Rethinking Startup Ecosystems to Build What Investors Really Want

In most of the world, startups are in disrepair. No more effectively can we just reboot or defrag a computer to actually fix it, than we can try again and again to host demo days, networking events, and run incubators, expecting different results, when there is a virus in the system. Begging the question, that, while we can tell if a coworking space or a single startup program is helping founders therein, can we determine macroeconomically if the ecosystem is working well?

This becomes important when startup ecosystems reach a tipping point where traditional markers of success — like high company formation rates, pitch events, and press coverage — fail to correlate with real economic impact. In startup ecosystems, distinct from the economy at large, we have to appreciate that impact of success on founders can’t be discerned by jobs created, revenue, or office space consumed, because were that to be sufficient, economic development offices would merely focus on growing businesses (or attracting companies) that accomplish that goal while startups struggle. Startup ecosystems have to create conditions that align with how successful ventures are developed, rather than encouraging founders to chase activities that sound impressive but don’t translate into long-term value.

Here’s what you might see in your city, warranting a look at what’s being done and the metrics determining success:

1. Increasing Startup Failure Rates
   As ecosystems mature, high startup failure rates may expose weaknesses in the existing approach. If ecosystems are producing lots of companies but seeing fewer succeed past initial funding or traction stages, it reveals a lack of focus on sustainable, iterative development. Investors and policymakers would start to see that the “startup hype” doesn’t lead to real growth without deeper, product-centered support.
2. Investor Fatigue and Capital Flight
   If local investors become fatigued by backing early-stage startups that consistently fail to mature or scale, they may begin diverting funds to regions or sectors with higher success rates. This loss of capital signals an economic risk for the region, pressuring ecosystems to refocus on building companies that meet investor demand. When investment begins to flow outward, local stakeholders recognize the need for a fundamental change.
3. Mismatch Between Investor Needs and Founder Development
   Venture capitalists increasingly seek startups with proven product-market fit and scalable models, rather than those simply making a splash in the local media or on social platforms. As the gap grows between what investors want and what founders deliver, ecosystems will feel the pressure to reorient their efforts. Founders who haven’t built viable products can struggle to raise later-stage funding, stagnating growth across the ecosystem.
4. Policy and Economic Development Goals
   Local governments and economic development agencies may begin prioritizing policies and funding focused on economic resilience and job creation, rather than just startup activity. When policymakers see that startups are struggling to deliver the anticipated economic benefits, they may push for policies that foster long-term product development, sustainability, and investor alignment, which make for a more robust economy.
5. Cultural Shift Toward Sustainable Growth
   Finally, if startup culture begins valuing vague impact metrics over lasting, disruptive, global impact, ecosystems will fail to remain competitive, while those that don’t will start to lag. Ecosystems in this new wave will be incentivized to adopt frameworks and programs that genuinely prepare founders to build lasting companies, leading to a broader cultural shift.

When examining the economic development of startups, viewing startups as analogous to products offers an insightful lens through which we can assess the effectiveness of a local ecosystem. In this framework, venture capital (VC) investors are the primary customers, and the local ecosystem’s ability to deliver startups that align with investor demand becomes a critical metric of success. Therefore, understanding product development-what it requires and what it doesn’t-can help determine whether local ecosystems are supporting or undermining entrepreneurial success. The relationship between VC trends and startup ecosystems should reflect a clear product-market fit: if the ecosystem is robust, we should see increased local investment, signaling that investors find value in the “products” (startups) being developed.

It that helpful? Take a look at this trend of venture capital investment by major ecosystem in the U.S. and tell me, if cities are growing and effectively developing startups, as seems so for many places, should venture capital investment not follow?

All of this, from the Q3 2024 Pitchbook-NVCA Venture Monitor, which you can download here.

So much data can make it a little difficult to tease out my observation here so let’s take a subset of popular cities and reduce the chart to only the four.

To look at how Pitchbook rolled up so much, you might be tempted to say that everything appears flat; in instead let’s look on Silicon Valley, Austin, Washington DC, and New York.

The peaks find our economy in 2021 / 2022 which, absolutely worth appreciating, falls in the middle of the coronavirus quarantine period that ran from late 2020 through early 2023. Arguably, this might reflect the appreciated fact that venture capital investors are rather like philanthropists, and when times are difficult or opportunities emerge, they help through funding — and yet, if and when challenges persist, or returns fail to manifest, they have to pull back (they can’t invest what they don’t have).

