In Part II yesterday we ended with Steven Malanga’s four areas in which the state of California has sprayed “startupicide” on the economy: ”suffocating regulations, inflated business taxes and fees, a lawsuit-friendly legal environment, and a political class uninterested in business concerns, if not downright hostile to them.”  Here we provide a few highlights from the original piece.  The original article can be found here in the Autumn 2011 City Journal. 

1. Regulation
Andrew Puzder, chief executive of CKE Restaurants, says that although the corporate headquarters remained in California, the “real job creating engine has already moved.”

Indeed, CKE has stopped opening restaurants in California, where the process can take up to two years because of regulations, and plans to open 300 in Texas, where a new place can debut in just six weeks. Because those two years are spent on expensive administrative work—everything from negotiating permits to filing planning documents—it can cost $200,000 more to open a restaurant in California than in Texas. And once open, a California restaurant costs more to operate, too, thanks in part to the state’s complex labor laws, including the requirement that employers pay overtime after eight hours of work in a day. California treats even service employers like CKE as if the harsh industrial conditions of the 1930s were still prevalent, Puzder complained: “It’s not like we have kids working in coal mines or women working in sweatshops.”

Many firms share this frustration with California’s regulations, and for good reason. A 2009 study by two California State University finance professors estimated that regulation cost the state’s businesses $493 billion annually, or nearly $135,000 per company. That weight, the study found, fell disproportionately on small firms and pushed California’s overall employment down by some 3.8 million jobs.

California’s regulations often utterly defeat entrepreneurs. John Bowen, the owner of an 82-year-old family-run business, King Kelly Marmalade, sold his firm to an out-of-state operator in 2007 after tiring of the ceaseless regulatory battle. At one point, Bowen started counting the government agencies that he had to deal with to run his business; he gave up when he reached 44. Bowen’s biggest woe was complying with the state’s aggressive air-pollution laws, wastewater regulations, and workplace rules. “I loved the work,” he says. “This decision [to sell] was largely as a result of excessive and oppressive government rules.”

2. Tax burden
Gino DiCaro of the California Manufacturers and Technology Association contends that, “The tax burden for a company to operate a business in California is 13 to 14 percent higher than the rest of the country,” and financial executives surveyed by CFO recently ranked California’s tax bureaucracy among the country’s most aggressive.”

Dave White, the Colorado Springs economic-development official, told the Orange County Register that his area offered significant savings, including income- and corporate-tax rates less than half California’s and workers’-compensation charges 25 percent lower. The only thing that cost less in California, White boasted, was “citrus.” Owners who have fled California for Colorado Springs concur. Earlier this year, when Howell Precision Machine and Engineering, a Los Angeles County–based maker of military and aerospace parts, announced that it was moving to Colorado Springs, its owner said bluntly, “Our survival depends on our relocating to another state.”

3. Expensive litigation environment
The American Tort Reform Foundation recently named California one of the country’s five worst “judicial hellholes,” in part for its long history of “wacky consumer class actions.”

Blame the state’s infamous consumer-rights law, which allows trial lawyers to sue firms for minor violations of California’s complex labor and environmental regulations. Abuses of the law earned California the reputation of being a “shakedown state,” with lawyers regularly sending out threatening letters in mass mailings to thousands of small businesses, demanding payments in return for not suing over purported minor paperwork violations.

4. Hostile political class
Assemblyman Dan Logue says the business community can’t match the environmental lobby’s clout:  “The state’s environmentalists think capitalism is harmful to the environment.  They think jobs and people leaving the state are good.”

California prides itself on being a leader in the environmental movement, but now even some green manufacturers say that they can’t afford to stay there. Earlier this year, Bing Energy, a fuel-cell maker, announced that it would relocate from Chino in San Bernardino County to Tallahassee, Florida, where it expected to hire nearly 250 workers. “I just can’t imagine any corporation in their right mind would decide to set up in California today,” Bing CFO Dean Minardi said. Other California green firms staffing up elsewhere include Be Green Packaging, a Santa Barbara recycling company, which decided to build its first U.S. manufacturing facility in South Carolina; AQT Solar, an energy-cell maker based in Sunnyvale, which will employ 1,000 people at a new 184,000-square-foot manufacturing plant, also in South Carolina; Biocentric Energy Holdings, a Santa Ana energy company that moved to Salt Lake City; and Calisolar, a Santa Clara–based green-energy company building a factory in Ontario, Canada, that will employ 350 workers.

