An innovation gap has long existed in the U.S., where startups cluster in major cities like San Francisco and New York, leaving much of the middle of the country relatively bereft of young tech companies that generate new ideas. The recent banking crisis, which took down Silicon Valley Bank, which served about half of U.S. startups, may make this gap more pronounced.
"I do think that the gap is real, and this is likely to make it unfortunately worse," said Ben Milne, founder of Des Moines-based blockchain technology company Brale and original founder of payment tech company Dwolla, also based in Des Moines. "It's kind of a bummer."
Some of this has come about due to the way people think rather than reality, noted Max Brickman, managing director of Heartland Ventures in Columbus, Ohio.
"There's a perception you have to be on the coast, you end up going there, and then that leads to very few startups that are actually headquartered in the Midwest historically," he said.
In the wake of Silicon Valley Bank's collapse, many startups shifted their bank accounts from community or regional banks to the mega banks.
"That's going to create an additional concentration of power and leverage that these big banks have that are primarily on the coast," Brickman said.
Why location matters
Technically, startups can use online and mobile banking from banks that are based anywhere. But in the case of startups, there is value to being able to meet people in person.
A lot of critical networking happens locally, said Healy Jones, vice president of financial strategy at Kruze Consulting.
"Banks, law firms, accounting firms, we're pretty good introducers of our clients to venture capitalists," Jones said. "Part of my job is to get coffee with VCs. I take them out to dinner and I get to know them. And then since I know our client base, I can make referrals and say, 'I have a very interesting client raising funding. Would you like to talk?' There's a bias in geography because of that to a certain extent."
Silicon Valley Bank's downfall shone a spotlight on the need to have connections and to be able to use them.
"You saw a lot of large players within the fintech space use those connections and networks and help a lot of the startups that were in danger of not meeting their near term expenses, make those connections to other banks and other fintechs that could provide the proper funding, and help open new accounts," said Rudy Yang, analyst at Pitchbook. "That was a very heartwarming thing to see within the community. That shows the power of those connections, especially in a modern-day banking crisis occurring within hours."
Many of these frenzied conversations happened over WhatsApp and text messages. But there's still a large in-person component to building these kinds of networks.
"Having that human connection for partnerships is definitely very important," Yang said.
There are Midwest cities, such as Des Moines and Kansas City, that have their own culture of networking and helping startups, Milne said.
"You're one degree of separation between anybody in the town," he said. "If I get an intro from one of 50 people, I will hop on the phone with somebody I don't know tomorrow. And if it's an entrepreneur building fintech stuff and they're trying to get through something, I'll get in front of a whiteboard and help out. That's just how people were when I got to town. They helped me work through things and helped me create some structures and that was really impactful for me. So I think in the city centers, it's less of an issue because now you have people that have a desire to grow the next generation, even if our careers aren't over yet. Once you get outside of the city centers, I do think it's a challenge."
A rural bank in a town with 30,000 residents is going to have a different level of sophistication than a top-tier bank, he noted.
"They're both called banks, but to compare them on that basis alone is very difficult," Milne said. "There are some opportunities for which it's easier to be discovered if you're in a big city."
The flight to the big banks
Milne tries to work with banks in Des Moines as much as he can.
"I'm a little bit old school in that way," he said. "I kind of believe in the local bank."
But in the wake of SVB's failure, "you start to look at where to put your program, and it's clear that there's a benefit to working with larger financial institutions that is different than it was even a month or two ago. "This would be a tough time to be brand new, building your first fintech application, in a town where no one knows what you're talking about."
As deposits leave smaller communities, eventually those communities will have less money flow to lending, Milne said.
"So for businesses, the incentive is to continue to migrate to the big banks right now," he said.
The recent mass movement of fintechs from regional and specialized banks to the top four banks – in the interest of keeping their deposits safe in banks considered too big to fail – could hurt innovation in a couple of ways, Jones said.
"First of all, the money center banks, where many startups are putting their cash, tend to have their technology, startup and venture capital bankers in only a couple of cities, San Francisco and New York City, mainly. So it will be much harder for innovators to get the banking advice they need."
And specialized banks like the former Silicon Valley bank tend to be better at providing debt financing to the specific sectors or geographies that they serve than the money-center banks, Jones said.
"If these specialized banks have fewer deposits, and more of those deposits are put into Treasuries, money market accounts and other savings vehicles that the banks cannot use to make loans, we'll see a decrease in funding to startup enterprises in specific geographies," Jones said.
What could bridge the gap
There is a fresh need for banks that understand tech startups.
"The big bulge-bracket banks tend to have a team that understands startups, and if you get into that team, it's a lot easier to open an account versus if you just walk into a branch and say, 'I need to open a $10 million account'," Jones said. "The small bank branch staff are likely to say, 'That's a lot of money. Are you money laundering? Are you a drug dealer? Can we see your financials?' 'Well, we're a startup. We don't really have financials.'"
In addition to more tech startup-savvy banks, Jones would like to see higher Federal Deposit Insurance Corp. insurance limits.
"What our clients are doing right now, and what I'm willing to bet a lot of high-net-worth individuals are doing, is instead of having a $5 million checking account, they're putting a small amount in checking to fund their operations, and the rest is going into Treasuries. That's not driving the same type of innovation as [a bank that can lend to] technology startups."
The geographic innovation gap will gradually diminish as physical location becomes less important, Yang argued.
"Covid has changed a lot and you no longer necessarily need an office within those states to be successful," he said. "And fintech is becoming more of a global business every day. So you have a lot of B2B fintech infrastructure companies enabling a lot of fintech startups to scale on a global basis and have quick times to market, going from years to months to weeks. People are tapping into other markets for business and for talent, so that's not necessarily going to be based on physical office location."
But Milne pointed out that although the technology changes made during the pandemic helped pave the way for more digital banking, "fintech programs are still built with a handshake. And I think people are still getting on planes and still getting to know one another because when you do one of those deals and you build a big program, those are five to 15 year relationships, they last for a long time."
Communities that are intentionally hospitable to entrepreneurs and founders will thrive, he said.
"And when communities thrive, that compounds over time," Milne said. He pointed to New York as an example: It wasn't always a tech scene, and now it is, partly through accelerator and incubator projects like the
"There are these anchors that people put in and they take 10 or 20 years to really start paying the dividends," Milne said. "If you focus on watering the seeds that are already in your community, you'll start the process of growing a really strong community. I think you could probably fit the entire Des Moines tech scene in a coffee shop 10 years ago. And now I can't even keep track of how many accelerators we have, how many banks are getting involved to be supportive." A similar effort has been taking place in Ohio, he said.
Brickman would like to see regulators quell concerns in the market about bank risk.
"If this is just a new way of life, that banks are just going to fail every once in a while, then people are going to be scared," he said. "I think we need to bring stability and certainty. I don't know if that's by increasing the FDIC limit or making things like sweep accounts more commonplace and easier to set up and more well known. Or something that doesn't put small and even medium-sized banks at a disadvantage."
