Will the California Exodus Impact Innovation?
By: David Gross
Tags: Startup, Bay Area, California, Los Angeles, Bioeconomy

Every week we hear another story of a company, CEO, celebrity, or venture capitalist leaving California. What does this mean for the future of innovation in the state?

Hewlett Packard Enterprise, Joe Rogan, 8VC venture capital, Palantir, the CEO of Splunk, almost every day brings another story of a prominent person or company leaving California. The reasons aren’t that varied, the big five — high taxes, housing costs for employees, wildfires, government mismanagement, and needles/homeless on the streets — dominate the causes listed for moving to other states. Combined with the post-pandemic increase in remote work, can California hold its position as a center of American innovation?

Capitalists Showing More Mobility than Capital

Corporate relocations remain a challenge for California, but while a number of established companies have moved their headquarters out of state, far fewer startups have. Companies whose success is not guaranteed are more concerned about market acceptance than costs, and few are leaving. Established companies, from Charles Schwab to Nestlé to McKesson, who worry more about costs than market acceptance are having a harder time justifying the expense of remaining.

While some venture capitalists have left the state, the capital they invest has yet to follow. In the third quarter, Bay Area companies raised $13 billion from venture funds compared to just $400 million for Austin companies. Moreover, in the growing biotech and bioeconomy sectors, where VCs are on course to invest close to $30 billion this year, 180 California companies have raised money in 2020, compared to just 12 Texas companies. Moreover, the top competitor in this area, as it has always been, is Massachusetts.

An interesting area of growth for Bay Area startups has been food and ag tech. Twenty three Bay Area companies have raised $1 billion here in 2020, about half the national total. They include Finless Foods, a company making seafood out of stem cells, Prime Roots, which makes protein-based plant foods, and Trace Genomics, which is porting the success of human gene sequencing to agriculture to help farmers increase their production yields. And the emerging industry’s best known company, Impossible Foods, is staying put as far as we know.

Innovative Thinking Requires a lot of Bad Ideas

Some of the food tech ideas might seem odd or simply bad to you. But you can’t have innovations and new ideas without a lot of bad ideas, or ideas that seem unworkable to an average person. When Genentech said it would make insulin by growing DNA in bacteria, instead of extracting it from pigs, it was seen as impossible or ridiculous by big pharma. When it said it could make human growth hormone, but that the drug would have to be injected, and not taken as a pill, conventional wisdom was that no consumer would go for that. When Apple and Xerox developed graphic interfaces, it was thought that no business would ever use them. Same for Salesforce’s idea to deliver corporate software over the Internet. Self-driving cars and synthetic proteins might be the graphic interfaces and commercial Internet of today, but most truly innovative ideas sound a little stupid or outrageous when first proposed, and California’s strength here hasn’t slowed down.

Many of the examples I’m giving are centered on Bay Area companies. But San Diego is, and has long been, the number three U.S. region for Biotech IPOs and venture funding. This year, nearly 60 San Diego biotechs have raised close to $3 billion, more than the amount raised in any state besides California itself and Massachusetts. However, Los Angeles, while being home to Amgen, isn’t as strong in biotech as San Diego, or in traditional tech as the Bay Area.

Los Angeles doesn’t just trail the Bay Area in venture funding, its housing is even more expensive relative to wages. The value of residential real estate in the LA, Orange, Riverside, and San Bernardino Counties is $2.8 trillion according to LendingTree. However, the region generated just $109 billion in wages in the 2nd quarter of 2020 according to Census data. Home values at 26x quarterly wages are among the highest in the country. In contrast, the Bay Area’s $1.9 trillion real estate market was supported by $99 billion in quarterly wages. While this is well above the national average of 10–15x, the job market around San Francisco and San Jose is better able to support regional housing costs than LA’s job market is.

State Support for Los Angeles

LA is less dominant in film than the Bay Area is in tech. While it still leads in direct spending by the movie and filming industry at over $11 billion, Georgia has risen quickly to over $3 billion, a tenfold increase since the mid-2000s. Avengers, Black Panther, and Ozark are just some of the projects filmed there. Moreover, the state has been much more open to shooting during COVID than California has been. And even before COVID, FilmLA reported that “shoot days” for film, web series, TV, and advertising had fallen 5% annually in 2019.

California state government, not known for being business-friendly, has made a big effort to fight off other states capturing the on location filming business. It launched a $330 million tax incentive program through the California Film Commission for entertainment and advertising projects who shoot in state, and this program is cited by industry leaders as an important factor in preventing more productions from going elsewhere.

LA and Orange Counties were already experiencing their slowest growth ever before COVID. With Netflix now worth nearly as much as Disney, and with a limited number of startups to replace Toyota, Northrop Grumman, Nestlé, and other companies moving out, the region has to sell its lifestyle to sustain its economy. In addition to Google, a handful of Bay Area startups have shifted operations to Santa Monica and Venice, creating beach-side offices, and more could follow if the “exodus” out of LA pushes down housing costs and stabilizes traffic.

Insane Tax Policy vs. Insane Ideas

While California could suffer lost tax revenue if Sacramento doesn’t do more to address the wave of people and companies moving out, there’s also no other city or state emerging as a hub of innovation that can attract capital the way California companies do. Most crazy ideas don’t become businesses, but places that don’t welcome crazy ideas struggle to create innovative companies. Another state sanely welcoming successful businesses isn’t going to stop this crazy state from developing new ones.