California seems to find innovative ways to expand environmental regulations every few years. Construction firms, recyclers, and other users of big off-road machinery, for instance, now face significant additional costs because new emissions standards will require them to replace much of that equipment. Executives at SA Recycling in Anaheim testified at a 2010 forum on business costs that their company had to spend $5 million for new parts and equipment to meet the standards. Of even broader concern are aggressive new environmental mandates, signed into law by Governor Brown, that require the state to produce one-third of its energy from renewable sources by 2020. In a state where average energy costs are 50 percent higher than the national average, businesses are understandably nervous about how such a shift will influence their bottom lines.

UPDATE 12/31/11:  The best climate for entrepreneurs,  Part I and Part II

In Unleash the Entreprenuers, Edward Glaeser argues that “Bad policies are holding back the ultimate job creators.”

Such policies ignore a simple but vital truth: job growth comes from entrepreneurs—and public spending projects are as likely to crowd out entrepreneurship as to encourage it. By putting a bit more cash in consumers’ pockets, the tax cuts in the stimulus package may have induced a bit more car- and home-buying, but the next Steve Jobs is not being held back by too little domestic consumer spending. Tax credits for home buyers and the infamous program Cash for Clunkers encourage spending on old industries, not the development of the new products that are likelier to bring America jobs and prosperity.

Unemployment represents a crisis of imagination, a failure to figure out how to make potential workers productive in the modern economy. The people who make creative leaps to solve that problem are entrepreneurs. If we want to bring America’s jobs back, our governments—federal, state, and local—need to tear down barriers to entrepreneurship, create a fertile field for start-up businesses, and unleash the risk-taking innovators who have always been at the heart of our economic growth.

In The Long Stall, Wendell Cox contends that “California’s jobs engine broke down well before the financial crisis.”

Economists usually see business start-ups as the most important long-term source of job growth, and California has long had a reputation for nurturing new companies—most famously, in Silicon Valley. As Chart 1 shows, however, this dynamism utterly vanished in the 2000s. From 1992 to 2000, California saw a net gain of 776,500 jobs from start-ups and closures; that is, the state added that many more jobs from start-ups than it lost to closures. But during the first eight years of the new millennium, California had a net loss of 262,200 jobs from start-ups and closures. The difference between the two periods is an astounding 1 million net jobs.

In Cali to business:  Get Out!, Steven Malanga points out that not only has California lost a net 124,000 jobs to relocation since 1994, but even its vibrant early-stage ecosystem creates most of its jobs out-of-state.

California isn’t creating jobs in other ways, either. It generated just 285,000 more jobs from new businesses than it lost to business failures, placing 29th in the country (first-place Florida gained 2.4 million net jobs). What’s particularly disturbing… is that nearly none of those net jobs were created between 2000 and 2008, meaning that start-ups haven’t contributed to California employment for more than a decade…

California’s defenders argue that the state continues to incubate cutting-edge companies in places like Silicon Valley, where investment remains vigorous, thanks in part to the area’s muscular venture-capital industry. And it’s true that California entrepreneurs and early-stage firms still get one-third of all venture funding nationwide. Unfortunately, if those firms actually succeed and start creating jobs, California has difficulty cashing in. In 2007, California-based Google built a new generation of server farms not in its home state but in Oregon, employing 200 people. The following year, one of California’s most successful tech companies, Intel, opened a $3 billion production facility in Phoenix, Arizona. Earlier this year, eBay, based in San Jose, said that it would add some 1,000 back-office jobs in Austin, Texas, over the next decade.

Malanga goes on to identify four areas in which the state has sprayed “startupicide” on the economy: ”suffocating regulations, inflated business taxes and fees, a lawsuit-friendly legal environment, and a political class uninterested in business concerns, if not downright hostile to them.”  More on that in Part III – tomorrow.

UPDATE 12/31/11:  The best climate for entrepreneurs,  Part I and Part III

As was the case in 2010, the Southeast captured 5 of the Top 10 spots in the ranking.

This year’s index has been expanded to include 44 different measures covering the broad areas of taxes, regulation, energy costs, health-insurance mandates, government spending and employment, state liability systems, education reforms, and property rights and protections. It is the most comprehensive ranking of the states in terms of policies affecting entrepreneurs and investors, and therefore the economy and job creation.

The SBE Council’s interactive map provides the state-by-state breakdown.

