Embracing the State of the Union theme, RIoT Executive Director Tom Snyder discussed the economy and jobs, domestic and foreign affairs and North Carolina’s opportunities and threats. This is a transcript of that address.
2023 saw a lot of the trends from 2021 and 2022 continue to linger, entrench and escalate. Labor continued to be adversarial with industry, as we saw major automotive, entertainment and retail sector strikes and increased unionization. Interest rates drove consumer prices upward at multiples above the interest rate itself and the cost of capital dramatically slowed venture investment. War and instability continue in Ukraine and the Middle East with no end in sight. And the federal government continued to announce and deploy major new domestic investments.
Expect all of these to continue in 2024, but through the amplified megaphone of an election cycle where politics and bluster have completely overshadowed reasoned policy debate, recognition of facts and common sense.
Steering away from bombast and hyperbole, let’s dig into facts and data about how the North Carolina economy is performing; what technology, business and entrepreneurship trends we are seeing locally; and how we measure up compared to other regions.
Labor and Jobs
The US Census Bureau reports that North Carolina saw an increase of new business applications of 6.5% in 2023 compared to 2022. 88% of those are businesses “anticipated to create jobs” as opposed to single person companies, like consultants. The growth is good news and continues a strong trend that began in 2021. Of note however, NC growth lags the US average of 7.4%. Compared to our immediate neighbors, Tennessee sees faster new business growth (8.2% application growth) and Virginia much slower (2.7%). South Carolina saw a 2.2% year over year reduction as its economy slows.
New companies are great, but jobs are more important, and filling jobs requires talent growth and attraction. Lightcast ranks North Carolina #8 nationally for employment growth in 2023, though the exact new job total has not been published. That is up from #10 in 2022 where we saw 812k new jobs across the state. More locally, Wake County is the #12th strongest large county (>100k population) in the US for talent attraction. Travis County, TX, home to Austin, is #1.
What does this all mean? For the second year in a row, CNBC ranks North Carolina as the #1 state to do business. Yesterday I wrote about Virginia, who ranks #2. [You can read about that at WRAL TechWire here].
One key reason North Carolina ranks so highly is the tax environment. NC continues to reduce income tax, which is appealing to residents. Corporate taxes are even more appealing. The current 2.5% corporate tax rate is already the 5th lowest in the US and legislation passed in 2021 indexes a decline in corporate tax rate to zero by 2030. Further, NC is a right to work state, meaning that our laws and regulations heavily favor business freedom to hire and fire employees at will, creating a weak environment for unions and labor.
I expect these policies to reap benefits for the foreseeable future, and to provide a strong near-term competitive advantage for North Carolina to compete on the national stage. Essentially, as long as North Carolina continues to significantly grow jobs, it can overcome the reduced tax rate. But when viewed through a long lens, the policy is not sustainable. Eventually, when growth slows, the state is at significant risk to be financially unable to maintain services and infrastructure. Government’s role is to think in terms of decades and our policies are currently optimized for the next few years.
Technology & Research
The most recent numbers published in the NC Department of Commerce’s NC Innovation Index report are from 2021 and show that 75% of all R&D spending in the state is conducted by industry. Overall NC spends 2.7% of total GDP on research and development. This is slightly below the US average (2.9%) but ahead of Virginia’s 2.1%. We spend significantly less than states that have a global reputation for technology advancement. California, Washington and Massachusetts all spend between 5.5 and 6.2% of GDP on R&D activities.
The good news is that North Carolina has had a number of recent, high profile wins to establish research and manufacturing infrastructure in advanced technology. In late 2022, the North Carolina Biotechnology Center was awarded an EDA Build Back Better (BBB) award, bringing $25M to expand life sciences and biopharmaceutical manufacturing workforce. The Department of Defense recently awarded NC State $39.8M to advance research on wide bandgap semiconductor materials, which enable advances in high power electronics, radio frequency communications and laser technology. Just last month, the National Science Foundation made North Carolina the only state to win two NSF Engine projects, each up to $160M in value. One focuses on advanced textiles and the other on regenerative medicine.
