Go East, Young Man: Are Private Companies Leaving Silicon Valley?

The thought had crossed Brian NeSmith’s mind before — whether or not he should pull his company out of Silicon Valley and move somewhere else. There were a few reasons such a move made sense, and in October NeSmith acted.

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His Sunnyvale, California-based cybersecurity firm Arctic Wolf — valued at $1.3 billion — now calls Eden Prairie, Minnesota, home.

NeSmith’s reasons mainly centered on family and travel — Arctic Wolf already had significant operations in Minnesota that often drew him to the Gopher State — but he admits California’s business environment made the decision to leave easier.

“The regulatory requirements … in California they were just starting to accumulate,” he said. “I can’t argue with any one of them, but when they accumulate it’s hard to do business.”

The departure from California of large public companies such as HPE, Palantir and — maybe most notably — Oracle, has raised questions about the future of Silicon Valley.

Despite those headlines, Crunchbase numbers do not show a slowdown in funding to startups and private companies in the state. To the contrary: 2020 saw more than $68 billion roll into private companies, compared to more than $59 billion the previous year. This year is on an even better pace, with more than $14.1 billion in funding to California companies raised thus far. The state also has received a steady percentage of all venture capital in the U.S. the last several years — taking in just slightly more than half every year.

Those figures don’t just stem from large growth rounds, as more than 37.3 percent of that money went to seed rounds last year, compared to 36.5 percent in 2019.

However, tangential data points to a retraction in the number of companies founded in California, despite the amount of funding keeping pace.

In 2018, for example, 3,166 startups were founded in California, per Crunchbase data. That number dropped to 2,087 in 2019 and then just 1,013 last year.

History repeating?

While John Chambers is most closely associated with Cisco and Silicon Valley, the longtime former CEO began his career back East, and in a different booming tech hub — Route 128.

“We were the Silicon Valley of the world and we knew it,” said Chambers, now founder and CEO of Palo Alto’s JC2 Ventures.

Boston’s burgeoning tech hotspot was anchored by names such as DEC, Data General and Wang — where Chambers worked before moving to Cisco — and were surrounded by hundreds of startups.

“It drove the economy and it was tied very tightly to MIT,” he said.

However, missed market transitions and trends — especially the move to personal computers — as well as some local government decisions, led many investors and companies to look west to Silicon Valley, Chamber said.

Now he is seeing a geographic reversal.

“The numbers would never show up,” Chambers said about startups leaving California. “But it’s worse. I don’t know if there’s a single boardroom that isn’t having a discussion about how many employees do they locate here in California. And the number is probably going to be less — dramatically less — than what gets the press.”

Not just about taxes

While taxes in California are often cited as the reason for large public companies leaving the state, many startup and private companies are not profitable, thus negating that issue. And although California’s high personal income tax rate — up to 13.3 percent for some this year — may make the state less appealing, many agree with NeSmith’s point that the increases in regulations around privacy, diversity and more have become too burdensome for startups.

“Startups are about revolution,” said Bob Ackerman, founder of Allegis Capital, who left California last year for Wyoming. “It’s already hard for them to succeed and now you are tipping the odds further against them.”

One reason Ackerman left was because he saw a change in Silicon Valley, he said. As an investor in cybersecurity, he saw more and more companies choosing to headquarter around Washington, D.C., as National Security Agency engineers are desired in the industry, as are lucrative federal government contracts.

“We’ve kind of lost some of our foundation,” Ackerman said of the San Francisco Bay Area. Whereas once Silicon Valley was about “deep technology,” Ackerman said, now many want to make money from more ancillary avenues such as social media.

“More want to be a part of the ride than contributing to the technological concept,” he said. “It’s been diluted.”

Not dead yet

That said, Ackerman is the first to admit Silicon Valley is not done.

“2021 is not the year it will die,” he said, adding that the region’s ecosystem and historical dominance means it will remain a tech hub to some extent.

Others are more optimistic. They believe the region will not just continue to play a role, but will continue to be the center for diversity, technology and culture it has been for decades.

“When things come back and people are back in the office (after the pandemic) … I guarantee you people will want to do it in California,” said San Francisco-based Lucidworks CEO Will Hayes. “The legacy that is here will not be washed away.”

Hayes admits the cost of resources can be problematic in the state. Last year, Lucidworks opened a small office in Raleigh, North Carolina, largely for backroom office operations such as finance. However, the expansion of offices across the country — or even the world — is just the natural progression of the modern business world, he added.

“Every single boardroom is asking ‘are we doing things in the Bay Area we don’t need to do here?’” he said.

However, the benefits of being in California or the Valley specifically, are numerous, Hayes said. The entrepreneurial spirit and attitude that has been associated with the area can’t be measured in just venture funding, he said. It is one of the reasons he does not buy the Route 128 comparisons — as one area was born out of academia and one was born out of innovation.

“The DNA between the two movements is completely different,” said Hayes, who is an angel investor in four companies all based outside California.

“All four want to come here,” he said.

Others remember that the dot-com bubble bursting at the turn of the century and the Great Recession in 2008 caused many in the tech industry to leave the Bay Area, only for more to eventually return.

“I have seen the ebbs and flows,” said Umesh Padval, a partner at Thomvest Ventures who came to the state 38 years ago. “But Silicon Valley has not been duplicated anywhere.”

Padval said he has not seen an equivalent private company reaction to companies such as HPE and Oracle leaving. The tech ecosystem that companies such as Intel, Cisco and Juniper Networks have been able to spin out has helped create something that is difficult to replicate, he said.

“It’s a 10- or 15-year cycle for these companies creating more companies,” he said. “Now look at what people coming out of Facebook and Google are creating. That’s a very sticky thing.”

Still, California does need to be mindful of its drawbacks and the long-term impacts, sources said.

“California does need to wake up,” Padval said. “I hope they realize why companies are leaving. I hope there is a realization that you have to improve the roads and infrastructure, you have to look at taxes, you need to do something about the cost of living.

“You don’t want to kill the golden goose.”

Everything at once

Chambers agrees re-evaluation is necessary if California wants to keep its place in the tech world. He sees the current tax and regulatory environment in the state combined with a pandemic that has shown people can work anywhere as creating the perfect storm for taking startups away from the state — and jobs with them.

“The real job-creation engine in not only California, but also across the world, is going to be startups and small businesses getting bigger,” said Chambers.

“If we don’t create a great place for startups, not only do we lose the golden eggs that are being developed today, but the next generation of the innovative entrepreneurs that will create these golden eggs won’t come here,” he added.

For decades, California has taken great pride in creating disruption, but Chambers is not sure that is how the story will end.

“The outcome on this, the end of this movie, is something none of us want,” Chambers said. “There is no entitlement in this world, you either disrupt or you get disrupted.”

Illustration: Dom Guzman