Couple thoughts…

1. Claims of Silicon Valley’s demise. Real or hype?
2. How many 7-year cycles (the typical time it takes for venture capital investment to start delivering returns) should we go through before we can expect substantially greater investment from the yields?
3. Is it right to eventually expect that with the growth of a region, increase in support programs, and global attention, we would see venture capital investment increase to take advantage?

Startups as Products

Startups are, at their core, products designed to solve specific problems. Just like any physical or digital product, a startup must go through a process of validation, iteration, and market testing before scaling. Richard Florida, a leading urban theorist, once noted that “startups are not just firms; they are experimental units of economic development.” This framing implies that the process of building a startup is inherently similar to developing a product. Startups require multiple rounds of iteration, customer feedback, and refinement to find their place in the market. If we think of a startup ecosystem as a product development pipeline, its role is to guide startups through this process-helping them validate ideas, develop sustainable business models, iterate, and scale.

In his research, economist Paul Romer has highlighted that innovation and knowledge spillovers are critical to economic growth, particularly in regions aiming to foster entrepreneurial ecosystems. Romer’s “endogenous growth theory” suggests that the creation of new ideas (i.e., new startups) spurs economic development when properly nurtured. This brings into focus the role of the ecosystem: like a product development framework, it should be designed to support iteration, knowledge-sharing, and long-term growth rather than short-term, flashy successes.

What’s Essential in Product Development?

In the context of startup ecosystems, there are a few core components that are essential to this development process:

1. Market Validation: Just like any product needs to be tested in the market, startups require real-world validation that there is demand for what they are building. This is a fundamental necessity that often gets lost in flashy accelerator programs or initiatives that focus more on visibility than actual market traction. Notice, I did not say “customer” validation as it is increasingly evident that the idea of customer validation is misleading founders to suffer from confirmation bias while neglecting the critical path of market research and competitive analysis.
2. Iterative Development and Feedback Loops: Just as product designers must continuously iterate based on user feedback, startups need environments that emphasize building, testing, and refining based on real feedback. Unfortunately, many ecosystems focus more on “pitching” and less on real, tactical development.
3. Access to Resources (Capital, Talent, Networks): Startups, like any product, require resources to move from ideation to scale. This includes capital (to grow), talent (to execute), and networks (to connect with customers, investors, and partners). An ecosystem should be judged on its ability to provide meaningful access to these resources; I’ve covered meaningful access before because unfortunately it means what most ecosystems won’t do (and what most cities and programs can’t or don’t know how to do): removing the good-intentioned participants that don’t know what they are doing or are trying to monetize founders.

What’s Unnecessary but Over-promoted?

Many startup ecosystems fall into the trap of promoting unnecessary elements that do little to foster real product (startup) development:

1. Pitch Competitions and “Demo Days”: While these can be helpful in some contexts, many ecosystems overemphasize pitching over product development. In a product development cycle, a prototype isn’t endlessly pitched; it’s tested. Similarly, founders should spend more time refining their startups with real customer data, not tailoring pitch decks for competitions.
2. Over-glorification of Office Space and Coworking: While having a space to work can be useful, ecosystems often place undue emphasis on physical spaces as a sign of development. Great products are created in garages and bedrooms long before fancy office spaces become necessary. Startups need lean, resourceful environments, not cushy office perks.
3. Networking for Networking’s Sake: Ecosystems often promote networking events, without necessarily creating environments where useful, action-oriented connections can be made. For product development, what matters more are strategic relationships that lead to partnerships, investments, or key hires-not sheer volume of connections.

Notably, many of us are increasingly appreciating that if founders are struggling to connect with people, that they need introductions to investors, or that they spend recurring time at a hub out of a desire to network, something cultural, economic, programmatic, or systemic must be wrong.

What’s Involved in Product Development-and What’s Distracting Founders

In product development, focus is everything. Successful products are built through a process of iteration: rapid prototyping, testing with real users, collecting feedback, and making necessary adjustments. In the world of startups, this is no different. As Steve Blank, creator of the Lean Startup methodology, states: “The key to a successful startup is not just to build a product but to build the right product.” This process-often referred to as “iterative development”-is how startups eventually find product-market fit. Yet many ecosystems inadvertently distract founders from this critical process by emphasizing activities or practices that don’t serve the core development of the product itself.

