Washington Business Journal

Greater Washington needs a new approach to growing its technology startups. Unless we change what we are doing, the talent drain will continue, and economic activity will lag behind that of our competitors.

Ten years ago, the region’s technology economy was also at a tipping point. The enthusiasm and activity for starting tech companies had been driven by the first internet wave until it ran smack into the Great Recession. The world was rapidly running away from financial and business risk. Angel investors stopped funding startups and many people chose not to take the risk of starting new technology businesses. Meanwhile, the stability of working in federal employment, or selling to it, became compelling in comparison.

I and other members of our tech community rapidly reached consensus on two things we needed to do if the local entrepreneurial community was to stay focused on tech startups. The first was to reassure people that starting a tech company was still a risk worth taking and to advocate strongly for entrepreneurship as a positive career choice by sharing our stories and enthusiasm widely. The second was to mentor those who wanted to take the risk of starting a business by sharing our experiences to help new founders learn from our mistakes.

I helped lead two significant community groups that emerged as leaders of this movement toward mentorship and advocacy. The first was StartupAmerica, an initiative launched by Steve Case, and the second was FounderCorps, a not-for-profit I launched with a group of prominent regional entrepreneurs. Both initiatives focused on bringing experienced entrepreneurs into contact with emerging startup founders so that they could share their war stories, lessons learned and enthusiasm for the entrepreneurial journey.

In retrospect, these efforts were very successful. Many of our region’s best-known accelerators, incubators and mentorship programs were started by FounderCorps members and StartupAmerica leaders, including StartupVA/DC/MD, 1776, iCorps, TandemNSI and Connectpreneur. We were also able to influence various governments, as some of us worked directly in federal and state government in leadership roles. Today, of the more than 120 accelerators and incubators in our region, many have FounderCorps and StartupAmerica alumni providing active mentorship.

The positive results of these initiatives show that when our region’s experienced entrepreneurs work together we can make a difference to our tech ecosystem. By acting in concert 10 years ago, we helped ensure that our region remained committed to tech startup entrepreneurship and people continued to take the risk of starting tech businesses. As the broader economy recovered, the tech startup ecosystem we supported was still around to benefit from renewed access to risk capital and the greater risk tolerance of potential employees.

Today, we face new problems that threaten our tech ecosystem.

The first is that our collective focus on startup mentorship was so effective that we have helped to create an oversupply of places where startups can be formed, but the regional venture capital market has not grown at the same rate. This isn’t just a risk capital problem; it’s also an expertise problem. The lack of venture capital means that fewer companies get to benefit from the focused business scaling expertise that venture investors bring along with their funding.

The second problem is our region’s technology entrepreneur community has become far too reliant on the delivery of technology through consulting or build to suit, rather than the creation of technology products. Because many entrepreneurs took our enthusiasm and advocacy to heart and stayed in the game by selling to the federal government, the government’s technology purchasing practices and preferences shaped many of our region’s technology businesses and drew them away from the commercial market and product creation.

Both problems have resulted in other regions of the United States developing better ecosystems for creating commercial technology product companies. Venture capital prefers to scale product companies, and commercial customers prefer to buy products. This means that entrepreneurs who wish to build product companies move elsewhere, where there is funding and product company talent, and many of our entrepreneurs that do stay have a harder time building a team and scaling their businesses.

We are at a crossroads that can’t be solved through enthusiasm and advocacy. Although mentorship is enormously valuable for episodic advice, we need to create an ecosystem that will fill the void in scaling expertise created by a lack of venture capital through the creation of focused skill development. It’s no longer enough to make people excited; we must teach them how to develop commercial products.

As I did 10 years ago, I’m now talking with other experienced entrepreneurs and hatching a plan. Watch this space and get ready to help.

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Last week, an essay in a The Washington Post Magazine got my attention by asking an interesting question: Has Greater Washington become too cool to be the nation’s capital?

The essay used “cool” to describe a city with great apartments, trendy bars and modern condos that attracts and retains young talented workers but, in the process, replaces unglamorous but needed local businesses and changes neighborhoods. The essay argued that by working in a cool place our national government policy makers and workers are unable to empathize with Americans who don’t live in cool places and vice versa.

