Is anyone really surprised by Amazon’s announcement that it will build its new headquarters in two large, affluent East Coast metropolitan areas? Amazon’s decision is yet another data point in the increasing concentration of wealth in big multinational companies and large urban centers. Meanwhile, in smaller cities and middle-income regions across the globe, even the best ideas and most promising new businesses can die on the vine for lack of access to markets and capital. Those regions need new forms of innovation financing to prosper in an age of globalized commerce. With the right funding, many communities across the U.S. can — and should — build their own locally-sourced innovation economies. A new type of financial instrument, local innovation bonds, would establish a pool of debt financing for tech startups that stay locally owned and managed as they grow.

The rise in regional disparities of economic growth and opportunity is well documented. While coastal corridors thrive, heartland economies are suffering some of the worst declines in employment, wages, and productivity in modern times. Tax preferences and other government subsidies designed to spur growth in these regions have mostly failed, and the “opportunity zones” created by the 2017 tax overhaul will likely follow suit. Such programs typically have no provisions to encourage investment in the new companies and small businesses that support vital communities.

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Some Silicon Valley investors are seeking to redress the imbalance with new venture funds, such Steve Case’s Rise of the Rest and those of Drive Capital. But for regional economies, venture capital is part of the problem, not the solutionVenture capitalists invest in equity, so they look for startups that have big and fast exit potential: those that will be acquired or go public at high valuation within a few years of initial funding (the so-called unicorns). With their focus on exits, VCs tend to ignore perfectly viable but not-so-disruptive tech startups — in other words, most of them!

Faced with these pressures, many entrepreneurs are rebelling against the VC model. But it’s important to note that, even if local business owners could get venture funding, their communities would still lose out. The equity held by out-of-town investors means that much of the value created by new companies gets shunted elsewhere.

It doesn’t have to be this way. Not-so-disruptive tech startups are the very companies that can anchor growth in local economies. They may need a longer runway to succeed, and they may generate more modest returns for their investors. But they also have lower capital requirements, lower risk, and faster time to proof-of-concept and sales than the high-risk unicorns. And many “left-behind” regions actually have all the ingredients necessary to help these companies thrive: the wealth, the talent, and the demand. What’s missing is a unifying financial structure that would bring those resources together to promote the general prosperity of the region.

St. Louis is a case in point. Once a jewel of the American frontier, its fortunes and population have declined greatly in the post-industrial economy. Yet with its universities and hospitals, it’s got plenty of brainpower. During a recent trip there for a speaking engagement, I met with a half-dozen young entrepreneurs who had good ideas and sound business plans, mostly hatched in local university labs. One, for example, had developed a new kind of air filter for a local hospital, projected to generate $10 million annually in sales and licensing. That company already had a working prototype and a customer in the community and was at most nine months from product. It didn’t need to spend tens of millions of dollars on R&D or customer acquisition, but it did need a few hundred thousand dollars more to fund the last phase of development. And it was struggling to find even that amount of funding.

That sort of opportunity would not attract a venture capitalist, but it is amenable to certain kinds of bond investment structures. And bond investors exist at close range. Aging industrial cities like St. Louis typically host foundations and family offices run by descendants of the merchants and tycoons who built them. Family offices currently hold as much as $4 trillion in assets worldwide and are increasingly seeking out alternative investment options.

Most of these families already commit a portion of their wealth to their local communities through bequests and endowments. When it comes to investments, they aren’t looking for risky bets and huge payouts; they just want to clip a coupon every year and collect seven cents on the dollar. A cut of the $10 million in sales from a local air-filtration company would be just right for those kinds of investors. They’d welcome the chance to finance innovative startups in their home towns if the risk of that investment could be contained.

I’m proposing a new financial instrument called Local Innovation Bonds (LIBs) to connect these risk-averse local investors with cash-starved local entrepreneurs. The bonds would be de-risked by creating a diversified fund and by local and regional governments’ guaranteeing returns for the first few years. Companies would pay back LIB loans with a percentage of the revenues their new products generate, so they wouldn’t face a crushing burden of debt before showing any income. My preliminary analysisshows that, even without the guarantees, LIBs would offer a competitive rate of return for debt investors — whose pool of capital, by the way, far exceeds that of the VCs and other equity investors of the world.

In contrast to out-of-town equity deals, local debt financing helps keep value within the community and local entrepreneurs in charge. LIBs would be a good deal for regional governments, too, because securing this kind of investment is more cost-effective (and less controversial) than tax incentives designed to attract outside businesses that are already booming. This kind of fund won’t produce another Google or Amazon, and it won’t work for every struggling community or area. But it’s a good fit for the many small- and mid-sized cities across the globe, built by industrial or agricultural prosperity, that still have strong brain-belt credentials: from León, Mexico to Turku, Finland to Cheongju, South Korea.

I’ve given this issue a lot of thought over the years, because I’ve had a lot of exposure to it. I helped found a global invention company, and I now run a company that specializes in innovation networks, so I meet people with new ideas in all kinds of places. I’ve also had countless conversations with regional planners and investors around the world who are looking for a foothold in tech. Usually these folks assume that the funding, the talent, or the investment opportunity must come from far beyond the borders of their own communities. But often, the solution is literally right around the corner. With so many nations rocked by populism and division, strong regional economies are more important than ever.

Source: One Way to Finance Tech Startups Outside of Superstar Cities