One such distraction is the overemphasis on media attention on the ecosystem itself, rather than the startups, and early-stage pitching at networking events (frankly, usually to pretend for sponsors or investors that the venue/hub is capable of providing deal flow to people who aren’t effectively getting it otherwise — doesn’t that signal something is wrong?). While pitching is a necessary part of startup life, as it allows for validation of ideas and storytelling, ecosystems often glorify the pitch itself rather than the validation and iteration that should follow. “Pitch competitions, while valuable for visibility, often push founders into a performance mindset instead of a problem-solving mindset,” notes @Josh Lerner, an economics professor at Harvard Business School who studies entrepreneurship and innovation.

Now, I’ve covered how to pitch effectively, many times over the years, but every time I note that it is because the order in which, the content, and the quality of communication, tell us a lot about the psychology and priorities of a founder — that though, startups winning because of a good idea and well delivered pitch are distracting us from seeing if the founders are actually capable.

Runway and Financial Stability
The biggest challenge to effective product development for startups is often a lack of financial runway. A study by the Ewing Marion Kauffman Foundation revealed that 82% businesses fail due to cash flow problems, a figure that highlights the importance of sustainable, long-term funding in startup ecosystems — but more importantly notice, running out of cash is NOT the cause of a failure when we’re dealing with startups that start without it: it’s a symptom of something else. Founders misled by the ecosystem or investors, to chase customers or meet the expectations of bad advice from investors dangling checks, end up forced into survival mode, making short-term decisions rather than focusing on iterative product development — because they were erroneously pushed into the wrong focus. When ecosystems prioritize rapid scaling or glamorize “hustle” without providing the capital necessary to sustain real growth, founders are pushed to seek investment prematurely, often before they’ve validated their market.

Furthermore, entrepreneurial ecosystems that focus on vanity metrics-such as user signups, social media followers, or media mentions-push founders to chase superficial numbers rather than deeper product-market fit. In a study of 200 startups, CB Insights found that 42% of failed startups attributed their downfall to “no market need,” highlighting the danger of focusing on buzz instead of prioritizing the marketing to determine that there is no market need.

Cultural Barriers: Perfectionism and the Fear of Failure
Ecosystems that promote perfectionism can stifle startups from taking the necessary risks that lead to success. Michael Porter, a leading authority on competitive strategy, points out that “the essence of strategy is choosing what not to do.” In a startup context, founders must be empowered to focus on their core product, make decisions quickly, and avoid the paralysis of trying to perfect every aspect of their business before launch. However, in ecosystems where failure is stigmatized, founders are often pressured to launch something flawless, leading to delayed entry into the market and missed opportunities for real-world feedback. In contrast, ecosystems that celebrate iterative development and embrace failure tend to foster more resilient, adaptable startups. “Innovation ecosystems that tolerate failure produce more innovative outcomes because they allow for experimentation and learning,” once noted entrepreneurship professor Saras Sarasvathy, whose work on “effectuation” argues that entrepreneurs thrive by learning from what doesn’t work.

The Role of Venture Capital as the “Customer”

If startups are products, then venture capitalists (VCs) can be perceived as customers because it’s the investor class that is considering capital allocation in exchange for value into what they venture is BEFORE serving consumers of the solution.

The question becomes: is the local ecosystem producing startups that venture capitalists find valuable?

One way to assess this is by looking at where the money is coming from. If local investors are backing local startups, that’s a strong signal that the ecosystem is effectively supporting the kinds of companies that investors want to buy into.

In his analysis of venture capital’s role in regional innovation, economics professor Donald Siegel has pointed out that venture capital serves as a “signal” of the health of an ecosystem. When local VCs are investing in local startups, it suggests that the companies being built are aligned with market demand. However, when local capital is scarce and investment flows primarily from outside the region, it raises the question: why aren’t local investors stepping up? Often, it’s because the local ecosystem is focused on creating startups that look good on paper-ones that attract media attention or win pitch competitions-but don’t necessarily solve pressing problems or present clear paths to profitability.

