As Washington’s tech sector diversifies and matures, can it power a new local economy?

August 12, 2012

In many ways, HelloWallet is quintessential Washington. The company’s mission to bring personal finance services to moderate-income Americans is altruistic in origin. The founder, a public policy scholar, hails from the Brookings Institution. Its seed-stage capital was a Rockefeller Foundation grant, not venture capital. Yet it’s hard to imagine the firm taking root in the District even a dozen years ago. In a region long dominated by federal contractors, telecommunications providers and professional services, a start-up with ambitions of Web and mobile-based software had little place in the local economy.

In recent years, that has begun to change. Technology firms in industries as varied as e-commerce, education, health care, cybersecurity and energy have made their home in the nation’s capital and its surrounding suburbs.

The result is a burgeoning technology hub that some consider the region’s new economy, particularly in the District, where hundreds of young entrepreneurs have formed a creative class of technologists with business ideas and the zeal to execute them.

“If you want to change the world, you still come to Washington, D.C.,” said Matt Fellowes, HelloWallet’s chief executive. “What we haven’t done very well to date is connect that intellectual firepower with the capability of technology to solve these big problems. And that’s what is happening right now, so I only see growth in this area going forward.”

But that growth has already encountered challenges, and more are inevitable. Many of the ingredients that have allowed places such as Silicon Valley and Boston, and more recently New York, to thrive seem to be lacking here — or missing altogether.

Local entrepreneurs and investors have moved quickly to tackle such issues as the shortage of Web developers or the dearth of investors, but it remains to be seen whether those efforts can coalesce and a vibrant tech economy will emerge as a result.

Creating an ecosystem

AOL established the Washington region as fertile ground for consumer technology companies as the firm introduced millions of Americans to dial-up Internet, and pioneered the concepts of chat rooms and instant messaging.

The company’s epicenter shifted to New York in 2007 after its ill-fated merger with Time Warner, and many of its workers here have defected to start their own ventures. Indeed, if you scan the resume of many local entrepreneurs, including LivingSocial chief executive Tim O’Shaughnessy, a stint at AOL can often be found.

These veterans created an ecosystem that many say forms the foundation for a successful technology hub: A megalith company attracts thousands of workers, who then gain experience, grow restless and decide to forge their own path. The result is an ever-extending pipeline of fledgling technology firms poised for growth.

That has contributed in part to the more diverse technology sector around Washington today. Grotech Ventures partner Don Rainey points out that the big tech firms of the 1990s, such as UUNET Technologies and MCI Communications, traced their roots to technology developed by or for the federal government.

That’s not always the case anymore. Firms such as energy software maker Opower in Arlington, Web site builder Webs.com in Silver Spring and data privacy upstart Personal in Georgetown have been built exclusively with consumers and corporate customers in mind.

“Our historical, legacy core competencies have been government-derived things — security, wireless, Internet,” Rainey said. “You look at them and the DNA is all government expertise.”

“While you can’t see government DNA in this generation of start-ups, you can often see AOL DNA. And I suspect in 10 years, you will see LivingSocial DNA in the generation of start-ups that make headlines,” added Rainey, an early LivingSocial investor.

But even as LivingSocial has filled AOL’s void as the region’s banner consumer technology company, doubts remain about the company’s prospects for long-term success. Amazon, which holds a 29 percent interest in the company, disclosed in a July regulatory filing that the firm lost $93 million in the second quarter, down from a loss of $198 million during the same quarter last year. What’s more, LivingSocial has tried with limited success to untether its bottom line from the daily deals business.

Regardless, one LivingSocial does not an economy make. For the tech sector to buoy the region’s economy in the way advocates promise, the region will need several companies with a similar narrative of explosive growth, rapid hiring and global reach.

A new economy

The consumer tech sector’s rise comes as other industries have begun to wane. Government budget cuts and the threat of sequestration have formed a dark cloud over contracting. The recession and slow recovery have weakened many sectors from real estate to retail.

Those head winds are felt strongly in the District, which often lags behind neighboring Maryland and Virginia in attracting corporate residents; federal workers are the city’s mainstay.

“The federal government is not expanding now. Law firms are not growing at the moment. There’s a sense that the traditional anchors of the District’s economy, looking ahead, are not going to be big sources of growth,” said David Zipper, director of business development and strategy in the Office of the Deputy Mayor for Planning and Economic Development.

Zipper said the city’s ability to attract young urbanites with features such as public transit, bike-sharing programs and an increasingly cosmopolitan social scene give it the ingredients to become a thriving tech city.

“We have a positive environment that gives us some cards to play and the question becomes how the city is going to play those cards,” Zipper said.

