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January 21, 2021

DATA: Post-Pandemic Silicon Valley Isn’t A Place

By: Kim-Mai Cutler

Where are tech companies going to go once the pandemic subsides as vaccines reach more and more Americans?

I wanted to provide granular data to the question of how concentrated the technology in the Bay Area will be after the pandemic. I’ve been tracking data on this question for several years internally within the Initialized Capital portfolio, both through annual founder surveys and in looking at the geographic composition of company headquarters across funds. Typically, we get around 90 companies responding per survey.

Peak Bay Area was seven years ago in 2014.

The meme right now is that the pandemic has finally kicked the Bay Area off its pedestal. Rents are down 24 percent year-over-year, according to Zumper. Local sales tax collections are also down by more than 40 percent.

But the reality for us and our portfolio is that the Bay Area’s share of companies in our portfolio has been declining for seven years.

The percentage of companies in our portfolio based in the Bay Area topped out in the 2014 fund at a little more than three-quarters. Following the 2008 financial crash, the region was both substantially cheaper and had a strong corps of technical talent. But by the mid-2010s, the stresses and pressures of the rising cost of living became widely known, it became much harder to compete against Big Tech companies on recruiting and so this trend began reversing as companies began spreading out. By 2018, fewer than half of our companies in the fund beginning that year were based in Northern California.

In the current fund starting this year, fewer than one-third of the companies thus far are based in the Bay Area. This has long-term implications for California’s top-heavy revenue structure, in which capital gains tax revenue fuels a highly volatile structure. The state’s top 1% of earners will pay for about 48 percent of California’s $106.6 billion in personal income tax revenue this coming year. This year amid a pandemic and a recession, the state will see a $15.5 billion windfall because of IPOs in the latter half of the year. But these are older vintage companies that were started around or more than a decade ago like Airbnb in 2008.

We should expect California’s share of IPO tax revenue to decline as these newer, more geographically distributed vintages of companies mature and go public. To be fair, the overall pie could grow quickly enough that California could be OK in the medium-term even as its share of venture-backed companies declines. (Or it might not.)

Before the pandemic, slightly less than 20 percent of the companies in our two more recent funds were decentralized or remote.

Starting in Fund III (2016), we started to see a meaningful percentage of our companies go remote with no centralized office. By February of last year — a month before the pandemic — a little less than one-fifth of the companies in our two more recent funds were fully decentralized.

Post-pandemic, we expect to see the remote or decentralized share to nearly double to 36%.

We just ran our annual portfolio survey again and gave three options to founders for how they plan to return-to-work after the pandemic subsides:

  • Return primarily to a single office (e.g. executives are generally co-located in the same physical office but the company still might have some remote employees or allow more work-from-home days)
  • Use a hub-and-spoke strategy with multiple smaller offices across a number of geographies
  • Go fully decentralized or remote with little to no office usage

Two-thirds of our portfolio companies will still use an office, but we’ll see a huge step change pre- and post-pandemic, with more than one-third of companies moving to a fully remote or decentralized model.

Post-pandemic, the Bay Area will be the second leading technology hub after the cloud.

Pre-pandemic, the Bay Area was still the leading choice for our founders in terms of where to start a company. There were many other cities that were distant seconds or thirds including New York and Seattle.

Post-pandemic is a different story. More than 40 percent of founders say that the best place to start a company will be in the cloud. We expect to see decentralized or remote companies displace venture-backed companies based in the Bay Area over time.

That said, there’s a lot of media coverage about singular cities like Austin or Miami displacing the Bay Area and I am generally skeptical of that because it:

  • Assumes a more centralized office model, albeit in cities outside the Bay Area, and we suspect that employee pressure for remote work will probably drive companies towards allowing for more distributed structures. So even if a company technically moves its headquarters to a different city, it’s unclear how many actual jobs physically located in that headquarters city the company will attract if the industry continues to embrace a more remote structure.
  • I’ve also seen a lot of praise of Mayor Francis Suarez for actively courting entrepreneurs to move to Miami.
    • But the technology industry has a short memory span and people forget that the late Mayor Ed Lee essentially did the same thing, by routinely speaking on-stage with then SV Angel’s Ron Conway and actively recruiting companies to move north from Silicon Valley’s historical base on the peninsula ten years ago. He even literally changed San Francisco’s entire business tax structure in order to do so.
    • Even if you have one favorable politician now, it doesn’t mean you’ll have favorable politicians three or four years from now — especially if you don’t take the time to support a strong downballot bench of future leadership. There is almost a Newtonian law of politics in the sense that every force creates an equal or opposite force and if the technology industry moves into a city and doesn’t deliver a better quality of life for the average voter or constituent, a backlash and organized political opposition will emerge. This is what happened in San Francisco over the course of a decade and over time, I wouldn’t be surprised if the same thing happened in other cities, especially in Austin, which already has an active anti-gentrification political coalition.
    • The City of Miami has a weak mayor system and the powerful position in the region’s governance structure is actually the mayor of Miami-Dade County, Daniella Levine Cava, not the mayor of the City of Miami. The City of Miami’s operating budget at $1.1 billion, is far closer to that of Palo Alto’s ($820 million), than it is to San Francisco’s. So people praising Suarez — and good for him for diversifying his city’s economy — do not understand the political structure of the region and where power really resides.

For companies with physical offices, two or three-day office work weeks will become the norm.

For the two-thirds of companies that will continue to use office space, the baseline expectations on working from home vs. being in the office will be a two- or three-day WFH week. We don’t know what this was before the pandemic, because we’ve never run a question on it before. But it’s safe to say that only a small minority of companies will expect employees to be in the office all five days of the workweek.

Most of our companies will not make salary adjustments based on the local cost of living.

There has been some media attention paid to how large companies like Facebook will adjust compensation downward to match local market rates. We find that most of our companies do not currently plan to make salary adjustments based on the local cost of living so this might let employees have more leverage to establish new market-clearing prices and salaries in these other metros.

All in all, if you’d like to found a company and physically be in a place with the largest concentration of entrepreneurs and technical talent you can find, the Bay Area is the leading hub and it’s substantially cheaper now with rents touching rates from a decade ago. But fully remote or distributed work is now possible at a level that’s never happened before, and so the benefits of recruiting from anywhere in the world may outweigh this.