Back from the Future

It's been a summer on the road for me; I'm home again for a little while after spending the last week in the San Francisco Bay Area (some work, some family, some vacation). I picked up two blog-worthy notes while I was out there:

First, last week the California Supreme Court decided a case that entrepreneurs and start-up investors everywhere should note: Edwards v. Arthur Andersen. [Text of the opinion is here.] At issue in the case was the validity of a noncompetition agreement, the sort of thing that is standard in many professional contexts around the country -- except in California. It has long been understood that noncompetes are invalid under California law (California Business & Professions Code Section 16600, to be precise), except under very narrow conditions defined by the statute. The court was asked to decide whether noncompetes could be upheld, even under Section 16600, if they met certain narrow "reasonableness" tests. And the court -- unanimously -- said no. The California statute, which was adopted in 1872 along with much of the rest of California law, means what it says. Noncompetes are presumptively invalid. Most of the California technology community is rejoicing. Employee mobility has been a key driver of that state's economic performance over the last three decades (cf. Annalee Saxenian and "Regional Advantage").

In Pennsylvania as in most states, noncompetition agreements are enforced if they are "reasonable" in scope. Employers understandably hold noncompetes in high regard; they want to keep their employees -- and the investments in recruiting and training that employees represent -- from taking their labor to competitors. But noncompetes contribute to sclerotic labor markets, and according to Saxenian's research sclerotic labor markets explain much of the difference in rates of economic growth between high-tech communities in Boston and the Silicon Valley. What would happen in PA if the Commonwealth adopted the California approach? It's an interesting thought experiment.

Second, I read a draft paper on angel investing, which argues that angel *groups* are more effective than individual angels, and that because angels are more widely dispersed than venture capitalists, angel *groups* will play a key role in developing tech-based startup economies outside the classic tech regions. Of course I thought of Pittsburgh: Here is a community with some meaningful number of angels, and with at least one angel group whose name is sufficiently well-known that it's part of the "usual suspects" in town.

If angels and their groups are so important, and if Pittsburgh has both, why does Pittsburgh's tech economy continue to move sluggishly? The draft paper noted that statistics on angel investors (reportedly more than 2 million of them in the U.S.) show that roughly 3/4 were prior entrepreneurs before going into angel investing, either on the side or as a full-time activity. (Source: Van Osnabrugge & Robinson, Matching Startup Funds with Startup Companies -- A Guide for Entrepreneurs, Individual Investors, and Venture Capitalists.) It also assumed that angels have either the same risk tolerance as venture investors do -- or more, since angels on average make more (but typically) smaller investors.

How does this map onto Pittsburgh? From what I'm told (by local lawyers, local entrepreneurs, and local intermediaries), the knock on the local angel community is that Pittsburgh's angels don't understand startup markets: They expect every investment to be a winner, and when one loses, they drop out of the investing game. Can this change? The paper, relying on Van Osnabrugge et al., suggests that it can: A greater part of the angel community needs to be comprised of former entrepreneurs, who have been on the other side of the capital equation. Very slowly, the investment community in Pittsburgh is being populated by former entrepreneurs. AlphaLab might be one example of this; Pittsburgh Equity Partners might be another. Is this shift happening at a pace and to an extent that it can make a difference in the rate of startup formation? Startup growth? And is the shift penetrating what Pittsburgh calls its angel community?

Comments

2 Responses to "Back from the Future"

Schultz said... 8/12/2008 4:25 PM

"If angels and their groups are so important, and if Pittsburgh has both, why does Pittsburgh's tech economy continue to move sluggishly?"

Mike - those individuals are right - the early stage investors here are very hesitant to take risks. They would rather invest in something safe that has already been done before rather than take a chance on something new that could someday be the next Google.

Jefferson Provost said... 8/13/2008 2:59 AM

My impression of the Pittsburgh start-up market it seems like most of the companies are targeting on narrow B-to-B niche markets, rather than broader consumer-oriented businesses. Now there's nothing inherently wrong with that. Some of my best friends work for (or run) companies like that. However, it doesn't seem like the kind of community that's chasing dreams like "organizing the world's information" or building "the largest river of merchandise in the world," or even monopolizing the world's desktop computing software, for that matter. I haven't figured out if anyone there dreams of changing the world.

I suspect that local investors are partly responsible for this. After all, settling into a nice vertical niche is probably less risky than shooting for a consumer business, and I'm sure it seems less risky to Pittsburgh's money. After all, steel, glass, aluminum, air brakes, switches and signals, nuke plants... Pittsburgh's heavy industry past lived entirely in b2b markets. But small B2B business are not the kinds of companies that anyone outside of their city or their industry is likely to have heard about, and that includes the national and world-class engineers, scientists, and managers whom you might attract to come and increase the talent pool.

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Pittsblog 2.0 is written by Mike Madison, a law professor at the University of Pittsburgh. Send email to michael.j.madison[at]gmail.com. Mike also blogs at Madisonian.net, on law and technology. Chris Briem of Null Space drops by from time to time.

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