But the tech sector is a risky bet. The vast majority of technology start-ups are small, produce little to no revenue and keep hiring to a minimum. At least in their early years, they do little for the city’s tax base or unemployment rate.

But the prospect that a few could grow into medium or large companies has the city taking a chance. A bill before the D.C. Council would exempt certain tech firms from corporate income taxes for up to five years and impose just a 3 percent capital gains tax on District residents who invest in them

The city also crafted and passed a massive $32.5 million tax break for LivingSocial that requires the company to employ city residents and keep its headquarters within the District’s limits.

Though LivingSocial has quickly become one of the city’s largest private-sector employers, firms such as HelloWallet offer a glimpse at what more measured success can look like.

The company moved into a 10,000-square-foot office in the District’s West End earlier this year, and is steadily adding customers and employees.

“What makes D.C. so special relative to any other place in the country is that it’s just chock full of ... experts who really understand critical problems facing this country, critical problems facing consumers,” Fellowes said.

“Clearly, on the other side of that equation, you have the best talent in the world to solve those problems through technology in Silicon Valley.”

The constant comparison

There are some who caution against making direct comparisons between Washington’s technology sector and those in places such as Silicon Valley. For one, D.C. would never win that matchup, and probably never will.

But increasingly, sector advocates contend that D.C. doesn’t need to replicate Silicon Valley in order to be considered a success. This region has its own strengths — proximity to the federal government being just one of them — that should be capitalized on.

“I think the comparisons are inherently apples and oranges,” said Rainey at Grotech.

Still, that doesn’t stop Washingtonians from looking westward.

Silicon Valley has a magnetic pull for Web engineers and computer programmers that doesn’t exist in Washington, at least not yet. Sector advocates have sought to replicate Silicon Valley’s culture of mixing business networking and socializing, which many credit with making that region a destination for young, eager technologists.

Monthly D.C. Tech Meetups, which began last year, regularly attract hundreds of attendees for two hours of start-up demos and entrepreneur panels, followed by a trip to a nearby bar. The second annual Digital Capital Week, Washington’s biggest conference for the young tech crowd, tallied roughly 10,000 registrants last November, including many out-of-towners.

But the entrepreneurs must be balanced out by venture capitalists and other investors who provide the money to get a business off the ground. Venture capital data show Washington has been outpaced by Silicon Valley, Boston and New York over the past 15 years in both number of deals and total money raised.

Of course there are local exceptions. District-based Revolution, an investment firm helmed by former AOL executive Steve Case, raised a $450 million fund last year. Just last month, New Enterprise Associates, a global financier with a large office in Chevy Chase, added $2.6 billion to its coffers. Both invest locally.

On the other end of the spectrum, several groups of early-stage investors, also called angels, have been funneling small sums of money to help firms get started. CIT GAP Funds at Herndon’s Center for Innovative Technology and the University of Maryland’s Dingman Center Angels are among the most active.

Once a business has been formed and funded, the last step in the time line of many successful tech ventures is an exit. That may take the form of an initial public offering, or as is increasingly the case, an acquisition offer from a larger player.

Jonathan Aberman, managing director at Amplifier Ventures, said start-ups here should be building companies to be acquired by the industries that dominate Washington’s economy — government, law, media and hospitality, to name a few. In Silicon Valley, start-ups live alongside some of the Web’s biggest players, including Google, Facebook, Amazon and eBay.

“My argument is if you really want to be like the Valley, you have to understand that what drives behavior in [mergers and acquisitions] is a lot of times proximity, and young companies building technologies that the large companies want to own,” Aberman said.

That prompted real estate search engine HotPads.com to relocate to San Francisco last spring after six years in the District. Chief executive Matt Corgan said at the time that he hoped the move would help the firm recruit engineers.

More than a year later, Corgan said he hasn’t done much hiring from within Silicon Valley — though it’s easier to get engineers to relocate there than the District, he said. Instead, being surrounded by potential acquirers has been the biggest benefit.

“Anyone who would want to purchase HotPads or invest in it further is going to be a large Internet media company most likely and the people who run those companies are either located in San Francisco or very comfortable with it,” Corgan said.

Beyond easier meetings with those strategic partners, Corgan said the business is not all that different today compared to its time in the District. The company’s servers are still located in Virginia and some of its 22 employees still work remotely.

“There’s actually no operational benefit to being here [in the San Francisco Bay area] whatsoever, it’s just the ability to network at the critical times,” he said. “It’s like an hour-a-week type benefit. It’s funny that you have to live here to get that, but it does matter in the end.”

Steven Overly covers the business of technology, biotechnology and venture capital in the Washington region for The Washington Post and its weekly Capital Business publication. In that capacity, he has written about start-up struggles, investment trends and major drug discoveries.
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