On a related note, our region also scored very well in Bloomberg’s rankings of the cities with the biggest growth in tech jobs.

UPDATE 12/31/11:  The best climate for entrepreneurs,  Part II and Part III

The graph below is only the most recent one we’ve used to make the point that restoring a favorable and predictable business environment, with the right incentives for new business formation, is the only approach that will re-start the stalled jobs engine.

If you’d like to reference other graphs on the same topic used previously at NVSE:

• Start-up activity is the lowest its been since 1977
• Job growth doesn’t depend on small business but on new small businesses
• New businesses are the engine of job growth even while existing firms shed jobs

Angels have varied experiences, interests, strategies, reputations, and (in the case of angel groups) cultures.  Choosing the one who best fits requires as much rigor and thoughtfulness as any decision an entrepreneur makes.  In their October Knowledge Bank Scale Finance has published a “Roadmap to the Angel Investor Community” which divides angels into six categories:

• Serial angels – perhaps the most productive type, often adds significant value to the companies in which they invest because they’ve done it before.
• Tire kickers – the opposite of serial agents. They lack a genuine commitment to angel investing – at least at present – but they’re using the process as a means of educating themselves.
• Trailblazer angels – experienced investors, typically partners in investment banks and venture capital firms who incubate deals too small for their firms while maintaining a link to their company for larger/later rounds.
• Retired angels - business executives with enough personal capital to enable them to quit their jobs and “retire,” but who remain perfectly capable (and eager) to keep up in the so-called rat race.
• Socially responsible angels – investors who are interested in double-bottom-line investing – that is, doing well by doing good.
• Angel syndicates – groups who episodically invest together, joining their capital for more influence in more material deals.

The early-stage investors with whom we work (and many of them are also investors in BPV and work with our portfolio companies) may not always fit neatly into just one of these categories, but it is a useful way for entrepreneurs to think about a critical part of their ultimate success.  The author emphasizes this point with what he calls The Chaperone Rule: ”(T)he odds of a startup company succeeding are significantly enhanced when the company has a chaperone from the get-go, an experienced guide on the trip from the embryo to the IPO.”

It’s not only the start-ups that benefit from angel involvement.  The prior success of these business-executives-turned-angels gives them both the tendency and the wherewithal to help support the next generation of high-growth companies that improve all our lives.  Forbes magazine discussed the critical role these successful business people (and their savings) play in fostering economic growth:

Saving is not the practice of the wealthy stashing money under plump mattresses. Rather, [those] savings are the funds [that allow] businesses access to the capital they need to grow. Firms use these funds to start or expand businesses and to buy machinery and other physical capital…

Because much of the savings that can drive investment and economic growth over time comes from the relatively small fraction of individuals in the top income tax bracket, permitting a tax increase on high-income earners would be a significant disincentive for savings…  This decision [to raise taxes on interest, dividends, and capital gains] will affect not only the near-term outlook for the economy but savings and investment decisions for the long-run as well. Consumer spending has its place, but it is not the answer to every economic question. By disparaging investment and in particular the taxpayers who account for most of that investment, Congress is biting the hand that feeds long-run economic growth.

With early stage activity at its lowest level since 1977 it’s imperative to support any and all politically feasible means to make the early stage piece of the entrepreneurial ecosystem more attractive:  tax relief to reduce the cost of capital and/or fund research, streamlined patent and FDA approval processes, and regulatory reform to relieve the deep uncertainty in the current business environment.

15 great home field advantages

Although we have written about the difficult start-up environment and the critical impact it’s had on the nation’s poor job growth, it’s good to be reminded from time to time that as bad as this environment feels at the moment there is still no better place to start and build a business.  Here’s  John O’Farrell of Andreessen Horowitz, writing at their a16z Library:

I grew up in Ireland.  With a population of only 4.5 million, it’s a tiny market—so Irish entrepreneurs have to think outside their borders from the beginning.  Relative to his Irish counterparts, the American entrepreneur is born with a silver spoon in his mouth.  He has the luxury of a massive home market—300 million affluent consumers, 30 million businesses, one language, one currency, one culture, one legal system—from sea to shining sea.  Initially, that’s a huge advantage that allows him to build a company of significant size without even needing a passport.  Google rocketed from zero to almost $350M in revenue in four years—80% of it from the United States market. 

