In developing VC markets such as the Midwest, some may think that funding from the government or economic development organizations are a godsend for local entrepreneurs. Startups are often looking for all the help they can get, and a boost in funds or an attractive set of economic incentives can be perceived as the fuel they need to take the next step in their growth journey.
While this type of funding can be helpful, a startup should ensure that funding from these sources is not a double-edged sword. The biggest positive, of course, is the money, which can help startups with product development, hiring, marketing, sales and more. But there can also be certain restrictions or limitations that are not fully understood initially—these restrictions could hinder growth at an inopportune time later on.
The inevitable question, then, is should startups consider partnering with the government or various economic development groups as they look to get off the ground? Let’s take a closer look.
What Local Economic Development Organizations Have to Offer
Today, particularly in the Midwest, it’s common for state and local governments to offer startups incentives such as tax exemptions or grants in an effort to keep local businesses around and also attract companies from other regions.
So how do these incentives work? When it comes to tax credits or exemptions, local governments are sometimes willing to provide these incentives if a startup can demonstrate how paying lower taxes will benefit the wider community.
These benefits come in various forms, such as investments in targeted areas including advanced manufacturing or the overall ability to create more jobs – a tradeoff of less taxes today for more taxes in the future via a more thriving local economy with stronger business and job growth.
Training grants are another avenue often supported by local governments. There are skills gaps that exist in many high-tech and high-growth industries and markets, and grants to train both new and existing employees can help startups avoid these gaps by improving the skills of their workforce. Governments are often willing to help with such training because it not only helps one company, it helps entire communities develop a deeper pool of tech talent.
In Ohio, much economic development from government-backed organizations takes place at the seed stage. It can help make it cost-effective to hire new talent, secure new or expanded office space, or purchase necessary manufacturing equipment.
How the Midwest Compares to the Coasts
On the East and West Coasts, the percent of investment activity from government-backed organizations is very low. You don’t see Salesforce being helped out by an economic development grant, for example. A quick look at Pitchbook’s 2018 annual report shows that investment activity from government-backed groups is far more common in the Midwest and Great Lakes regions compared to the coasts.
Pitchbook doesn’t quantify this in dollars, but considering how much more overall investment takes place on the coasts, it wouldn’t be surprising if the total dollar amount of this type of government-backed funding on the coasts mirrored or rivaled that in the heartland. But, again, when looked at as an average percentage of a company’s resources, it’s much higher in the Midwest.
Ohio, in particular, facilitates programs in each different region of the state, and these regional sources make up a much higher percentage of the resources for startups than they do on the coasts. That’s not to say that incentives such as tax credits or training grants don’t exist in, say, Silicon Valley, but the proportion is far lower.
Potential Positives of Economic Development Funding
Some ways the government or economic development organizations can help startups include:
- Providing attractive grants or loans for startup office space and needed equipment.
- Removing barriers to and encouraging commercialization of university technology.
- Publicizing real success stories — startups creating new industries and their customer successes — in an effort to help the region attract more talent and dollars.
In addition, the government can lower taxes and remove barriers and red tape for startups. They can also incentivize areas of excellence for a state’s unique resources — IoT, autonomous vehicles, med tech, advanced manufacturing and data science in the Heartland are just a few examples where the Midwest can thrive.
Tax credits for new employees, programs that attract talent by paying for relocation expenses, employee tax breaks for moving to a specific area, or aforementioned training grants are ways that these groups foster talent. It may not seem like much, but even groups who provide help in other areas, such as offering to help construct a new parking lot for an expanding manufacturing facility, are very helpful.
A great program would be if you’ve had a startup that was acquired for more than $100 million, there are significant incentives to start another one, as those entrepreneurs have proven they can be successful.
The government also encourages commercialization. Encourage and recognize and reward. I know that institutions such as The Ohio State University, Ohio University and others keep stats and recognize and reward commercialization: in one case, we had a celebration for a company that had just broken the $25 million revenue level.
If governors around the region recognize a particular startup from a college or university, it could cause a chain reaction that encourages others at that institution to focus more on their own commercialization efforts. It’s all about creating the right environment with the right incentives and the right help.
Image via Getty Images / tinbee
Now for the Buzzkill: Government-Backed Investment Can Have Its Drawbacks
When seed-stage startups are starving for funding, support from government-backed economic development organizations can be enticing. Yet while the injection of cash flow is certainly welcome, this type of funding often comes along with a set of restrictions.
There are typically very specific geographic restrictions on where these organizations can invest, or where they require businesses to be located after receiving the funding — this isn’t particularly surprising, considering the main aim of these groups is to spur economic activity in their local area.
I’ve seen a situation where a company could locate on certain streets in Columbus, but not others based on various criteria. It was more complicated than congressional districting, which proved to be limiting when searching for an office space.
Also, while economic development organizations want to help individual startups, it’s important to remember that they have their own interests top of mind as well. They may be focused on specific metrics such as the number of jobs created or other measures of economic impact, which may or may not align with the specific goals of the company involved. This also means you will have increased reporting requirements around those metrics, which call for time and other resources that are often limited at a startup.
One of our companies turned down economic development money as we felt the natural timing and flow of hiring was not a fit with pre-scripted yearly mandates. Startups are unpredictable and need flexibility to make sensible decisions without the worry of repaying economic development funds if they do not achieve certain yearly hiring targets.
In another case, an organization had restrictions on salary levels. This is problematic, especially when startup companies are competing for top software and data science talent.
Generally speaking, there can also be a lack of a long-term commitment, particularly when working with the government and new hot-button political issues arise. The funds they offer are not long term. If a startup depends on government-backed economic development to drive growth, it’s probably not going to happen.
These funds should be considered more of an initial/helpful injection or supplement and not the entire basis of a startup’s growth financing strategy. Companies take anywhere from five to seven years plus on average before a successful exit, and government priorities will undoubtedly change over that amount of time.
In the end, support from local government or economic development organizations can certainly be helpful, but entrepreneurs should weigh the risks and rewards before making such a commitment. The capital and incentives can be helpful; just minimize the strings attached and do not become reliant upon these funds as your primary growth financing strategy.