The essay suggests redistributing government workers across the country as a solution to the perceived “coolness problem.” I agree that our government should be more responsive to its citizens, but the suggestion that the solution is to deprive our local economy of one of its economic advantages is not something that I can accept. Let me explain why.

That solution — a legislated step toward equalizing regional incomes by distributing government spending around the nation — shows how this is really a conversation about economic development, focusing on how a region approaches issues of opportunity and fairness. The reality is that market forces determine whether a region becomes cool and how long its cool factor lasts. In a market-based economy, once people satisfy their basic requirements, those with discretionary income spend it on things that they enjoy. If a region creates high-paying jobs that attract highly educated knowledge workers, communities necessarily change to satisfy their tastes and expectations. Their higher salaries do drive housing costs upward and change the composition of neighborhoods. By competing for workers on a national scale, we do create the conditions for coolness and displacement to occur.

Speaking specifically about our region, let’s be clear that there are many likely reasons why the national government is becoming less connected with its citizens. I hear many more experts blame the Supreme Court’s decision in Citizens United and the weakening of our party system for giving a small number of wealthy families disproportionate influence on politics than those that blame gentrification. I also hear often that gerrymandering gives rise to political extremism, since candidates no longer worry about the general election, where they would have to appeal to a broad range of voters.

Nevertheless, we must acknowledge that coolness reflects underlying economic conditions that should be identified and addressed: What role should questions of economic fairness have in a market-based economy? Should economic development be based on winner-take-all thinking or on a system that leaves something for others? That’s really what any conversation about coolness and gentrification is about.

This is a hard conversation to have. As tempting as it may be sometimes, winners can’t just spike the football and gloat. There must be room for acknowledgement of others. Unless the winners take the time to create a broader shared stake in our communities, they will create social instability and resentment among whoever ends up on the losing end. Anyone who cares about the benefits of a market-based economy should be paying close attention to this. It’s great to be cool, but it’s smart to also be kind.

Distributing the federal government around the nation into smaller pockets won’t make it any more responsive to its people. Let’s be clear. The issue of coolness is not limited to our region, nor will it disappear in any place where there are market-based determinations of how resources and opportunities are allocated. Instead of running from the problem, let’s meet it head on.

Years ago, D.C. was established with a belief that it should be a different place — an exemplar for the nation of how to grow and manage a capital city. This is just as true today.

Creating connections and balancing cool with the commonplace is a goal that every region of the country should have, whether it’s the nation’s political capital or not. But here in our region we have a unique opportunity, because we are the nation’s capital, to provide leadership and an example of how you can be cool and kind.

It’s not our region’s proximity to the national government that makes this important. It’s our responsibility as citizens.

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Maryland recently enacted two new cybersecurity industry tax credits — good news for Maryland’s cybersecurity industry and also an example of how a business-oriented group can turn advocacy into results.

The first tax credit will promote investment in Maryland’s cybersecurity product companies by providing a credit for individuals and entities that invest at least $25,000 in those businesses. The second tax credit encourages small businesses to purchase cybersecurity products or services from Maryland-based businesses, by giving them a tax credit equal to 50 percent of qualified spending. The aggregate amount of the tax credits available for both purposes is $10 million over the next two years.

If you have been paying attention to diverse groups such as The 2030 Group, the Montgomery County Economic Development Corp. and TEDCO, you know that each has been advocating for greater investment in building cybersecurity product companies and encouraging regional businesses to buy local when purchasing technology. They and others have also often pointed out that small businesses are actually the most at risk for cyberattacks, since they often do not have the resources to purchase cybersecurity technologies. Based on this, it shouldn’t be surprising to learn that the creation and promotion of these tax credits results at least in part from strong business community engagement.

Somewhat surprisingly, the Cybersecurity Association of Maryland Inc. led the charge on this legislation. I’ve always found CAMI interesting. It is a not-for-profit that was formed by Art Jacoby to promote the growth of Maryland’s cybersecurity industry. Art formed the group because he saw a need for it; he was an entrepreneur who saw a market need that needed to be filled. CAMI wasn’t formed as a legislative advocacy group. Its mission was to show which companies were growing in Maryland’s cybersecurity industry via its on-line directory of cybersecurity companies and to create opportunities for these companies through business connection events. CAMI’s leadership took a small budget, and, like many entrepreneurs I know, bootstrapped CAMI’s way to relevance.

