November 23, 2015
Austin is an ideal place to start a business, but there aren’t enough sources of local investment to help startups grow, according to a recent study by two Austin business associations.
Last month, the Austin Technology Council and the Austin Chamber of Commerce released the Capital Landscape Analysis. This survey collected and analyzed data on the investment climates of nine different metro areas nationwide, including Austin. They found it’s easy to start a business and get early-stage funding in Austin, but these startups have trouble finding additional sources of investment when they start to grow.
“I think it’s obviously a concern,” said Jonathan Packer, director of global technology and innovation at the chamber. “You want Austin to be the appropriate market for a startup, no matter where they are in their evolution.”
Austin ranked No. 1 in startup activity in 2015 with about 181 startups per 100,000 resident population, according to data from the Kauffman Foundation, a non-profit that focuses on developing entrepreneurship. Silicon Valley, the previous No. 1, had about 168 new startups this year per 100,000 resident population. However, the National Venture Capital Association, a national association of investors, found that Austin has a less favorable network of “venture capital,” or investment, sources. The Capital Landscape Analysis also found that Austin ranked second to last among the nine metro areas in number of funding sources for various stages.
“We do three stages: we do emerging, growth and scale,” Packer said. “Scale is where capital’s really important. So we’re profitable, we’re really growing, and the only thing that’s preventing us from growing more is capital.”
In 2014, Austin startups received $620 million across 114 deals, with an average deal size of $5.4 million per business. Most of the other metro areas had average deal sizes of around $11 million.
“We have a high concentration of startups, but our average deal size was about half of what the other metro area’s average deal sizes were,” Packer said. “That’s a concern, but it also might reflect the stage the startups are in.”
Austin’s smaller deals and lack of funding sources could be due to the fact that startups are less than 1 year old, according to Packer.
“I don’t think it’s a complete lack of funding situation, I think it’s a matter of guiding startups through the later stages,” he said. “I’d argue that we don’t quite have enough capital, but that might be solved by good companies maturing.”
Without later-stage funding, many startups find their business becomes unsustainable before turning a profit, according to Jensen Yancey. Yancey is a staff manager at Createspace, a small business that rents temporary office space to other small businesses.
“You see a number of startups kind of fizzling out after a year if they’re not hitting exactly what their goals are financially,” Yancey said.
A phenomenon known as the “network effect” may be a cause for Austin businesses not growing, the study found. The network effect is a mathematical relationship that gives bigger funding markets, like Silicon Valley, exponentially more success, while smaller markets such as Austin experience slower growth.
In this theory, startups and funding sources use this network effect to feed off of each other, according to Wen Wen, an associate professor at the McCombs School of Business. Startups stay in an area because of these sources, while the sources stay because of the startups, she said.
With the network effect, there are two sides: startups and funding sources, Wen said. “They would exchange benefits from each other, and the growth in size of one side will make the size of the other side become bigger, and vice versa. This created network effect will sustain the growth of both sides.”
A possible solution is to encourage the development of Austin businesses so Austin will attract more investors, according to Packer.
“In a network, the number of sources influences the volume,” he said. “A natural conclusion might be that we need more sources, because if we had more sources, then we’d have more activity and higher deals.”
Overall, the report is a positive one, Packer said. The priority now is to work on keeping Austin startups in the city and making sure they are well funded.
“Entrepreneurs look at Austin as a great metro area to go to, so we want to make sure we have the infrastructure to support that,” he said. “I think we have a large stable of companies that are in the early stages, and they’re here for a reason. There’s talent here.”