's impact on successful businesses - again using a more accurate metric for success.  Are startups more successful in a given location because they have more customers to sell to within their industry?

I would love to hear other thoughts on this... anyone agree?  disagree?

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