Talking with Executive Director Stacey Smith, I learned that CAMI had looked at the Maryland cybersecurity legislative landscape and decided to take an entrepreneurial risk. Legislation that would have accomplished many of the objectives of the recently adopted tax credits had languished during last year’s legislative session. Rather than wait for others to advocate for these credits, CAMI decided to take the financial risk of hiring a legislative expert and jumping into the legislative process. CAMI went from connecting members of the cybersecurity industry with one another to connecting these members with legislators.

As is often the case when members of the business community start to speak with a single voice, policy makers paid attention. For example, Guy Guzzone, a Maryland state senator from Howard County, shared with me that CAMI’s engagement in the legislative process was a “very significant” reason why the cybersecurity industry tax credits were adopted on a bipartisan basis.

Smith had worked in the Maryland government before taking on the leadership of CAMI. She sees the tax-credit process as a template for how the region can grow more rapidly. Because cybersecurity is a very fast-moving industry, government policy makers often cannot move quickly enough to keep up.

“What works best is to have a partnership of collaboration between the public and private sector, with the public sector providing some of the resources and connections needed by the private sector while seeking insight from the private sector and relying on the private sector to execute on the plan,” she says.

I see in CAMI’s actions a successful model for how to combine entrepreneurial energy and engagement with the government to achieve a business community objective. It’s another example of how the region’s business leaders can accomplish meaningful changes when they work together.

It also provides an additional lesson of broader application. The overall financial amount of the tax credits — $10 million – is a far smaller amount than dollars made available to attract large businesses. It will be interesting to see over the next two years how many Maryland cybersecurity businesses will benefit from these tax credits. My suspicion is that the number will be significant. There’s no better way than finding new customers to help a business grow – getting financial assistance to find them is a big deal.

Although policymakers will often focus on hunting elephants – searching for the next large company to locate in their jurisdiction – the best solutions are often found in helping the businesses that are already there. Asking them what they need and finding ways to promote their growth is just as important as elephant hunting, if not more so. And it’s usually easier and cheaper to accomplish.

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What does it take to be a founder of a cybersecurity startup in the Greater Washington region? Prior experience, according to a new study from American University’s Kogod School of Business.

Professor Erran Carmel led a team at Kogod’s Center for Business in the Capital that looked at the founding teams of 177 pure-play cybersecurity companies – businesses that operated exclusively in cybersecurity. A previous study that Carmel and I had done showed that our region had more than 850 cybersecurity companies, which was important and useful information. But as Carmel put it, “I thought there was something missing. We knew how many companies were engaged in cybersecurity, but we didn’t know who was starting them. I thought by focusing on pure-play companies, I would get a clearer picture of where our cybersecurity company founders come from.”

His report has some eye-opening observations. Almost three-quarters of these firms had at least one founder with prior experience either as a vendor to the national security establishment or as a government employee working in that area. More than half had a founder with government service in their background. This struck me as an important confirmation of what many had sensed – that our local cybersecurity industry is tied closely to the national security sector.

Another significant finding was about the level of prior experience of the sampled cybersecurity founders. Almost nine out of 10 founders had prior cybersecurity experience. Unlike some other technology sectors where founders could have more varied experiences, there appears to be a close connection between developing hard technical skills in the cybersecurity domain and business formation. If this is true, then cybersecurity is clearly not an area where you can wing it.

Carmel’s other findings should also encourage policymakers. Almost eight in 10 founders were residents in the Greater Washington region prior to starting their most recent firm. Moreover, more than a quarter were serial entrepreneurs, which means that experienced individuals are staying in the region to start new companies. Generally, a technology community’s effectiveness is evaluated by how well it does at retaining entrepreneurial talent. This makes Carmel’s latest report good news for the region.

