Startups Try to Spread Outside of Silicon Valley

Former AOL chief and Revolution LLC founder Steve Case calls this the “rise of the rest,” and it is a real phenomenon. And yet, as fast as the rest of the country creates startups, Silicon Valley grows even faster, disrupting entire industries, from transportation to lodging, retail and media. Silicon Valley is transforming fragmented industries into unified, winner-take-all markets that reward the biggest, best-funded, most aggressive companies—which are still being built, for the most part, in Silicon Valley.

Consider the data. According to Dow Jones VentureSource, in 1995, about 30% of all venture capital invested in the U.S. went to companies in the Bay Area. By 2015, that figure was close to 50%.

Venture investment in startups is highly cyclical. After peaking at $84 billion in 2000, it fell to $18 billion in 2003 before surging back to $68 billion in 2015. What hasn’t changed is that the Bay Area’s share has been growing, by about 1 percentage point a year. If this trend continues, in a generation or so it will be the only place anyone can build a startup.

There are several forces driving the trend. The first is proximity. The internet was supposed to erase distance. But it also created a better, more liquid market for talent and investment, making it easier for companies to find the best people, and vice versa.

Additionally, as companies stay private longer, gigantic late-stage financing rounds are changing the nature of venture capital. Money that used to come from public markets is now funneled through VCs. Because the biggest private tech companies are disproportionately based in Silicon Valley, this skews the statistics and becomes part of the feedback loop concentrating money in the region.

Even when companies start outside the Bay Area, they often move to take advantage of the financing climate and talent pool. As companies grow, Silicon Valley is the most likely place to find people who have previously managed big teams, and the challenges of growth.

Strikingly, this is the opposite of what happened during the first industrial revolution. Machines were difficult to move, but ideas were highly portable, helping the revolution spread from its epicenter in the north of England, most recently to China and Africa. But now that people and money can move, they apparently do.

Just look at the market for housing in the Bay Area. In 2012, 19.6% of homes in San Francisco and a neighboring county were worth $1 million; now, that figure is a jaw-dropping 57.4%, according to data from real-estate-listings company Trulia.

It seems that for investment in startups, the result of our connected age is centralization, not a dispersed tech-fueled next industrial revolution. This doesn’t bode well for a tech-based revival of America’s second-tier cities, once hubs of manufacturing and now gutted by globalization.

But history isn’t destiny. Jonathan Teo, co-founder and managing partner of San Francisco-based Binary Capital, says his firm is about to launch a $70 million venture-capital fund. Mr. Teo says he makes a point of seeking out startups away from the usual tech hubs because they’re more likely to be undervalued.

Mr. Case says that 90% of his firm’s investments are outside the Bay Area. He favors companies in complicated, fragmented and regulated industries, like health care, education and food service, where technology is being applied more slowly than in fields to which it is native, like software and gadgets.

Founders in these atypical startup cities are quick to extol their virtues. Cameron Doody, and Stephen Vlahos, co-founders of Chattanooga-based moving-services company Bellhops Inc., say that they’ve been able to recruit technical talent who are burned out on the rising cost of living and declining quality of life in the Bay Area. At the same time, they don’t have to fight “crazy salary battles,” says Mr. Vlahos.

Rivals don’t poach talent as often in cities with a smaller startup community, says Lee Mayer, CEO and co-founder of Denver-based interior-design marketplace Havenly Inc. Five of the six members of her executive team came to the company via the Bay Area.

The downside of being in Denver, says Ms. Mayer, is that it was harder to get startup capital. In pitch meetings in Silicon Valley and New York, “I always felt like I was making the case for Colorado along with making the case for the company,” says Ms. Mayer.

No one knows if the seemingly inexorable trend of venture capital flowing to the Bay Area will turn, so that other cities can benefit from the job creation that comes from startups. Investors like Mr. Case and Mr. Teo argue that their money, expertise and help recruiting talent are what startups outside Silicon Valley need to thrive.

The alternative, which is worth contemplating, is that the accumulation of money, power and influence in Silicon Valley continues to feed on itself until companies based there control pretty much everything. In other words, it may not be just software eating the world, but Silicon Valley eating the world.