Let’s look at Austin, Texas, as an example. For years, Austin’s ecosystem has been touted as a rapidly growing tech hub. Yet, if we take a closer look at localized VC investment trends over the last decade, there’s a noticeable discrepancy between the hype and actual capital inflows. Despite a high volume of startup activity, a significant proportion of venture funding in Austin still comes from out-of-state investors, particularly from the Bay Area. This indicates that while Austin’s ecosystem has produced a high volume of startups (products), many of those products do not match the needs or desires of local capital.

In other words, the local investor base may not see the value in the startups being developed locally, or the startups are not aligned with the particular sectors or growth models that local VCs prefer. This misalignment could be the result of over-promoted aspects of the ecosystem (like pitch competitions or coworking spaces) that do little to drive real product-market fit, which is what VC investors ultimately care about.

In contrast, regions like San Francisco and New York have strong local VC support because the startups developed there are in sync with the investment theses of local venture funds. These ecosystems emphasize product-market fit, iteration, and scalability-just as a strong product development process would-rather than superficial metrics like participation in networking events or media hype.

Developing a Region’s Startup-Market Fit

Provide the startups that satisfy a strong demand within a well-defined target market, which creates a sustainable foundation for growth, and customers (investors) will come. How?

1. Understanding and Defining who Values the Solutions
   This part is all about deep market research. You’re looking to understand not just demographics but the psychographics, pain points, behaviors, and needs the market. Pinpointing specific personas or segments to target, figuring out the circumstances or challenges they’re trying to resolve, and understanding competition, are critical early steps.
2. Problem Validation
   Once you understand the market, you need to validate that the opportunities are real, pressing, and not just a minor inconvenience. Opportunity > Problem so we validate that a problem exists because there is an opportunity, by engaging directly with potential, conducting interviews, or using market research to help assess whether the problem resonates widely and is compelling enough to demand a solution.
3. Solution Development and Testing
   Here, you’re crafting startups that fit the problems and in which people will invest (whether investors or customers). Prototyping, beta testing, and gathering feedback from a small cohort of initial adopters are important for assessing if a startup effectively solves the problem — and they need funding and experienced resources to do this BEFORE going after paying customers with their solution. Often, this phase will involve refining, iterating, and adapting based on real-world usage and feedback.
4. Unique Value Proposition (UVP) and Differentiation
   For any startup to gain traction, it needs to stand out in the market. Identifying what makes your startups uniquely valuable to the market — in a way that competing solutions do not — is essential. Cities fail this while most startup programs and investors have no idea how to do so. It’s also critical that this UVP is both easy to communicate and resonates with everyone.
5. Go-to-Market Strategy and Distribution Channels
   Startup-market fit also depends on how well your ecosystem helps founders reach and acquire audiences. Understanding the best distribution channels and crafting an effective go-to-market strategy are crucial; your region can do this for startups just as much as your investors are demanding founders do it themselves.
6. Testing Metrics and Validation Through Traction
   Startup-market fit should be measurable and as we’ve explored here, it can be — are investors arriving and funding the products (startups) being brought to market? Traditional marketing metrics such as customer retention, engagement rates, Net Promoter Score (NPS), and revenue growth can be translated to the macroeconomic impact of startups but note that these are trailing metrics, not leading metrics!

Aligning Ecosystems with Product Development

In the end, the success of a startup ecosystem should be measured not by the number of companies launched or the amount of media attention generated but by whether it is creating valuable, investable products. Ecosystems need to stop focusing on distractions like vanity metrics, excessive perfectionism, or superficial pitching and start giving founders the runway and the cultural support they need to iterate, fail, and eventually succeed. As the data shows, ecosystems that emphasize sustainable product development, rather than quick wins, are more likely to create long-term economic growth. And venture capital-both its presence and its absence-serves as a clear signal of whether the ecosystem is on the right track.

If we are to take startups seriously as the experimental products that they are, then local ecosystems must support founders in the same way we support product developers. You can’t just reboot the machine and hope it works when it’s evident something is wrong.

It’s about fixing that bug so as to build something that works, something worth investing in, not just what looks like a healthy ecosystem. Localized VC trends are a clear indication of whether ecosystems are aligned with investor demand. And as venture capitalists continue to serve as the ultimate customer in the startup economy, ecosystems must ensure they are building products that their customer is willing to buy.

Originally published at https://seobrien.com on October 28, 2024.