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Published: Friday, January 02, 2004

Location is still king, but with a new twist

The old adage in the venture capital community has always been: "I only invest in companies within an hour's drive of my firm." That expanded during the 1990s to include an hour's flight. But the coming year likely will see the beginnings of a sea change in traditional approaches to venture investing that will add a critical new layer for entrepreneurs.

In soon-to-be published research by two Santa Clara University professors, the locations startup companies choose will begin to shatter myths of geographic location -- of how close they are to their VC sugar daddies. What's more, entrepreneurs need to consider global locations for all or certain parts of their companies if they want to remain competitive in a global marketplace.

As important as management teams, distribution channels, marketing efforts, pricing and other traditional components of a business plan are, companies must now consider their "return on location," according to the research conducted by Terri Griffith, a Breetwor Fellow and professor in SCU's Leavey School of Business; and Patrick Yam, a Dean's Executive Professor and founding Sensei of Sensei Partners in Menlo Park.

I met with Griffith and Yam over coffee at The Adobe on the campus of SCU recently and pored over data collected from a random sampling of 20 Bay Area VC firms. The trend is unmistakable.

Unrelated research conducted in 1988 indicated that more than 75 percent of venture capital dollars went to companies in the same region in which the VC firm resided, such as the Bay Area. But in the intervening years, the advent of the Internet and a host of other communications tools has enabled VCs to reach out and touch their portfolio companies at greater distances. Griffith and Yam's survey indicates that now only about half of these firms' portfolio companies are located in the Bay Area.

This may have wide-ranging implications for entrepreneurs. First and foremost, if you are thinking about chasing VC investment, the ducks that must be lined up today should include what locations will provide the best return. Gone are the days when it made sense to combine all the functions typically ascribed to a headquarters -- human resources, finance, research and development -- in the same region. While the executive offices and marketing may make sense in Menlo Park, it may make better sense to have all or part of your research and development in Bangalore.

Either way, you should be prepared to answer tough questions about your choices for location. A "return on location," as Griffith and Yam dub the new trend, will require top entrepreneurs to develop an argument within their business plans justifying where they plan to locate key components of their companies. The question increasingly likely to be asked, is: "Why isn't your software development unit being established in India instead of Palo Alto? Few young code-writers can afford to live here, and you'll be burning precious capital on paying higher salaries so workers can afford over-priced housing."

Of course, business is never that black and white. There are a number of factors that can dramatically affect a return on location. For example, the research showed that younger VC firms (defined as 10 years old or younger) tend to adopt more of a mixed approach. Some parts of their portfolio companies' businesses are in the Bay Area; others are outside. Older VC firms, with their broader network, tend to be more comfortable with investing in companies entirely outside the Bay Area.

Another factor that may play a key role in these location decisions is the stage of the company. Most VCs still want early-stage companies close enough so they can easily change their diapers. The more mature companies are expected to place greater consideration on location.

Welcome to 2004, where setting up shop within an hour's drive of your VC partners may, after all, be a liability.

Dennis Taylor is Biz Ink's editor. You can reach him at dtaylor@svbizink.com.