by John McDonald, Managing Entrepreneur with NEXT Studios
For Indiana communities, new startup companies are the difference between a future of prosperity or no future at all.
In its groundbreaking report entitled, The Importance of Startups in Job Creation and Job Destruction, the Kansas City-based Ewing Marion Kauffman Foundation, a thought leader in entrepreneurship, noted:
“Put simply, this paper shows that without startups, there would be no net job growth in the US economy. This fact is true on average, but also is true for all but seven years for which the United States has data going back to 1977.”
There is a myth that it’s small business that drives the American economy. This study reveals that it’s new businesses less than five years old that create all the new job roles. The report explains that existing businesses generally create and destroy jobs at a relatively equal pace, which means that though job functions change, the number of openings doesn’t. Startups only create new roles and have no destruction function, and so they stand alone as the driver of new job creation.
Said more succinctly: no new startups, no new jobs.
Just like the fire triangle you learned about in elementary school, turning an idea into a company also requires three elements: capital (the oxygen), talent (the fuel), and place (the heat), in that order. Entrepreneurs, who play the “spark” in the metaphor, raise capital to hire people, and then they need a place to collaborate and work. Often communities start with co-working spaces and wonder why they are slow to fill, but if you begin with capital, entrepreneurs can hire great people at market rates who will then fill the working spaces.
The ready availability of capital, especially in the earliest stages of the process, is the key in the lock to new startup creation.
The need is particularly acute in underserved founder communities.
With generous support from the Lilly Endowment Inc., the Central Indiana Corporate Partnership launched the “GPS Project” with the American Enterprise Institute at the Brookings Institution to understand the challenges Indiana faces now. Their “Indiana GPS Project Key Findings and Recommendations” report from the initiative points out that Indiana’s economy is at an inflection point and there are challenges that need to be addressed with urgency and intentionality. One of the challenges highlighted is,
“Among all states, Indiana has the lowest share of employees working at new firms, as well as more older firms than young firms—a trend that runs opposite to the country as a whole.”
Tragically, Brookings discovered that Indiana is also last in the nation when it comes to the share of employees working at new firms, and that Indiana has more employer firms that are 16 years old or older than it has firms fewer than five years old — a trend that runs opposite to the country as whole.
Importantly, this disparity extends to entrepreneurism and small business startups in underserved communities – places where the traditional venture capital system has not delivered, including LGBTQ+, Latinx, Black, and women founders, rural areas, and urban areas. The report points out that while 21% of Indiana’s population are minorities, only 16% of the State’s businesses and 12% of the State’s startups (in operation less than 2 years) are owned by minorities. Of note are Black founders, who own businesses at just 15% of the rate of their overall share of Indiana’s population.
Urban areas are also problematic: while Indianapolis is the 33rd-largest Metropolitan Statistical Area in the United States, it ranks 55th in diverse business ownership, with minorities accounting for 26.2% of the region’s population but only 8.9% of business owners.
These findings are corroborated by data obtained from the US Census Quarterly Workforce Indicators as reported by the Indiana Chamber of Commerce in their Indiana Vision 2025 Report Card, which reveals that Indiana ranks 47th in America in the share of total employment in companies 0 to 5 years old, behind all of our neighboring states, Michigan (35th), Kentucky (37th), Illinois (38th) and Ohio (46th), as well as most of our peer states with similar workforce sizes, including Utah (5th), Tennessee (19th), North Carolina (28th) and Minnesota (44th).
It is critical that we directly and urgently address the challenge of the low rate of creation of new businesses in local communities across Indiana, particularly among underserved communities.
The capital needs of startups break down into four primary steps.
What are the types and sources of capital that founders need?
- Pre-seed funding which generally comes from friends and family and is used for creating a prototype of the idea,
- Seed funding which generally comes from wealthy “angel investors” and is used for gathering input from potential customers, refining the product, and building a market strategy,
- Series A funding which is often led by Indiana’s own Elevate Ventures with participation from other investors and is used to launch the product in the marketplace, and
- Series B and beyond funding which generally comes from organized venture capital funds and is used to scale up the company towards an exit.
While in Indiana we are fortunate to have Elevate Ventures who often forms the cornerstone of Series A funding activities, and there are multiple venture capital firms who like to invest in companies in our State who have advanced to scale-up stage, the challenge is in the Pre-Seed and Seed-stage funding. Specifically, angel investors who might want to invest in their local innovation economy are often unsure where to go, or what ideas and founders to bet on, and if you don’t have access to friends and family who can provide you with your first investment, many ideas die before they even start. Traditional venture funds tend to invest later in the process and in founders who have delivered for them before, which tends to lock out underserved founder communities from the process entirely and has resulted in dismal participation rates in venture capital from these communities.
Community impact funds effectively address gaps in local pre-seed and seed-stage capital availability.
Underserved founders often do not have access to wealthy friends and family who could help them launch. Having access to essential pre-seed funding provides a “center of gravity” to coalesce an emergent idea. Seeding these early stage investments are imperative, especially in smaller communities. Community Impact Funds address both issues, and possess four main features:
- Community impact funds are true venture funds. They make equity investments in startup companies, expect a return, and execute “due diligence” review of the company’s business model and financial performance on behalf of investors in the fund. This creates a discipline for the founder that prepares them well for future investors. In other words, CIFs provide a solid footing for growth for their investments.
- Community impact funds employ philanthropically donated money. Instead of regular limited partners, the source of funds are donors, such as individuals, foundations, or other grant makers. Because the funds are donated, they are completely “de-risked,” which frees the fund to make investments in first-time founders and in underserved founder communities without the common constraints of traditional venture funds.
- Community impact funds create a focus for angel investors. Instead of working to understand each individual founder or company on their own, the fund provides the due diligence and scrutiny that reduces the risk for the angel to participate and offers the opportunity to do “side car” direct investments in companies alongside the fund.
- Community impact funds are evergreen. As the money they employ is donated, if there are any returns on the investments, they are redeposited in the fund to be reinvested again and again over many generations. This creates a long-term capital base that grows over time for the benefit of the community.
There are also additional positive side effects to the local community, including attractiveness for business relocation, retention of local talent, the benefits of a thriving innovation ecosystem for local established companies, and the overall image of a community as a growing, thriving, and inclusive place.
“Cultivating entrepreneurship requires access to necessary resources—capital being at the top of that list,” said Michael Huber, President & CEO, Indy Chamber. “The Indy Chamber is appreciative of partners like NEXT Studios, who are working to ensure there is equitable access across our region.”
For all of the reasons stated above, we should all find ways to support entrepreneurs. Each and every effort helps build a stronger sense of place, and most importantly, creates new jobs. We are overdue to move the needle and improve our ranking. Based on the data, we have nothing but opportunity for improvement.