Broadening Venture Capital's Reach to Spur Innovation in the American Heartland

By: Alexander Kersten

In the U.S., technological innovation has traditionally clustered in regions such as the San Francisco Bay Area and the Boston-New York-Washington Corridor. A major factor reinforcing this concentration has been the availability and range of venture capital firms. But the COVID-19 pandemic is disrupting the way that Americans live and work. As the U.S.’s large cities have seen more and more knowledge workers move to fulltime remote work that allows them to be anywhere, some industry experts have even predicted the end of highly concentrated knowledge clusters like Silicon Valley. What are the implications of this shift for the geography of innovation in the United States?
Long mythologized as heroes in the United States’ entrepreneur-obsessed culture, venture capitalists play a vital role in identifying and providing advice and funding – from early-stage and expansion through to late-stage and acquisition – for some of the world’s most innovative firms. Overall, though less than 1% of new firms receive venture capital’s backing, they account for about 50% of companies that make it to an initial public offering and about 90% of research and development (R&D) spending by companies that go public.
To a large degree, the range of venture capital investors has dictated the geography of innovation. This clustering effect by venture capital was reinforced by Sequoia in the 1980s, when it set the tone for the technology investing industry with a Silicon Valley-first mantra: “if we can’t ride a bicycle to it, we won’t invest.” Today, 75 percent of venture capital dollars are invested in three states: California, New York, and Massachusetts. California alone corners half this market, and this is further concentrated around the San Francisco Bay area.
Does this concentration of venture capital investment overlook the latent dynamism of other U.S. regions? Companies that want to commercialize new technologies, grow rapidly, create jobs, and hope to build significant businesses need first to raise venture capital, but doing so is harder for entrepreneurs in those regions – like in Detroit or Atlanta, for example – where venture capital investors are scarce. 
This limited access to venture capital appears to hurt regional economic productivity. According to University of Kentucky executive director of technology commercialization Ian McClure (speaking at a September 2021 Renewing American Innovation Project virtual event) the average innovation industry worker in an innovation cluster produced more than a hundred thousand dollars per year more than an average innovation industry worker located elsewhere in the country. Further, firms that do not receive funding due to a thin local venture market may not be able to realize sufficient economies of scale, limiting their potential contribution to regional economic growth and employment.
The expansion of venture capital to other regions of the country could improve regional economic growth as well as enhance the nation’s global competitiveness. During the pandemic, millions of Americans have reportedly moved from the dense economic clusters in the Northeast and coastal California to Sun Belt cities (Southeastern and Southwestern U.S.) that offer more space and a lower cost of living. With them, companies have also moved and are taking advantage of lower taxes, like Elon Musk’s now-famous moving of Tesla from Silicon Valley to Austin, Texas, in 2021. Indeed, the venture industry needs to capture deal flow to remain profitable and to do this, it must go where the talent is moving.
The Sun Belt is already home to some of the world’s largest corporations and could benefit further by nurturing a more diverse industrial ecosystem. Looking across this unexpectedly dynamic region, Charlotte, North Carolina, is a major banking center and home to Wells Fargo and Bank of America, among other corporations like Lowe’s, Honeywell, and Duke Energy. Walmart, based in Bentonville, Arkansas, is the world’s largest company by revenue. Atlanta is home to Delta Airlines, Coca-Cola Company, UPS, and CNN, and serves as the U.S. base for Mercedes-Benz and Porsche. In Texas, American Airlines Group is based in Dallas-Fort Worth, as is the world’s largest company, ExxonMobil. Further, the world’s largest telecommunications firm AT&T also has its home there, as does microchip inventor Texas Instruments. Recognizing that a local venture capital industry is in their own corporate self-interest, some of these large firms have also opened their own venture arms in recent years.
Looking to another neglected region, venture could also support research ideas coming from Midwestern universities. These institutions produce 26 percent of university patents, conduct 31 percent of university research, and graduate 33 percent of the country’s STEM graduates. Yet the Midwestern states where these universities are located are home to only 98 total venture capital funds. By comparison, California, New York, and Massachusetts are home to 1,503, or about 12 times more than those Midwest states. Realizing more venture activity in these oft-ignored parts of the country could stimulate new innovative activity. Indeed, some Midwestern universities are already drawing in venture capital activity to their regions as a part of a broader technology transfer strategy. For example, University of Michigan’s Accelerate Blue Fund just made its first investment in spring 2021, after reaching its initial $2 million fundraising goal.
Meanwhile, the nation’s legacy innovation clusters are reaching saturation points in terms of congestion and affordability. Their rapid growth has placed significant stress on their infrastructure, resulting in traffic gridlock and lack of affordable housing. With the exception of Honolulu, every American city listed in both Rocket Mortgage and Quicken Loans’ respective 2021 rankings of the country’s least affordable cities is within the coastal innovation centers.
The COVID-19 pandemic is accelerating existing trends, according to some experts, with everything from commerce to education moving online. With the decade-long trend towards remote work reinforced over stay-at-home orders and office closures, the old “if we can’t ride a bicycle to it, we won’t invest” guideline is becoming outdated. While the major tech centers have certainly begun to bounce back, there has been a major shift in thinking, with investors in Silicon Valley, New York, and Boston now more willing to make decisions about supporting startups miles away from their offices. Last year, for example, 14 states saw at least 1.5 billion dollars of venture capital flow into startups that were headquartered in those states, which is up from 10 in pre-pandemic 2019. 
Moving venture capital towards regions with great innovative potential will strengthen the U.S. economy while bringing demographic and geographic diversity into the innovation ecosystem – potentially reversing the “brain drain” from the heartland to the coasts that is so weakening the nation’s social and political stability. The pandemic may just have given the country a shove in the right direction.
This trend is being supported by federal and state innovation programs. The Small Business Innovation Research (SBIR) program already offers a proven model for how the federal agencies can help draw venture capital to promising regional startups. SBIR awards serve as a signal of technological promise and commercial potential, lowering risk and attracting follow-on investment, including from VC firms. Some states like Kentucky have developed programs to complement SBIR with the goal of growing and keeping innovative firms in-state.
With the passing of the United States Innovation and Competition Act (USICA) of 2021 in the Senate, more help may be on the horizon. For example, the Strategy Implementation Grants and Cooperative Agreements section of that legislation would promote new private investment and the establishment of regional venture and loan funding operations in regional hubs.
Together, new activities by large and small firms, labs, and universities – often supported by federal and state policies and programs – as well as the changing opportunities of the venture capital industry itself are altering the geography of innovation funding in the United States. Broadening this network is a critical element in the renewal of American innovation.

Alexander Kersten is a deputy director and fellow with the Renewing American Innovation Project at the Center for Strategic and International Studies in Washington, DC.

The Perspectives on Innovation Blog is produced by the Renewing American Innovation Project at the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).