What concerns me, however, is how the new data reinforces a troubling conclusion from our earlier work together. Greater Washington’s cybersecurity industry is far too dependent on delivering its technology as part of consulting engagements. Previously, we had shown that only 5 percent of all cybersecurity companies in the region were product-oriented, with the vast majority delivering technology as a service. Even when Carmel focused on pure-play cybersecurity businesses for his recent study, the percentage was still low: only 10 percent.

I shared these findings with a number of our region’s leading cybersecurity entrepreneurs and investors to get their reactions.

No one was surprised by the prior experience point, although a few were surprised the percentage was so high. Venture investor Stephen Smoot of Lavrock spoke for the group when he observed “entrepreneurs obviously lean on their prior experience when starting a company. Given that the majority of cyber talent in this region cuts its teeth in and around government customers, I’m not surprised.”

The bigger area of concern was the lack of product companies. Some, like Anup Ghosh, the founder of Invincea, a commercially successful cybersecurity product company, put the blame squarely on a shortage of venture capital, pointing out that “product oriented companies typically require more startup capital,” making access to capital a key challenge for entrepreneurs in the region. Kevin DeSanto, co-founder of Kipps DeSanto and a merger and acquisition expert in cybersecurity, thinks that the lack of capital properly leads entrepreneurs go grow service businesses, since customer revenue from the government is where they find the money to grow in the absence of risk capital.

Work like Carmel’s gets us closer to understanding our region’s innovation ecosystem and being better able to diagnose our challenges and to see opportunities. With respect to new company creation, we are fortunate to be proximate to the national security establishment because it is a tremendous developer of cybersecurity talent and a key customer. Our efforts to grow new companies should reflect that this is not an industry for the inexperienced, but one that rewards proven competence and expertise. It is also an industry that remains heavily reliant on less profitable business models.

As we consider how to grow our technology economy, this most recent data reinforce that if we focus on experienced cybersecurity technologists and giving them the support they need to grow product-oriented businesses, we can accelerate regional economic growth.

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When it comes to growing our region, what should our business community work on next? This is a question I am asked more and more frequently when I talk with regional business leaders. It reflects the beginning of a significant change in how our business community sees itself, and I think that’s a big deal.

Over the last few years, I have not been alone in voicing my concern about how siloed our business community has been. We identify ourselves first by where we live or work: “I founded a Northern Virginia business” for example. Or we describe ourselves by our industry: “I’m biotech entrepreneur.” When we network with other business leaders, we tend to do it in venues that are tied to either our industry or our geography.

Tribalism is nothing new. But tribalism prevents people from seeing the vibrant, larger world around them. Software entrepreneurs based in Northern Virginia often have no sense of the depth and success of the biotechnology industry in Montgomery County. Consumer-focused software founders in D.C. see their entrepreneurial drive as being different from that of an owner of a successful public relations business or construction company.

Similarly, I’ve seen regional organizations create closed communities that serve their members but also tend to obscure the activities of other groups and businesses that are not members. Often organizations hold similar events on the same day, and participants have no idea that there is a similar event across the river or down the street. Recently, a friend in the business community looked at all of our region’s events focused on blockchain and grumbled that it was impossible to choose which one to go to meet the best-informed people when they were spread out across so many events.

But times are changing. Two recent events highlighted the broad scope of the region’s business community and what it can accomplish when it focuses its energy.  Key business leaders and business owners learned how their common interests transcend jurisdictional boundaries and tribalism.

The first event is the very visible MetroNow Coalition. Sharing a crumbling Metro system brought business leaders and the regional organizations that connect them into a common enterprise that cut across jurisdictional and industry identification. The people involved saw firsthand how effective their collective effort was in convincing our elected officials that Metro needed stable funding. The MetroNow experience also showed the leaders of jurisdiction-focused organizations that they can serve their members by embracing regionally coordinated challenges. Most importantly, it showed the business community it can come together and provide leadership and demand accountability from politicians and economic development officials.

