The cost of doing business is always on the mind of startup executives. Salaries, rent, and other expenses like software licenses can often make or break a company.
Much of the math comes down to how much money you can raise for your business, and startups often look to San Francisco and Silicon Valley to find the capital they need. Where the business is based would seem to have an impact on how much money it can raise: If you’re a San Francisco startup, you’d presumably get more money to cover the price of those high-salary engineers and that expensive office space.
It’s not a new concept that it’s pricier to do business on the coasts, and startup activity has been flourishing in the middle of the country as a result, from Detroit to San Antonio. But how much cheaper is it—or how much less venture funding does a startup need to raise—to operate a business in middle America versus the Bay Area?
One Philadelphia executive put pen to paper (er, finger to keyboard?) and developed a website that calculates a cost-of-doing-business comparison for various cities around America. Robert Moore, CEO and co-founder of Philadelphia-based software-as-a-service business Crossbeam, calls the website VC Arbitrage, which aims to compare what raising money in San Francisco will mean to your business if your startup is based in another city. It’s easy to think that a business operating in a city with lower costs might get less funding, or be offered a less attractive term sheet, from Bay Area VCs than one that is based in San Francisco.
Moore contends that isn’t true—at least, according to his experience—adding that he believes venture firms do not discount valuations based on the location of a startup’s headquarters. He says Bay Area venture firms will pay the same for a good company regardless of its location—that a deal for a company outside of San Francisco wouldn’t result in greater dilution—which would mean businesses in a lower-cost city will have more relative cash to operate. The reason? Venture firms work in a competitive environment, Moore told Xconomy. “When a (San Francisco) VC wants to invest, you have typically demonstrated that you are a world-class company and you can command a top-of-market valuation regardless of where you are based,” Moore wrote in an e-mail.
Why not then operate your business in a place where a dollar can stretch further, argues Moore, whose business Crossbeam added $3.35 million in a seed funding round this month, largely from Bay Area venture firms. If he can spend $3.35 million in Philadelphia, where salaries and other costs are lower relative to San Francisco, without giving up additional equity (causing dilution to his stock), he’ll take it. Venture firms in San Francisco pay a higher “price per share” than local VCs, too, Moore says, which is a reason why he is only using money raised from Bay Area firms in his calculator.
Xconomy compared the various innovation hubs it covers to the Bay Area using Moore’s website, estimating how much raising $1 million in San Francisco is worth to each other region. Click through the slideshow to see where your city ranks, from highest cost to most affordable.
Moore’s calculations consider the amount startups must pay for engineers, sales people and other staff, rent, and the cost of business products, such as software licenses. The data is heavily weighted toward staff salaries, which account for 75 percent of the formula, while the cost of business products remains consistent throughout each city because things like cloud servers and computer hardware typically don’t change by geography, Moore wrote in a blog post this week. (These comparisons are largely focused on the tech industry; for another industry, like life sciences, the weighting of the categories might change, but the core principles would stay the same, Moore says.)
If a startup does raise money from a San Francisco venture firm, there are indeed benefits to being close to them, and hiring talent there—which can outweigh a lower cost of business. In his blog post, Moore argues that cities outside the traditional tech hubs are quickly maturing, with extra resources to develop tech talent, experienced mentors who can compensate for not being near a VC, and new business models that allow for remote workers.
Images courtesy of VC Arbitrage and Robert Moore.
David Holley is Xconomy's national correspondent based in Austin, TX. You can reach him at [email protected]