Understanding the geography of venture capital

In the U.S., venture capital (VC) firms are disproportionately concentrated in a few geographic areas. Ever wonder why? Well, a new study explores the relationship between venture capitalists’ location and their investments  — and finds some intriguing results.

Henry Chen, Paul Gompers, Anna Kovner and Josh Lerner examined the location of U.S. venture capital firms’ headquarters, branch offices, and investments — as well as their investment success rates. Here are highlights of a few of their findings:

• First, no surprsies: U.S. venture capital is heavily clustered in just three areas of the country — San Francisco/San Jose, New York, and Boston. More than half of all venture capital offices in the U.S. are located in those three metropolitan areas. Just under half of all companies financed by venture capital are located in those areas, too.
• And, it turns out, there are reasons for that. Venture capital firms are disproportionately concentrated in regions where VC investments have been successful in the past — and those regions are in states with higher than average levels of economic output per person. VC-intensive regions are also areas with high numbers of patents per capita. What’s more, venture capital firms headquartered in the three regions that the researchers call “venture capital centers” have a higher average success rate than VC firms based elsewhere.
• Now, here’s a surprising finding. Even though VC firms headquartered in venture capital centers like San Francisco and Boston perform better overall — and even though VC firms disproportionately invest in local start-ups — the VC firms, on average, get better results from their investments in locations outside their headquarters region.

Why would that be? The researchers suggest one possible explanation: Because venture capitalists prefer to invest close to their offices — so they can more easily monitor performance — they may only invest farther afield when start-ups are particularly promising. Conversely, the investors may have slightly lower standards for start-ups that are closer to home, since such start-ups are less costly to keep tabs on.

In other words, start-ups outside the hubs of venture capital may have to overcome higher hurdles to gain VC investors — and then are more likely to perform well.