O’Farrell penned that in the context of recommending ways in which entrepreneurs can prepare to expand internationally, but much of his advice applies to any high-growth company:  prioritizing markets, protecting intellectual property, choosing a well-thought-out operating model, and acquiring talent with the right ”DNA” from the outset.  Replace the word “international” below with a different adjective (finance, healthcare, consumer retail) relevant to one’s industry or function and it becomes good advice for any CEO/entrepreneur.  Here’s O’Farrell: 

• Mix in some international DNA on your management team—consider making international experience an explicit hiring criterion for at least, say, 30% of your positions.  In addition to international perspective, your team will benefit from diversity of thinking.
• Make internationalization and localization experience mandatory for senior product management and engineering hires.
• Recruit board members with international experience and perspective.  At my last company, Silver Spring Networks, we killed two birds with one stone, adding the CFO of Nokia to our board for both his international and financial expertise.

The Kauffman Foundation recently proposed a way to do that with a set of ideas aptly called the Startup Act. Those ideas, which would cost the government virtually nothing, include:

• Letting in immigrant entrepreneurs who hire American workers.

• Reducing the cost of capital through capital gains tax relief for early stage investments.

• Reducing barriers to IPOs by allowing shareholders to opt out of Sarbanes-Oxley.

• Charging higher fees for patent applicants who want quick decisions to remove the backlog of applications at the Patent Office.

• Giving licensing freedom to academic entrepreneurs at universities to accelerate the commercialization of their ideas.

• Having the government provide data to permit rankings of startup friendliness of states and localities.

• Regular sunsets for regulations and a consistent policy of putting new ones in place only if their benefits exceed their costs.

There is no time to waste. The president must meet as soon as possible with congressional leaders to develop a menu of policy initiatives to reignite the startup job machine. Despite the deep divisions on taxes and spending, there is overwhelming support in this country for letting entrepreneurs work their magic without excessive government interference.

Other nations look to the United States as a model for new company formation. Our Treasury debt may not be as valued as it once was, but we can’t let our entrepreneurship brand be tarnished.

We realize America’s larger businesses have their own agendas and ideas for moving our country forward. But all of us know where the energy that drives our economy comes from—new companies with new ideas that build confidence and optimism. We will all profit when our elected leaders understand and act on this fundamental fact too.

The authors make a valid point about the politics of the situation.  Although we are on record as supporting growth-oriented tax policies – with a preference for broad-based measures since they tend to be a more efficient solution than targeted credits – it’s important to support any and all politically feasible means to make early stage investing more attractive.

With early-stage activity at its lowest level since 1977, it’d be a good time for ideas like the aforementioned to help restore a favorable and predictable business environment that provides the right incentives for new business formation – for entrepreneurs and their sources of capital.

Few Businesses Sprout, With Even Fewer Jobs - WSJ, 11/18/10

One more reason to spur entrepreneurial activity during a downturn:  over half the companies on the F500 were started during a recession or bear market.

The team of economists in their Securities Economics Group credit (among other things) the availability of skilled workers in our region – both homegrown and those drawn to the quality of life.

States with a large number of high-growth industries that also have a large skilled workforce will be at a greater competitive advantage. This would tend to favor states, such as Georgia, North Carolina, Arizona, Virginia and Texas, which not only have a large supply of skilled workers but have also been successful at attracting such workers from other parts of the nation. Florida, which has more high-growth industries than any other state, would be in a stronger position if not for the weakened housing market, which has cut into worker mobility. The Sunshine State is making important enhancements to its university system to bring in more cutting-edge research, and this should pay off with an even better mix of high-growth industries in future years.

How does a device like MelaFind come into the world? It begins when a small defense contractor specializing in computer vision is approached by pharmaceutical giants seeking objective ways to evaluate unguents for hair growth, wrinkle reduction or wound healing. An adviser to the small company, a world-famous dermatologist, pipes up: “Wound healing is cool, but if you really want to do something for humanity, help us detect melanomas.”

America having great capital markets, it’s possible to raise $130 million for a speculative venture.

In addition to extolling the wizardry of American medicine and the strength of our capital markets, Mr. Jenkins recounts some of the challenges faced during FDA approval by the current “wave of devices bringing artificial intelligence to bear on medical diagnosis.”  The details Mr. Jenkins reports are a clear example of what our friend Rhys Williams has argued before Congress:  in addition to streamlining its approval process the FDA needs to switch from the “zero defect” to the ”calculated risk” model.