North Carolina is clearly punching above its weight. BBB was 1 of 20 in the US, The DoD project was 1 of 8 funded by the CHIPS Act and NSF Engines represents 2 of only 10 projects awarded across the US. That sums to 4 huge wins for North Carolina among only 38 project awards, equal to a 10.5% success rate.
Why the success? I believe it is a combination of factors. First is the long commitment to funding for Tier 1 research universities. North Carolina is 5th in the nation in academic spending on R&D proportional to state GDP. We spend 49% more than the national average.
Second, we have a strong history of industry collaboration with university research. As an example, for a portion of the last decade, NC State was the only university in the nation to have two National Science Foundation Engineering Research Centers at the same time. Time and again, we see extremely large collaborations come together between university researchers and consortia of industry partners. We also have several nonprofit and B-corp organizations with more than a decade of proven industry convening and collaboration leadership. The Research Triangle Cleantech Cluster (utilities, cleantech), RIoT (technology), All Things Open (open source software) and Digital Health Institute for Transformation (healthcare), are a few local examples.
We have an extremely diverse economy, coupled to a strong university system. Most of the competing technology hubs in the US are far less diverse. If you look at Boston, for example, the tech space is highly focused on medical and robotics. Houston is almost all medical and energy. Seattle is absolutely dominated by software and cloud services.
The Research Triangle has significantly more breadth, concentrated into a single region. This is hugely beneficial, and is long-term strategic. In the same way that investors guide clients to have a diverse investment portfolio, recognizing that at some times, one type of investment will outperform another, but that the market is always dynamic and changing, it is also good for a region to not be overbalanced towards a single industry.
In the Triangle, we regularly see people job-hopping between industries, bringing diverse experiences and viewpoints that spark new ideas. When industries become siloed, with no new ideas coming in, they focus on winning markets through cost-cutting and efficiency measures, rather than through continuous new value creation and innovation. Diversity is one of our region’s super-powers and will serve us well for a long time. With significant inbound migration from other regions of the US (California and the Northeast in particular), we see our diversity increasing at a really healthy rate.
Here are a few examples of significant industry collaborations in our area:
- NCBiotech supports life-sciences industry growth, reporting that NC has seen an average of 13% annual employment growth from 2018-2021 compared to a 5% US average.
- The Research Triangle Cleantech Cluster supports ~1,900 clean technology companies that contribute $4.9B to the regional economy.
The FREEDM Systems Center and Power America bring together dozens of industry leaders in developing solid state electronics for energy grid innovation and resilience.
- RIoT remains the largest Internet of Things and Data Economy consortium in the US, supporting startup growth accounting for more than 1000 new jobs since 2014.
- The ASSIST Center creates body-worn and body-powered electronics for healthcare monitoring, along with a consortium of industry partners.
Beyond some of the formal groups and consortia above, this region is also extremely strong for agriculture (#1 industry in the state), banking (Charlotte ranks #2 for finance behind NY and ahead of SF), AI and Machine Learning (IBM and SAS are both in the top 4 analytics companies globally and headquarter their analytics divisions here), Pharmaceuticals (top vaccine production state including the largest flu vaccine production facility in the world) and computer gaming (second only to California for diversity and scale of the industry).
The R&D investment in North Carolina means more than just research dollars. The activity leads to major industry investment in the state, including a resurgence of new advanced manufacturing facilities. A few examples from 2022 and 2023 include:
- VinFast – $2B – electric cars
- Boom Supersonic – $500M – aircraft
- Bosch – $130M – power tools
- Wolfspeed – $5B – semiconductor manufacturing
- Toyota – $8B – vehicle batteries
- Dai Nippon Printing (DNP) – $233M – advanced batteries
- Siemens Mobility – $220M – passenger railcars
- SO-PAK-CO – $85M – military rations
- Dymax – $47M – industrial adhesives
- Albemarle – $180M – mining materials
Entrepreneurship and Funding
The Small Business Administration reports that more than 64% of new jobs are created by small businesses every year in the US. For all the major industry investments and facility ribbon cuttings that North Carolina has secured, even greater economic impact is created by entrepreneurs and small businesses. So how is North Carolina performing at supporting new and small businesses?
