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An entrepreneur's No. 1 source of frustration

Considering the unprecedented wealth and clout of Silicon Valley (some call it the third Industrial Revolution), it would be easy to assume that there is plenty of money to go around. Yet while IPOs continue to grow and the titans of technology expand their grasp on our country's increasingly electric future, the funding numbers tell a different story.

The venture capital gap is real, and it is an agonizing incongruity.

Given a pool of nearly 2,000 2013 tech start-ups, why is it that only 9 percent received seed funding? And even more staggering, why did only 1 percent of those original 2,000 receive any further VC funding (traditional Series A)?

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Is it a matter of distance, the distance an entrepreneur stands from Silicon Valley. Do you need a yoga mat laid out, head pointing toward Sequoia Capital?

Within Silicon Valley, VC investing has surpassed $30 billion since 2009, reaching nearly $5 billion in the first quarter of 2014, up a staggering 67 percent from the final quarter of 2013. This massive swing comes in stark contrast to the entire Southern California region, which has plateaued at $1 billion for the past two years. The hegemonic influence wielded by Silicon Valley VC firms dominates and distorts any discussion of tech investments and their spread (or lack thereof). The fact remains that 40 percent of all VC investment in tech, and 50 percent of all the tech investment in the U.S., comes from Silicon Valley and the 26 major incubators and accelerators located there.

Combine the power of Silicon Valley with the general economic power of California—a state, I remind you, with a GDP comparable to Russia's and which also contains the third-largest U.S. venture capital market in the Southern California area—and you get a true power vortex.

All things drift toward Silicon Valley, and the closer you are to the area, the more likely you are to receive the funding you need, not to mention the increased likelihood of continued funding.

Deep thoughts

Is it a matter of depth? Does the venture capital gap more accurately reflect the unfortunate bell curve of our global talent pool (separating the wheat from the chaff)?

Across all industries, about 600,000 new business are founded every year. Only 300 of those are tech start-ups that receive any VC funding (0.05 percent of all companies). Considering that the total amount of VC funding in 2013 was about $34 billion from just under 3,500 deals across all industries—a so-called "bad" year for tech start-ups—the median funding size was still $3.3 million for those who were lucky enough to get it. Nevertheless, even the median amount is extremely difficult to come by. And, of course, the reality remains that this median amount is distorted by well-established behemoths, giants looking to IPO and young guns with revolutionary ideas. The majority of these VC deals are much closer to $1 million to $2 million, a feat no less incredible, given the difficulty.


"While true talent is always scarce, it's hard to believe 1 percent investment is an accurate representation of the industry. Such an extreme talent cliff probably only exists in chess and football." -Ron Miller, Partner at StartEngine

Is the difficulty of crossing this vast gulf due to a drop-off in talent (an extreme bell curve as might exist in any industry) or perhaps just the unwillingness of a VC to invest? How many big deals can one expect per year, and how many record-breaking companies can there actually be? Perhaps the 1 percent is really a fact of life, the cruel natural distribution of humanity?

While true talent is always scarce, it's hard to believe 1 percent investment is an accurate representation of the industry. Such an extreme talent cliff probably only exists in chess and football. Not only is there ample talent out there (and decentralized to an extent), but there are also tons of great ideas in the world today. VCs must be missing something.

And no doubt they are. VC and angel investors are human and invest like humans: They put more money into larger investments, in companies they consider to be guaranteed hits. They hedge their bets on companies with proven traction and lower chances of failure in an industry that is almost exclusively "too big to fail." But because of this, the people most in need get squeezed out, and the gap grows.

Maybe it's neither

Perhaps the venture capital gap is not a matter of distance or depth, but something else.

Nepotism? Tightening wallets? Learned wisdom and the unfortunate reality of the world we live in? Or maybe the VC gap exists because VCs don't want to deal with the little guys anymore, preferring to put their money into people with a little bit more under their belts than a computer in a garage—the "If you can't get your friends and family on board, why should we?" mentality.

In any event, NYC, Seattle and LA are all growing due to increased focus on supporting talent pools. So if it is a matter of distance, the only solution is the same as before: Continually grow and support regional talent pools, and the funding will follow. If it is a matter of playing the odds, then it shouldn't hurt entrepreneurs. Just keep pressing on, because that's the only way to know if you're in that 1 percent, and where that 1 percent goes, money will follow.

The VC gap will not stifle entrepreneurs who are ready and willing to start new businesses. When there is a need for something, the market finds a way to make solutions appear. The VC gap has existed in one form or another for a long time, and though many of the original ways to work around it have become naturalized, still others pop up routinely.

While significant, the VC gap is not insurmountable—and certainly not permanent.

This is how angel investing first happened. This is why we now have a distinction between a seed round and a Series A. And once it is finalized, Title III equity crowdfunding will come forward and take its place as yet another way for entrepreneurs to receive the funding they need. Title II allowed for regulated crowdfunding and public solicitation of funds from accredited investors. Title III will lower the minimum investment requirements, ushering in a new wave of investors while giving entrepreneurs a new path to capital.

Soon the investor and the entrepreneur will reside in the same demographic, and the chasm between them will be filled by new intermediaries. And who knows what will come from that? Start-ups funded in real time? Flourishing and supportive investment networks? Will VCs begin to look toward those networks for advice? Will they become incorporated, or will those networks rise and replace the VCs altogether?

For the most part, VCs (looking out at the world from behind Google Glass) stay away from crowdfunding because the prospect of supporting a product without having a piece of the profit is simply uninteresting to those searching for greater traction and returns. But once Title III goes into effect, the lack of accredited investors won't be as great an issue due to the increased participation of the unaccredited.

Still, with that comes a whole host of post-funding problems as young entrepreneurs struggle with the new (old) problems of business: what to do with the money, how to keep and grow your user base, expanding, secondary markets, going public, etc.

The first step in this process is nailing down the Title III rules. Everything else until then is speculation, except for what Heraclitus said more than 2,000 years ago: Change is the only constant in life.

By Ron Miller, CEO and partner at StartEngine, and a CNBC-YPO Chief Executive Network member

About YPO
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