CNBC Disruptor 50

Silicon Valley edged out: Google employees aren't the only ones walking away from elite tech headquarters

Key Points
  • Silicon Valley is not about to lose its dominant position as the home of billion-dollar technology start-ups and hub for top talent, but there are a growing number of reasons why more workers and new companies are choosing other cities, far from San Francisco, Boston and New York, to call home.
  • Several quality-of-life considerations come into play, from housing costs and transportation ease to education opportunities.
  • Cities, including Pittsburgh and Philadelphia, also have strong research university bases and large, established anchor corporations becoming more active in venture investing.

Google employees aren't the only ones walking away from Silicon Valley headquarters.

More start-ups are choosing to call cities like Pittsburgh and Philadelphia home, over San Francisco and the two other coastal epicenters — Boston and New York. And they aren't struggling to find workers.

Some of the reasons are obvious, such as housing costs, an issue that has led an increasing number of young workers to migrate to Rust Belt cities. Other factors are less obvious, such as birthrate of employee families.

Let's start with the surprising fertility finding for a look at some of the reasons why more tech workers and start-ups are settling across a growing number of U.S. cities.

1. Start-ups often get a lot richer — quickly — when they leave the coastal epicenters.

David Hall, a partner at the Rise of the Rest Seed Fund — part of a venture firm formed by America Online co-founder Steve Case to fund start-ups located outside the tech hubs and that includes among its investors Jeff Bezos, Eric Schmidt, Howard Schultz, the Walton family (Walmart) and hedge fund billionaire Ray Dalio — said the riches that come to start-ups based in smaller cities occur at both the level of balance sheet and babies.

Hall, whose fund raised $150 million late last year and invests 90 percent outside of Silicon Valley, Boston and New York, recently invested in a company that left Boston for the Midwest. Just by relocating, Hall said, the company added six months of cash burn onto its balance sheet. And the birthrate among staff "went up dramatically," Hall said. "Staffers felt you could have family, you could invest in a city," he added, speaking at the CNBC Disruptor 50 Road Show in Philadelphia on Oct. 24.

Hall was not at liberty to name the start-up, but he said that rootedness and feeling of financial security has a positive spillover effect for companies. Turnover goes down, and existing staff can be effective recruiters, bringing more friends and peers to the city. "You can create that distinct community just by leaning into your own community."

Language-learning app Duolingo took out billboard ads in Silicon Valley to recruit tech workers to its hometown of Pittsburgh, part of a trend among start-ups setting up shop in cities across the US that offer a better quality of life than the expensive Bay Area.  
Source: Duolingo

Jorge Mazal, vice president of product at language-learning start-up Duolingo, worked at several companies in Silicon Valley, including a giant and a start-up. His last job was as a manager at MyFitnessPal, the Under Armour-funded fitness app, and although he said he would never regret the time in California, he knew when it was time to move away.

"The decision to go to San Francisco was to find mentors in areas I cared about, but I needed to go somewhere to raise a family and have a better lifestyle. I was looking for anywhere in the U.S. — not New York or San Francisco," Mazal said on the panel with Hall at the CNBC Disruptor 50 Road Show.

He ended up at Pittsburgh-based Duolingo, a company that has taken out snarky billboards in California to send that quality-of-life recruiting message to tech talent.

No city is going to have the density of talent that exists in Silicon Valley, and so it is harder to recruit, but Hall said that challenge is offset by two factors: It can often be significantly less expensive to hire talent, and companies can generate a better return on investment on the talent. "They are not always looking for the next start-up to go," he said.

Mazal said when it comes to bringing talent to Pittsburgh, it is not as simple as the Duolingo billboard makes it seem, and the company does have to tailor its pitch to each candidate. "It depends on the person, how we sell it. We have to find the right story for each candidate. For me what resonated was housing and prices, but for others it is about cool neighborhoods, the food scene."

Mazal said it is getting easier for Pittsburgh to make a case because of, rather than in spite of, the biggest tech companies: Google, Amazon, Uber and Facebook all have offices in Pittsburgh now, and that "helps someone take the plunge of moving," he said.

Hall said there is an obvious psychological "tell" — to use a poker phrase — which lets him know when to not even try to sell a candidate on a city or invest in a firm. "We look for swagger, someone not apologetic about being in Pittsburgh."

2. You can't solve society's problems from Stanford.

There has been a recent debate in California — and between two high-profile billionaire tech CEOs, Twitter's Jack Dorsey and Salesforce's Marc Benioff — over a ballot proposition in San Francisco to levy a tax on large companies to help support services for the homeless.

If the tech visionaries can't agree on how to solve the pressing problems in their own hometown, why do we trust them to solve all of society's problems? That is a question that has led Hall's Rise of the Rest Seed Fund to invest in start-ups like AppHarvest, a tomato-farming operation based in Kentucky coal country.

AppHarvest, a start-up in Kentucky coal country that plans to farm tomatoes.

"We have these huge problems as a society, like health care and agriculture and transportation, and the idea that some person at Stanford will think up a solution, having never worked on a farm or rode on a bus ... Solutions are born out of lived experience, and that happens outside of these coastal hubs," Hall said.

Pikeville, Kentucky-based AppHarvest is converting an old coal strip mine into a tomato farm and retraining displaced coal workers to farm tomatoes. "That idea does not get dreamed up and executed in New York City," he said. "It takes the local focus, and we think we will make a lot of money off that. ... They are doing something new and different and novel in a place that needs it and appreciates it. ... It is like the perfect storm for us."