Unfortunately, the top levels of public sector support skew towards the mega-deals I’ve described above. Nearly all state-level taxpayer money that is budgeted for economic development is used for large industry tax incentives and to wine and dine large companies across the US and around the world, to convince them to relocate or expand to North Carolina. While tax incentives often have clawbacks, (if a company doesn’t achieve long-term hiring commitments, for example), that reconciliation occurs years later, leaving a massive opportunity gap cost behind.
North Carolina has seen considerable failures with this style of economic incentive, where large companies make promises then fail to deliver. The examples in the non-exhaustive list below represent $432.1M in tax breaks that failed to deliver in the recent past (source: Carolina Journal reporting on the NC Dept of Commerce Economic Incentive Committee):
- Bandwidth – failed to meet $113M payroll goal (Raleigh)
- Allstate – missed hiring goal by 850 jobs (Charlotte)
- Centene – pulled out of $1B expansion and 6,000 job commitment (Charlotte)
- Advance Auto – failed to create 700 new jobs promised to create $1B benefit to NC (Raleigh)
- Microsoft – pulled out of two multi-million dollar expansion promises (Charlotte, Morrisville)
- Sonic Automotive – failed to create “hundreds of jobs” (exact number not reported)
- Conduent – did not achieve 200 job expansion (Durham)
- S&D Coffee – promised 200 jobs but actually reduced headcount by 150 (Concord)
At a local government level, most economic development funding is allocated similarly to the state, but with additional expense on site development – essentially spending public funds to prepare sites with utilities and other infrastructure in hopes of attracting a large external investment. The Virginia Economic Development Partnership (a state budget appropriation in VA for this kind of work) calculates that for every $1M a large company invests in expansion, it creates $7,000 in new recurring annual tax revenue. The math is that those big companies create short term benefits – the $1M is paid to local construction workers to build facilities, for example – and long term tax revenue through property and income taxes.
Aside from the poor performance of this style of legacy economic development, there are good reasons for the general assembly to think differently. First – tax breaks for corporations is a policy incongruent with phasing corporate taxes to zero. How does the state recoup its investment? Companies will get tax breaks now, and by the time those gifts expire, they’ll have no future taxes remaining to pay.
Remember that property taxes are collected at a local level and will continue to decline in a “work from home” culture of the tech sector. Site development may still make sense for factories, but is riskier for enterprise office space. And advanced manufacturing requires fewer total workers, reducing the positive impacts of income taxes compared to our past.
We need to recognize that these big projects are “ribbon cutting media moments” that help get people elected. They are not sound economic policy in today’s landscape. The good news is that most states in the US are also stuck in this legacy paradigm. If there’s a universal truth in an ever-polarizing political system and a soundbite-driven education and news cycle, it is that big announcements remain valuable to elected officials. We need a longer view and deeper thought.
The bad news is that a few states are starting to “get it.”. And arguably our top competitor, Virginia, is way ahead of North Carolina in funding entrepreneurially led economic development. While Virginia still spends the lion’s share of budget incentives on mega-projects (Amazon, Lego, AWS and Wells Fargo are a few recent big wins), they reserve a budget allocation to support technology and life science innovation. A VA state budget appropriation is assigned to a nonprofit, the Virginia Innovation Partnership Corporation (VIPC) to administer, with appropriate board oversight. It was seeded with $142M in funding through FY2025, and then $42M annually thereafter. This money is allocated to four primary areas, three of which directly support startups.
First, VIPC operates a number of early stage startup grant programs to award at least $5M annually in non-dilutive grants. This is quite similar to how NC IDEA operates in NC. For all the great work NC IDEA (a private foundation) achieves, they don’t have a comparable budget to an entire state, and NC is falling behind VA in total volume of early stage grant funding.
Second, VIPC operates a grant program that provides up to $200k each to qualified startup accelerators in Virginia. This spreads another ~$2M in support to entrepreneurial support organizations that are frequently under-funded across the US. Further helping these accelerators, VIPC supports $20k stipends for early stage startups to participate in the programs, giving a competitive advantage to VA accelerator programs compared to accelerators in other states.
