PROJECT FINANCE

ith Boston and Silicon Valley absorbing nearly half of all U.S. venture capital investment, many second- tier cities until now have not attracted their fair share. But some have begun to emerge as stars in their own right.

   That’s one finding of recent analysis sponsored by the W.K. Kellogg Foundation and published by the Federal Reserve Bank of Boston. Authors Carole Carlson, managing director of Carlson Partners Consulting, and Prabal Chakrabarti, deputy director, community affairs, Federal Reserve Bank of Boston, reported that “from January 2003 to August 2005,

secondary cities received 13 percent of all deals and 20 percent of total investment dollars, despite the fact that secondary cities account for roughly half of the U.S. population, half of the number of business establishments and 38 percent of U.S. payroll. The disproportionate flow of venture capital into secondary cities matters because venture- backed companies can play a major role in economic development.” Their research included interviews with 17 venture capital firms and 53 companies that had received that capital.

   The research also identified the 20 highest performing secondary cities in venture capital deals. Cumulatively, they attract “seven times as many deals on average and 15 times as much private equity investment per capita as other secondary cities,” say the authors.

   While venture capital is known for helping to spawn patent activity, it can also spawn facility and employment activity. Among the country’s 20 highest- performing secondary cities for venture- backed deals (see chart) are several that have also performed well in Site Selection‘s annual measure of metro- area new plant and expansion activity, according to the Conway Data New Plant Database. That subset includes Tulsa, Okla.; Louisville, Ky.; Salt Lake City, Utah; and Durham, N.C. Ann Arbor, Mich., is home to the expanding Toyota Technical Center as well as a major new sales center from Google. The Bakersfield, Calif., area is seeing a wealth of new logistics operations, including a Formica distribution center. Durham has seen the backing of local company Motricity by New Enterprise Associates, which subsequently has also invested in another area firm, Liquidia Technologies, in Morrisville. That firm is now looking to triple its facility footprint.

   “The companies I talked to were typically early enough in their genesis that they hadn’t gotten to the plant development stage yet,” says Carlson, “but some of the factors that make a community supportive of new business formation also make it supportive of business expansion.”

   Such a potent blend of idea development and traditional industrial development may spell great things to come for those communities that can manage the balance and keep the momentum going. Among the factors that help the successful cities, say Carlson and Chakrabarti, are clusters and networks, established investor presence, technology transfer capability, accessibility, community attractiveness and historical rate of return on investment.

   In addition to the usual support of prominent research universities, second- and third- tier metros can also boost their venture capital infusion through cultivation of angel capital networks, as well as better networking with foundations and corporations that may be looking to take a more active role in such endeavors. But the institutional infrastructure can go beyond that, say Carlson and Chakrabarti.

   “One significant opportunity for foundations as well as states is to use their pension plans and increase the flow of capital to secondary cities by directing additional investment to venture capital and private equity firms that are targeting secondary cities,” they write. “Also warranting further exploration are public policy alternatives such as favorable tax treatment for these kinds of investments.”

   “Foundations, like anchor corporations, can be important as anchor institutions in communities,” says Carlson, a former city planner. “They too can provide that critical density, intellectual capital or network facilities.”

   She cites as an example the foundation that sponsored this very research.

   “Kellogg is a great example in Battle Creek, Michigan,” she says, “just by being there, hiring professionals, helping create community wealth and caring about the community.”

   Carlson says second- tier communities need to think about their assets strategically.

   “The same old tricks just move resources around – they don’t create wealth,” she says, calling on communities and economic developers to think proactively about quality- of- life areas like education, transportation and parks. Administrators tend to “think more in terms of regulation than facilitation, but they really have a role to play,” she says. “There is an opportunity there. It requires a changed mind- set, but it would result in more efficient use of community resources.”