We have these huge problems as a society, like health care and agriculture and transportation, and the idea that some person at Stanford will think up a solution, having never worked on a farm or rode on a bus ... Solutions are born out of lived experience, and that happens outside of these coastal hubs.
David Hall
partner, Rise of the Rest Seed Fund

Start-ups also can learn a lot more about their customers away from the Valley. Mazal said that was a lesson he learned while still working in California. "When I was at MyFitnessPal, we had to leave San Francisco to get user insights, talk to people we thought were 'regular people.' In Pittsburgh it is totally different. You open the door to your office and people are really interesting with useful insights."

Most of Duolingo's users are located outside the United States, but its mission adds a global focus to the need to leave the Valley: "If we can understand them and build something they will love, we will be fine," he said.

3. Amazon HQ2 has provided a roadmap for 238 cities on how to lure start-ups and investors.

"Philadelphia, Baltimore and these gilded cities of the last generation are now having their resurgence, their second moment, and we are really excited about them," Hall said. "Cities in the southeast, Raleigh-Durham, Charleston, Nashville, are really starting to spin up again and it is hard to bet against places like Austin, which were once part of the tech core with Dell and are now seeing a great resurgence. We see opportunities in all of them."

Four of those cities — Philadelphia, Raleigh-Durham, Nashville and Austin — and others in the Southeast (Atlanta, Miami) and Northeast (Newark, Pittsburgh), also are among the metro areas vying for the coveted $5 billion, 50,000-job Amazon HQ2 project to build a second headquarters for the Seattle-based tech giant. If you trust the speculation in the press, most of these cities have no chance of actually winning the Amazon deal — the Northern Virginia metro are close to Washington, D.C., is considered the front-runner, though Amazon has said nothing to support that. Jeff Bezos offered a cryptic answer in an interview on Thursday night when he said the Amazon HQ2 decision has to ultimately be made "with your heart."

Hall said since the one thing we know for sure is that 19 of the 20 finalist cities will lose, the key is what the cities do with all their effort once the decision is made. He thinks the Amazon HQ2 process has done metro areas across the U.S. a great service by forcing cities to devise all sorts of incentives to lure Jeff Bezos. Those incentive packages should not go to waste in cities that are ultimately spurned by Amazon. Incentive packages were devised by many more cities in the initial round of requests for proposals from Amazon, before it whittled down the list to 20 finalist cities. That was a group of bidders that reached 238 cities.

"It has become a roadmap on how to make your city and county more attractive to tech start-ups, from education needs to housing costs and transportation needs," Hall said. He added that a city can't have successful companies without making the market as attractive as possible to investors. "Incentives in a region often compel new investors to come into a market," he said.

"It's right there, and if a city or municipality is willing to do all of this for one big company, divide that by 100 or 1,000 and give a small piece, an incentive package to a dozen start-ups and one of these could become the next Amazon. But you have to start from one of those."

The dollars haven't changed dramatically

Even with the progress being made by more American cities to position themselves as urban start-up accelerators, the overall numbers still favor the big three.

In the third quarter of 2018, deal funds raised by firms located in Northern California (San Francisco, San Jose and Silicon Valley) reached roughly $25 billion, according to PitchBook's Venture Monitor report. New York-based firms received roughly $4.5 billion. In Boston, the total was $2.8 billion in Q3. No other cities saw deal flow above $1 billion in the third quarter, and the two cities that saw the greatest volume of deal dollars after the big three are not surprises — Seattle, home of Amazon and Microsoft ($855 million) and the California biotech hub of San Diego ($783 million).

Highly valued start-ups branching out

Company Valuation Location
Epic Games$13.75 billionCary, North Carolina
Outcome Health$5.5 billionChicago, Illinois
SmileDirectClub$3.2 billionNashville, Tennessee
Fanatics$3.2 billionJacksonville, Florida
Reata Pharmaceuticals$3 billionDallas-Fort Worth, Texas
*Qualtrics$2.5 billion Provo, Utah
Mozido$2.4 billionAustin, Texas

Source: PitchBook (*Qualtrics filed to go public in October, valuation is last private valuation)

There is something other than dollars in Silicon Valley that no other city can match: an appetite for risk.

"No one is afraid to share an idea in Silicon Valley," Donna de Carolis, dean at the Drexel University Close School of Entrepreneurship and a CNBC Disruptor 50 Advisory Council Member, said on the panel with Hall and Mazal.

De Carolis was referring to the fact that Silicon Valley idea generators aren't afraid about ideas being stolen, and Mazal agreed: "Some of the great things about Silicon Valley is the risk-taking and speed with which people move, and the passion people have for developing ideas."

Hall sees that same risk-taking attitude as key to the Valley's investment strength, and lead, over most U.S. cities.

"Getting comfortable with risk is something they do in San Francisco better than anywhere," Hall said. "The investor class in cities we invest in are relatively risk-averse."

Hall said one reason for the risk-averse investor mentality is many entrepreneurs come out of industries like real estate where they are accustomed to a kind of secure return stream that does not exist in venture capital. But if these cities really want to close the gap on the Silicon Valley, investors in these cities are going to be required to take a risk on high-flying start-ups that could be great investments. "We want to see the balance between risk and failure managed in these rising cities."

Hall said he knows the start-up founders are out there with "the swagger to go from napkin to IPO and through all of the ups and downs in between."

What cities across the United States need is more late-stage capital from more millionaires and billionaires "ready to double down on their hometown."