Third, VIPC conducts equity investing, both directly and indirectly into startups. Direct investments are typically made side-by-side with traditional venture capital firms, as either a lead or supporting investor. $51M in public-sector originated investments to date have attracted $1.9B in follow-on private investment. VIPC also invests in other investment funds, taking a fund-of-funds approach to diversify impact and leverage industry expertise.
Finally, VIPC operates as the CTO office for Virginia, investing directly in important technology and innovation initiatives, and funding projects that keep the state at the forefront for attracting technology companies and startups. For example, VIPC funds several technical testbeds. [Full disclosure, RIoT has previously contracted projects with the Virginia Smart Community Testbed in Stafford, VA]. These testbeds advance key future market verticals like smart cities, drones, advanced manufacturing and logistics. VIPC also runs technical projects that are strategic for the state. A current effort to develop cybersecurity guidelines for the state and establish a state-wide Data Trust to secure and share municipal data across the Commonwealth is a good example.
There was hope last year that North Carolina was thinking similarly, as rumor spread about a potential $2B investment into NC Innovation, a new nonprofit that was eventually awarded a $500M, 2-year project. While this investment is positive and should be lauded – it really is just the establishment of a state-wide technology transfer office to support the many smaller public universities and HBCUs in the state that lack resources to commercialize technologies developed on those campuses.
This funding is allocated to the universities themselves (not to startups or new ventures) and should more appropriately be thought of as an expansion of our overall NC university budget. It is tangential to growing startups and small businesses and a positive step forward, but is not directly entrepreneurial support.
On the private investment side, the news has been dominated by two major trends in investing.
The first is that the number of venture investments and the total value of venture investments precipitously declined in 2023. In his most recent quarterly newsletter, David Gardner, founder of Cofounders Capital shared Pitchbook data projecting a 67% decline in VC investment in 2023 compared to 2022. Much of this is a result of macroeconomic uncertainty, especially around interest rates, which have increased the cost of capital and changed the overall risk/return assessment of high-risk venture investing versus lower-risk investments like bonds and securities.
I’m not too concerned about this trend overall. The economy is always going to ebb and flow, and the calculus of portfolio investing adapts with current conditions. In the near term, the increased difficulty to fundraise will act as a positive lever, forcing founders to focus on revenue-driven growth instead of fundraising. In the long run this is better for the founders who are successful and for the broader middle class. Times when fundraising is relatively easier, indirectly means that the future success of startups is disproportionately returned to already wealthy investors, rather than to new founders working to climb the generational wealth ladder.
The second trend in venture capital is one that I am much more concerned about. This is the national trend towards larger and larger funds. Venture capital has been an industry for decades, but it has become particularly trendy in the last ~15 years as more and more wealthy individuals have added “Limited Partner” to their investment portfolio strategy.
Every large metro now has multiple angel networks and VC funds operating and most follow a typical path. A first fund is relatively small, perhaps $5-10M over 10 years. Then portfolio managers raise a Fund II and perhaps double the size. By the time Fund III or IV comes about, those investors are writing larger checks out of increasingly larger funds. We see this trend in NC.
Bull City Venture Partners’ four funds have grown from $5M → $15M → $26M → $53M
Cofounder’ Capital – Fund I – $12M → Fund II $31M → Fund III target is $50M
On the national level, perhaps the most famous Silicon Valley investment fund, Andreesson and Horowitz’s first fund was $300M in 2009. Their current fund is a whopping $5.5B.
While it can be argued that more investment capital is good overall for the startup world, my fear is that it is steering behaviors towards a “unicorn or bust” mentality. A unicorn company is a company with a market value exceeding $1B. That’s not really a “startup”, but rather a large company that is still privately owned. When funds get excessively large, it requires a swing-for-the-fences behavior to have any chance of returning a 5-10x (or larger) return to the investors in the fund. Remember, for every investment that does not achieve the expected return, another company in the fund’s portfolio must now deliver an even bigger individual return to cover the total fund’s expected return.
With reduced frequency will we see fund managers (who have board seats and voting rights in their portfolio companies) allow founders to take early and moderately profitable exits. There simply won’t be enough cash returned to satisfy these mega-funds. Instead, VCs will have no option but to pressure their companies to reach massive size and record-breaking exits, which are few and far between.
