Tech Based Economic Development: Creating Competition in the City, Not Helicopter Parenting

I have had the good fortune to coach my 10-year-old daughter’s basketball teams for a few seasons now. Reflecting on the past year, we’ve won trophies, we’ve shed tears, and we’ve questioned whether we want to keep playing at all after every season.

It’s pretty much like economic development.

A lot goes into it – coaching basketball, that is. Perhaps the toughest part is trying to balance boosting the kids up so they can put their best foot forward on the court with enough competition (bumps, bruises, gut-wrenching losses, and all) that they will improve every game and every season. My assistant coach and I always work on the long game: challenging the kids to be in their best shape to compete at the next level (perhaps junior high) and the level after that (high school) and the level after that (with a little luck, maybe college). We strive to enable them to push beyond what they can do today, which can be frustrating but prepares them for those future opportunities.

Quite simply, we tend towards tough coaching over helicopter parenting so our girls will be ready for the next level.

Tech-Based Economic Development as a Losing Game

Tech-based economic development initiatives often lose. To be clear, economic development comes in lots of sizes and shapes, from loan programs to direct investment programs to executive coaching to CEO headhunters. Today, though, most initiatives have an investment mandate of some type: a direct loan, matching funds, lead equity investment, or something else. My focus here is on tech-based economic development that puts skin in the game. It is typically taxpayer or foundation skin, and the game is investing in start-ups with the specific goal of creating an economic return – whether money or jobs – for the community.

By lose, I mean spending more money on the initiatives to fund companies than the actual net value measured in jobs, follow-on capital, etc. returned to the state or city.

Why is that?

Several years ago, in my days as a professor studying economic development and start-ups, a graduate student and I embarked on an interesting analysis. We looked at every tech start-up in several Midwest and Mid-Atlantic cities, precisely locations that were investing heavily in tech-based economic development programs. We matched them to how they were funded and looked at how the companies performed over a decade. Fortunately, the vast majority of companies fell neatly into one of three categories: venture capital-backed, economic development initiative-backed, or self-funded.

We found a curious result. At seven years since founding, the cumulative survival rate of tech companies was about the same regardless of how they were funded. Yet, that is where the similarities ended.

Venture capital-backed firms tended to experience a quick death rate in the first four years and stabilized thereafter. Those that survived the tough early years were thriving and growing well, and certainly returning economic value to their investors and the region. Self-funded companies followed a linear survival rate over time; they lived or died at roughly the same rate for the first seven years and the years afterward.

Tech-based economic development-backed companies, however, followed a very different pattern. Most firms survived in the first five or six years, then starting in the sixth or seventh year experienced a precipitous drop-off. As the economic development funds expired, companies simply went out of business quickly until only a very small percentage were surviving at eight, nine, and ten years of age. By later years, a far lower share of economic development-backed tech companies contributed to their cities and states than venture capital-backed and, perhaps more interestingly, self-funded firms.

The Challenges of Cash Availability

There are (at least) two problems introduced by the cash availability offered by tech-based economic development efforts that can work against the success of their portfolio companies. The best economic development programs I’ve seen purposely strive to avoid these challenges.

1. Cash availability creates a soft competitive environment for the company.

Self-funded and venture-backed companies fight for resources, which stretches management teams to ensure product-market fit, hone marketing messaging, carefully define their ideal customer, and constantly iterate on each of the above.

2. Cash availability can crowd out private venture funds: the toughest of coaches.

I have experienced this myself working with several funds over the years as they assessed companies in regions enriched by economic development funding. Companies performing fair-to-middling would expect outsized valuations, and they could afford to do so because if they failed to raise capital, there was a low-interest loan or follow-on tech-based economic development fund standing by to save the day.

Many programs can get their players to finish that first season, even win a few games. This is why tech-based economic development-backed companies held such a high survival rate in our study. However, these same companies are often woefully unprepared for that next stage of the competition: demonstrating consistent growth, proven product strategy, and financial metrics needed to attract follow-on, private capital.

The Fix

At least two hard but necessary changes are needed for many innovation and economic development efforts. First, an environment that has artificially injected capital must also artificially inject competition for those resources.

One method I have used is to distribute the investment money outside of the company. The company then has some freedom to operate, but capital is allocated by a board of directors that approves investment decisions. For example, a company may pitch to have money paid to a potential customer to defray the customer’s costs for running a pilot or early version of the technology. The company then competes to learn from the experience and win over the customer with product-market fit.

Second, the expectations communicated and the key performance indicators tracked in a tech-based economic development effort cannot focus on short-term activities, such as the number of companies supported, short-term jobs created, and the like. Venture capital funds do not compete with each other by listing the number of companies and jobs. The right metrics focus on longer-term returns such as total capital attracted in the following five years.

In sum, we are at an apex of economic development spending of all types. From the federal government to local municipalities, 2023 and 2024 seem like the era of big-dollar tech-based economic development programs. The challenge now is to set up systems that challenge the companies and replicate that hard work of the competition. We need to move beyond simply engaging in cheering as protective parents on the sidelines.

It is not the current season that will demonstrate these companies’ success, it’s all the future seasons.