A less visible but equally important undertaking has been the region’s efforts to attract Amazon HQ2. What is visible is the competition between our region’s jurisdictions to attract HQ2 through incentives and benefits. What has been less visible is how engaged many of our business leaders have been in working with our region’s politicians to ensure that the many positive attributes in our region were identified and described in similar ways across the competing efforts. Our business leaders spoke clearly that our politicians and economic development officials should sell the region first. While none of us know whether Amazon will locate HQ2 in our region and where it will if it does, these efforts ensured that the comprehensive strengths of our region were on full display.

In both instances, the business community came together to provide leadership on issues that mattered to it.  In doing so, the participants learned two key lessons. First, when the business community expresses itself collectively, our elected representatives will listen. Second, in telling the story of our region’s many positive attributes to Amazon, silos separating business people were broken down as a large cross section of business leaders developed a comprehensive picture of the diversity and depth of our region’s business economy.

When I speak with our region’s business leaders I am finding more and more often an underlying sense of shared opportunity because of these two lessons. What they are really asking is not “What’s next?” but “What can we do together?”

As our business communities’ members move away from seeing only the silos in front of them to trusting in cooperative effort, there is enormous promise for all of us.

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Business leaders say the metro area has a stronger track record of innovation than Atlanta, Austin, New York City, Boston, Miami and Raleigh, according to a survey of 185 local executives. The online nonpartisan survey of Greater Washington business leaders was a joint initiative of the Washington Business Journal and Cherry Bekaert LLP CPA & Advisors. Brand consultant McGinn and Co. and market research company REPASS conducted the survey.

The takeaway? Greater Washington businesses are not suffering from a lack of innovation-inspired self-esteem, generally giving themselves and the region high marks.

Forty-nine percent of survey respondents gave their organizations a “B” grade when it came to innovation activities. Companies with a formal innovation process tended to give themselves higher marks.

One quarter gave their own organizations an “A” grade, 22 percent a “C” and just 4 percent gave their organizations a “D” or lower.

The survey also found that:

• On average, nearly 20 percent of survey respondents’ companies were allocated to innovation. Firms with less than $100 million in revenue are less likely to allocate funds toward innovation while firms with $100 million in revenue or more allocate between 1 and 9 percent.

• About 46 percent of those surveyed said their organizations had a formal innovation process, while 47 percent said they did not. Public companies with $500 million or more in revenue are the most likely to have a formal innovation process, according to the survey.

• The person most likely dedicated to driving the innovation process is the CEO, with the chief information or technology officer a distant second.

Venture capitalist and innovation consultant Jonathan Aberman, managing partner of Amplifier Ventures LLC, said it is important for companies and organizations – especially large ones – to put into place formal innovation processes — or risk losing their competitive edge.

But the innovation process requires a conscious effort by the company to attract the creative workforce needed and buy-in from senior management to truly create ways to spur innovation.

“In order to encourage innovation you have to create a culture that rewards individual behavior around the concept of creativity,” Aberman said. “In order to do that you have to have a compensation structure, an information technology structure and a real estate structure and training structure that is in place to reward those kinds of behaviors.”

Companies can create “innovation centers” within the company — such as Booz Allen Hamilton’s Innovation Center in the District — or train employees in creativity and innovation and disburse them throughout the company, according to Aberman.

Smaller companies are less likely to have a formal innovation process because they must by their very nature be innovative in order to grow and beat out the larger competition – or else they fold, Aberman said.

Companies also incentivize innovation with company recognition, according to 62 percent of survey respondents. Another 41 percent (they could answer more than one) said financial rewards were also used to help spur innovation. About 20 percent of respondents said they provided no innovation incentives.

And the biggest barriers to innovation include the government, with 33 percent of survey respondents, too many regulations or policies being a close second with 30 percent, and politics coming in a distant third with 16 percent.

“In order to encourage innovation you have to create a culture that rewards individual behavior around the concept of creativity,” Aberman said. “In order to do that you have to have a compensation structure, an information technology structure and a real estate structure and training structure that is in place to reward those kinds of behaviors.”

More at WashingtonBusinessJournal.com.

