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Silicon Valley’s Profit-Killing Provincialism

Why venture capital won’t venture out.

JOHN SCHNIPKOWEIT shouldn’t have problems finding investors. A few years ago, he started and sold a business that set up WiFi hotspots at hotels and airports. His new project, a Facebook application that helps organize after-work sports leagues, employs seven people and is doing well in private beta testing. In Silicon Valley, which loves ideas that disrupt hidebound folkways, it’d get funded in a second.

But Schnipkoweit isn’t in Silicon Valley. He’s in Cedar Rapids, where his sideburns and blocky black glasses—and even his hipster t-shirt, with its map of Iowa above the slogan “Wave the next time you fly over”—are a bit more unusual. “We’re kind of like animals in a zoo,” he says of the co-working space he shares with several other Web businesses. “People walk by and say, ‘Look, there’s a start-up!’”

All the same, Schnipkoweit wants to stay in his hometown, where he’s helping transform a flood-damaged area into a district called New Bohemia. Named after the old Czech neighborhood across the river, it has a bar, a bookstore, and a bike co-op—all the elements that creative-class gurus like Richard Florida say are essential for a start-up-friendly community.

Alas, here’s another thing that’s essential for a start-up community: money. Specifically, venture capital (V.C.). In Cedar Rapids, that’s in short supply. “I know I’ll hit a funding ceiling,” says Schnipkoweit. “There are no V.C.s in Iowa to sustain what we could potentially need to go crazy.”

The Midwest is dotted with consumer Web start-ups getting by on small donations from friends and family. There are local sources of investment money, but they understandably focus on what they know—say, ethanol. So prairie-state start-up types are astounded when they travel west. At September’s TechCrunch conference in San Francisco, John Jackovin from Des Moines watched a largely unproved start-up win $1.8 million in seed funding. In Iowa, “you would have to give away three hundred eighty percent of your company to get 1.8 million dollars,” says Jackovin, whose app downloads a product’s warranty information and instruction manual when users scan a code on the device. “‘Come back to us when you have enough traction,’” he says, paraphrasing the investors whose money he needs to do just that. “Oh, OK. Great.”

This difficulty matters well beyond the frustrated techies of Iowa. It upends the myth that technology has effectively collapsed distance, allowing people to network and communicate and collaborate with folks in Chennai or Chongqing (or Cedar Rapids) as if they were right down the block. In fact, it turns out that, instead of using Silicon Valley innovations to scout far and wide, venture capital has remained stubbornly—and foolishly—local.

THE IDEA that every town is a few coffee shops away from being a tech hub rests on a couple of recent developments. The cost of servers and software has tumbled since the last boom, meaning that a good idea can become a viable product for only a few thousand dollars. And when founders on Main Street need more money, social media is supposed to seamlessly connect them to funders on Sand Hill Road.

In recent years, a whole start-up-promotion-industrial complex has helped sell this idea. The White House-backed, privately funded Startup America Partnership threw parties at both conventions this summer, preaching to state legislators about helping start-ups thrive. An arm of the philanthropic Kauffman Foundation stages “Startup Weekend” events around the country and beyond. Another beneficiary, Silicon Prairie News, focuses on Iowa, Missouri, and Nebraska.

But according to the National Venture Capital Association, Silicon Valley’s money spigot remains a trickle once you get beyond satellite hubs like New York and Boston, plus a few attractive small cities like Boulder and Austin. The Angel Resource Institute’s annual accounting of angel funding shows California mopping up 30 percent of the total. The Great Plains didn’t draw enough to even be labeled on a pie chart. “V.C.s in general, there’s a pretty antiquated view of many of them in terms of where to invest,” says Anand Sanwal of the venture capital analysis firm CB Insights. (A recent New York Times story celebrated the possibilities of prairie-state tech firms, but significant amounts of the investment money in places like Nebraska comes via state economic-development spending.)

One legitimate reason Silicon Valley investors stay close to home: The region is dense with the sort of talent a fast-growing company needs. A Palo Alto business that gets a cash infusion can poach talent without asking new hires to relocate across the country. Its investors can also lend a hand at short notice. “When the vice president of one of your key ventures resigns to go someplace else, you don’t want to have to get on a plane” to fix things, says John Doerr, the Silicon Valley titan who initially funded Google from his perch at Menlo Park’s blue-chip Kleiner Perkins Caufield & Byers. “You want to keep your hands on the steering wheel, turn back around on Highway 101, and talk to him face to face.” (So much for Google Hangout.)

But Silicon Valley’s kingpins also act like local yokels for reasons that have more to do with psychology. “Most V.C.s are network-driven,” says Sanwal. “There’s this myth within venture that everybody has access to ‘proprietary deal flow’” by knowing the right people. Like any online social network, Silicon Valley’s deal-making network can be self-perpetuating. In this case, though, it’s a physical network grounded in a specific place—one that’s hard for someone like Schnipkoweit to reach, no matter how robust his Facebook presence.

Legacy venture capitalists can be awfully lazy about reaching the other way. Investing in a company generally means taking a seat on its board—much less appealing when a firm is located in the sticks. “Let me pick on Omaha,” says Doug Carlisle, a managing partner with Menlo Ventures. “I doubt there’s a direct flight to Omaha.”

At least some V.C.s have profited from flying to the provinces, investing in tech success stories like the online-payment firm Dwolla (in Des Moines) and the online meat market AgLocal (in Kansas City). Other fly-over-land start-ups have found partners even farther away: The Iowa-based personal-savings tool SocialMoney added dozens of jobs after doing a deal with a major Indian bank. But these are the exceptions.

And yet poor old Omaha, with its indirect air connections, holds great potential. Its agribusinesses are a multi-billion-dollar chunk of the economy, ripe for disruption by nimble techies. But most coastal venture capital firms lack either the expertise or the inclination to explore the opportunity. “Agriculture,” says Carlisle flatly. “You just hit the beginning and the end of your average West Coast person’s knowledge.”

“It’s a bit like fishing,” explains Michael Moritz of Sequoia Capital, who claims YouTube, Google, and Zappos among his investments. “There are forms of aquatic life in almost every natural flow of water, but there are some spots that sport fisherman prefer because the pools are better. It’s the same with venture capital. And, also, none of us are keen on ice fishing.”

Lydia DePillis is a staff writer at The New Republic. This article appeared in the December 20, 2012 issue of the magazine under the headline “No Angels.”