Startups drive job growth with cash from venture funds

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BOSTON – How are jobs created? Finding answers to that question has been an economic and political priority for governments around the world, especially in the years since the Great Recession. Nurturing startups may be a critical component.

Studies, such as a white paper from the National Bureau of Economic Research in Cambridge, suggest that fostering business formation, rather than helping larger businesses survive, may provide the most effective job-creation solution for people the world over. The authors said their study showed that newly formed companies, rather than simply small businesses, drive job growth.

Similarly, research from the Kauffman Foundation in Kansas City, Missouri, showed that startups account for virtually all job growth. The NBER study showed that young businesses, including startups, generated 20 percent of all new jobs created in the U.S. from 1992 to 2005, concluding that age rather than size was most important.

“The real driver of disproportionate job growth, they find, is not small companies, but young companies,” the nonprofit research organization said in a summary of the 2010 study. “It is the startup firms that generate the surge of jobs that earlier research attributed to small companies.”

While they account for most job creation, the founders of many young firms lack the financial resources needed to begin and sustain their operations for any significant length of time. Because most banks shun risk, conventional loans are often not an option. Some founders rely on relatives or credit cards; some turn to mortgages; still others seek out “angel investors” and/or venture funds that offer seed capital. A 2015 survey from Silicon Valley Bank in Santa Clara, California, found that 42 percent of startup executives expect their next round of funding to involve venture capital.

In short, if newly formed companies are the fount of jobs, capital supplied by angel investors and venture funds provides the blood that can keep them alive and growing.

Boston’s reputation for technology innovation goes back to the Industrial Age and reflects a long history as the hometown of some of the world’s most life-altering advances, such as the sewing machine, the telephone and the microwave oven. Hub scientists even played a leading role in the creation of the Internet. This tradition also fostered the development of a strong financial network of firms and individuals willing to take the significant investment risks to help transform a bright idea into a successful business – and maybe create your next job.

That funding ecosystem remains alive in the Hub. In this year’s first quarter, New England startups received about $1.5 billion in early-stage funding, a 25 percent increase from the last three months of 2015 and second only to companies in Silicon Valley, according to the MoneyTree report from PricewaterhouseCoopers and the National Venture Capital Association. Most of that money probably went to companies in Massachusetts, based on earlier data.

The amount pumped into Bay State startups essentially doubled to $4.68 billion in 2014 from $2.36 billion in 2009, according to figures from the State Science & Technology Institute in Westerville, Ohio. Over that period, an average of almost $3.2 billion annually went to Massachusetts firms, with 385 receiving funding each year, the data show.

But going from idea to prototype to obtaining the money to start a business isn’t easy, even for technologists with great ideas.

“For early stage companies, it is still hard to raise the capital which would then allow them to prove out their technology business model,” Jeffrey McCormick, founder of venture capital firm Saturn Partners in Boston, said in a recent interview. Yet the further a company develops, the easier it is to raise money, and then raise more.

Boston’s innovators have long relied on the local funding ecosystem to start and grow companies, and in some cases, they look to venture investors and angels to provide business acumen as well. Getting a good idea off the lab bench and into the marketplace typically takes more than scientific genius or engineering skill. To succeed, startups must overcome many obstacles to evolve into stable, profitable, long-term operations.

Most never get there, failing within five years, McCormick said. The failure rate – by some estimates as many as 9-in-10 startups go under – means that early-stage investors take great risks, knowing that many of their gambles will turn out to be losers but count on a few big winners to produce net returns each year. Choosing where to invest and taking the steps needed to give each recipient the best shot at success is as much art as science, according to veterans of the game.

There are few predictable reasons for startup failure.

“It can be a brilliant idea,” said Saleh Daher of Walnut Venture Associates in Boston. But leveraging the insight or invention into business success takes “a lot of luck.”

“If it’s just not the right time, if it’s too early – or you manage to find a market, but then there’s another competitor and was better at marketing, but has an inferior product,” all can spell disaster, Daher said.

“For example, right now, mobile devices have made possible a lot of things that weren’t possible five years ago,” Daher said, referring to smartphones and tablets.

These increasingly ubiquitous handheld gadgets typically “have location services,” he said, which aid hailed drivers in finding their fares. “So someone who might have been trying to start Uber five years before Uber started would never be able to do it because they didn’t have location services,” he explained. “You can’t be too far ahead of the technology or the infrastructure.”

Another reason companies fail results from a simpler deficiency, McCormick said, referring to industries like biopharmaceuticals as providing classic examples. Developing new medicines, particularly those based on biotechnology, can take years and tens or hundreds of millions of dollars before the intended product gets tested in patients. The results can be devastating.

“If drugs don’t work, they don’t work,” McCormick observed. But in many other industries, a product’s functionality can be determined long before much significant investment is made, which means failure typically stems from factors outside the research lab.

“Very often, it’s because of management and execution,” McCormick said, explaining why startups fail and founders end up on the rocks.

“They didn’t really understand the customer’s needs. They didn’t really understand the market. They underestimated the difficulties of the sales cycle,” he said, recounting some of the many reasons for failure. “It’s not just about having the best widget or service,” he said. The key is often “about the business end of things.”

To help ensure these more mundane factors don’t foul things up, McCormick and his colleagues engage in what he calls “old-school” methods, by rolling up their sleeves and working very closely with founders and the startups that demonstrate serious growth potential. They don’t just bankroll bright ideas, in other words.

“We work very closely with management teams,” he said, becoming “invested in more ways than just capital.” The degree of engagement varies based on the growth stage of the startup, McCormick said.

“When you’re invested in early-stage companies, you’re in the same foxhole – we’re not money renters,” he said. “It’s the difference between the egg and bacon at breakfast; the chicken is involved, but the pig is invested.”