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I am currently working with Washington Business Journal on video interviews with leading Washington executives. Along with Executive Producer Tracey Madigan, I spent the summer conducting the interviews as an offshoot of my research for The 2030 Group, the organization of local business leaders working to shore up Greater Washington’s economic future. You can catch the first Profiles in Innovation video, with Honest Tea’s Seth Goldman discussing what makes D.C. an “ideas region,” above, and watch for the next installment featuring TrackMaven CEO Allen Gannett coming next week.

Watch now: Interview with Seth Goldman of Honest Tea.

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The local entrepreneurs who landed an investment from billionaire Mark Cubanon ABC’s “Shark Tank” for their fitness app Sworkit didn’t end up closing the deal — agreeing to disagree on several deal points, including how to value the startup.

Ben Young, CEO of parent company Nexercise Inc., and Greg Coleman, its president and chief operating officer, garnered attention in February for securing what they called the biggest tech deal in the show’s history. Cuban, the owner of the NBA’s Dallas Mavericks and chairman of AXS TV, would invest $1.5 million in return for 10 percent of the business, plus $1.5 million worth of unsold ad inventory on the app.

Read entire article at Washington Business Journal’s website.

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Greater Washington builds great startups – we just can’t keep them here.

Over the past 20 years, 105 D.C. area startups were sold for more than $1 billion, but only 16 of those deals kept the businesses in the region, according to a new report examining innovation in the D.C. area. And out of 6,000 business sales over the last 20 years, about 75 percent were to out-of-region purchasers.

Recent examples include the $1.65 billion purchase of Cvent Inc. by San Fransisco-based private equity firm Vista Equity Partners and the $532 million purchase of Opower Inc. by California-based Oracle Corp.

And when these companies are bought, it’s common for the acquirers to shift those workforces to other cities. More importantly, the executives and leaders who are able to start new companies often go with them, leading to the loss of top talent for the region.

So can the region create the entrepreneurial, innovative businesses it needs to spur growth? The short answer is yes, but the longer answer requires the business community to get involved by prioritizing local acquisitions, forming a new innovation entity and focusing on cutting-edge research to stay ahead of…

Read entire news article at WashingtonBusinessJournal.com.

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Vista Equity Partners is betting big on Cvent Inc. — and the California private equity firm looks to be in it for the long term as it takes the event management software company private.

One thing is for sure: Vista is paying a high price for the Tysons company, according to Michael Faulkender, an associate finance professor at the University of Maryland. The nearly 70 percent premium is about twice as much as the 30 to 40 percent premium on share price he would expect in a deal like this.

That means the private equity group sees a financial upside much higher than the $36 per share it offered. It also means that existing shareholders were not eager to sell, which is why the offer is so much higher than the $21 per share the company had been trading at for the last several weeks.

Vista and Cvent can only realize that gain by taking the company private, freeing the company from the short-term interests and share prices that can prevent long-term investment.

“The private equity investors are not idiots,” Faulkender said. “The only way this is rational for them is that they think by taking it private and getting it focused they can get some big long-term gains.”

The purchase was the end result of an unsolicited offer for Cvent that triggered a bidding war, CEO Reggie Aggarwal told me. He said the company reviewed the multiple offers and picked the best one for shareholders that would allow the company to continue investing in the future. The ultimate purchase price of $1.65 billion is more than eight times revenue, putting it near the top for technology companies.

“They paid such a high premium it was difficult to say no,” Aggarwal said.

While he declined to say what the strategy would be when the company goes private — since the deal must still be approved by the shareholders — he said Cvent has made it clear it wants to grow organically and through acquisitions whenever possible and that Vista Equity Partners has “deep pockets” for additional purchases.

“We are going to be growing and acquiring companies and there is no reason to think that will change,” Aggarwal said.

When newly private, Cvent will be able to ditch the quarterly earnings reports that make it more difficult to balance the short-term gains many stock traders want with the long-term gains that private investors desires.

Jonathan Aberman, the managing director of Amplifier Ventures, a seed and early-stage venture capital fund based in McLean, said strategic pivots can be difficult — if not impossible — when a company has to appease shareholders.

“When you are a public company you pretty much have to manage yourself quarter to quarter,” Aberman said. “There aren’t a lot of long-term investors in the markets anymore.”

Read entire news story at WashingtonBusinessJournal.

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