When a fund is small, it is much easier for companies to achieve reasonable success, and to exit early, helping those early founders and employees to graduate from the world of “income” and into the world of “wealth”. Those founders tend to then start new companies, mentor new startups and become angel investors in their local ecosystems. It is healthy towards growing a diverse middle-class of small, medium and large businesses. When we lock up talent in growing companies to massive size, we fail to regularly circulate entrepreneurs and capital throughout the broader ecosystem and risk creating monolithic economies.
There are clear parallels to the banking industry which shifted over the decades away from supporting the broader business community (using money to create jobs) to a majority focus on financial services (using money to make money). As a percentage of GDP, financial services has more than doubled since 1980 to nearly 9% of US GDP. Huge VC funds are using money to make money in a far more direct way than angel investments and smaller funds, which often are using money more directly to solve important problems in various market verticals.
Early venture funds have been instrumental in helping early stage companies to survive long enough to become truly revenue-driven in their growth. But even once a company is sustainable based on revenue, for many founders the appeal of much larger investment from larger funds is difficult to turn down. Later funding rounds are not typically targeted towards “survival”. They are targeted towards growth – typically enabling market consolidation via mergers & acquisitions and revenue growth through accelerated sales and marketing. Economies of scale, at the large company level, help a small number of winners to emerge, stifling competition from smaller competitors. This is “using money to make money” behavior.
The winner-take-all mentality that is emerging in the VC community is something to pay attention to. The good news is that our region is both participating in this macro-trend, but also bucking the trend. Gardner’s newsletter reported that early stage fund managers across the US raised only half as much money in 2023 as in 2022. Here in NC we see the opposite behavior with an expansion of smaller funds. While most of the country sees early investment contracting, we have the opposite.
Why? A lot has to do with local leadership from experienced entrepreneurs who truly care about our ecosystem and who understand the bigger picture. To use a baseball analogy, lots and lots of singles and doubles can more than make up for the rare grand slam.
Joe Colopy, founder of Bronto Software, has launched two early stage funds since 2019. Jurassic Capital invests at quite early stages of revenue-driving companies. The more recent launch of Primordial Capital demonstrates willingness to invest at extremely early stages with $50k investments. Similarly, Scot Wingo launched an index fund, the Triangle Tweener Fund, which has made 68 investments in just 2 years with an average check size of ~$51k.
We see a significant focus on making many more investments, at very early stages in North Carolina. This is really healthy. As a nonprofit startup founder myself and a startup accelerator operator, I know that the first few thousands of dollars invested in a company are far more impactful to the future success of the company than later multi-million dollar rounds. Having more small companies is significantly more important to our economy and to our quality of life than having just a few massive companies.
This is the mistake of major project attraction and site-development-style economic development. It is similarly the achilles heel of massive-scale VC investing. With all our proverbial eggs in one basket, the failure of one big company has an outsized negative impact on the total regional economy (or fund return). Having many smaller companies plays to the diversity strengths I discussed about North Carolina.
The national SBA data I discussed before bears this out. And we see external validation as well. Lending Tree released a report at the end of last year that evaluated the top 100 metros for startups. The top 3 on the list were Raleigh, Charlotte and Durham.
Bringing it All Together
North Carolina is deserving of the high rankings and accolades that have been touted in recent years. Our diversity of industry and in-migration fueled growth bode well for the present and the future. We are winning the competition for federally funded seed capital for advancing the industries of the future. That has led to major industry investments. Our venture community is raising larger and larger funds, like we see across the nation, but also remaining true to early-stage investment at a rate significantly higher than the US. This is a huge differentiator that we should recognize and support (NC IDEA is a great organization to financially contribute to).
Our biggest weakness is at the state level. The lack of entrepreneurial support strategy – and budget – puts us at a disadvantage compared to more creative and forward-acting places like Virginia. Our expectation that we can grow significantly without sufficient tax revenue to support that growth is near-sighted, likely to look rosy for a few years before we get in trouble by the mid 2030’s.
Hopefully between now and then we’ll see a resurgence of today’s startups becoming tomorrow’s middle class of business, maintaining the healthy, high-quality place to live that we enjoy today.