Non-Coastal Startups are Leaner and Offer Better Returns than Coastal Counterparts

It Turns Out, Fewer Entrepreneurs and Investors is a Good Thing For Returns

At Connetic Ventures, we have always focused on investing in founders from overlooked regions that do not have a surplus of local capital. We call these regions several things… like overlooked regions, middle America, flyover country, non tech hubs, non-coastal, heartland, and many more. Regardless of what phrase we choose at the time starts, Connetic is generally talking about startups that AREN’T located in the major VC hubs of San Francisco, New York, and Boston.

For the purposes of this article, we are going to refer to these startups as non-coastal. Even though some of them are coastal (DC, Seattle, Miami, and many others).

Historically, we chose to invest in startups located outside of those regions primarily because there is much more of a need for capital and non-coastal deals were easier to participate in. Over time we have noticed trends (qualitatively) and wanted to do some quantitative research to see how non-coastal startups were different from their coastal counterparts.

Do they have access to less funding? Are teams smaller? Does the performance differ?

To do this, we leveraged a variety of data sources including Crunchbase, Tracxn, Pitchbook, and our own internal data. The source we used for 80% of the data was Crunchbase and we looked across 20,000+ startups that had raised at least $1M over the last 10 years. This was our threshold for a VC-backed company.

TLDR:

• Non-coastal startups (compared to coastal startups):
• Raise less money and have fewer investors
• Have smaller founding teams
• Have the same likelihood of success
• Have better cash-on-cash return to investors

Part 1: What are core differences?

First, we wanted to explore whether there are core differences between costal and non-coastal startups.

1. There are more VC-backed startups in CA, NY, and MA than the rest of the country combined

Startups for Coastal (CA, NY, MA) and Non-Coastal (Rest of America)

Number of startups by State

2. Coastal startups have a higher average number of founders on the founding team

Average number of founders for a VC-backed startup

The number of founders seems to mirror the entrepreneurial activity and funding dynamics of certain regions. Coastal startups have more founders than non-coastal startups. This is even more apparent when you look at states with far less entrepreneurial activity like Mississippi, North Dakota, and Arkansas. We believe number of founders are likely correlated to the overall entrepreneurial activity which is also tied to the amount of VC funding.

And here is the geographical distribution of founders with more detail:

As you will notice, states with much fewer startups (less entrepreneurial activity) than average are well below average.

3. Costal startups have a much higher average number of investors

Average number of investors for a VC-backed startup

When comparing the number of investors, coastal startups have 7.9 investors compared to 5.3 for non-coastal startups. Phrased another way, coastal startups have 49% more investors than non-costal startups.

Average number of investors by state

4. Coastal startups have a much higher total amount raised

Average amount raised per startup

However, if you look at average amount invested per investors, non-coastal startups had a slightly higher average investor check. This was a bit surprising to us as we assumed investors between the coasts had smaller checkbooks are coastal counterparts. So, it appears that the only major difference is in total number of investors, not total check sizes being written.

So, coastal startups have access to more investors and entrepreneurs.

Part 2: Are there performance / return differences?

Now we wanted to explore the performance of startups to see if there were differences in overall performance and investor returns. To answer this question, we looked at data to identify three different performance related outcomes:

1. Company Revenues

One way to look at startup performance is to analyze revenue thresholds that startups hit. Most public and private companies now trade on a revenue multiple, so this is one of the most common way to value a private company.

When you look at a state-by-state level there are a much higher number of states whose VC-backed startups hit a $50M revenue threshold. VC-backed startups in Alabama and Nebraska both have greater than 10% chance of hitting $50M in revenues, the highest of any state.

When you aggregate the states together into coastal and non-coastal, VC-backed startups have the exact probability of hitting $50M in revenue. So, regardless of location or how much money you raise, every startup has roughly the same chance of reaching this revenue threshold.

Winner of Startup Performance: TIE

2. Acquisition relative to total amount raised

The below charts look at the ratio between the price that was paid via acquisition and the total amount of funding that was raised. For instance, if a startup was acquired for $100M and the company raised $10M then the Acquisition to Funding Ratio would be 10 ($100M / $10M).

When you compare coastal and non-coastal startups, non-coastal have a higher acquisition to funding ratio, this is a positive sign. We have already proven that coastal startups raise more money and have similar performance, so this ratio points to the two groups of startups likely command a similar exit valuation or valuation multiple on revenue.

Winner of Acquisition Multiples: TIE

3. Home Run Returns

Home run returns are what every VC investor looks for. For this analysis we classified a home run return as a return that exited for over $500M and had a minimum of a 5x cash-on-cash return, although the average return out of this group was 25x.

So, when you just look at exits that are over >$500M and generated a minimum of a 5x return then non-coastal startups had 2/3 of these exits. Due to the less total amount of money being raised, non-coastal startups avoid the same levels of dilution and are able to return a much higher % of home run returns.

If you want to look at it by a state by state basis, here is a chart that looks at home run returns / total capital raised. So, states like Virginia, Conneticut, Michigan, and Tennessee have a much higher likelihood of home run returns than coastal states of California, New York, and Massachusetts.

Top Performing Exits / Venture Capital Raised

Winner of Home Run Likelihood: Non-Costal

So, there you have it. Non-coastal startups have better performance than costal startups. They have the same likelihood of being successful and command the same exit valuations, but return more capital to investors due to lower amounts of capital raised.

So, let’s recap:

- Non-Costal Startups:

• Have less access to capital, mostly from lack of number of investors locally
• Have less active entrepreneurial ecosystems
• Have the same number of startups becoming successful
• Have better performing exits for investors

In other words, non-coastal startups provide strong financial outcomes without the strong competitive environments that can be found in the coast, creating a great opportunity for investors.