Being home to Silicon Valley gets California the reputation as a dreamland for start-ups. But it's a big state with lots of cities, and outside of the San Francisco Bay area — and the Los Angeles–San Diego entrepreneurial region — California is pretty harsh territory for business owners.

CNBC's recent ranking of entrepreneurial hot spots, the CNBC Metro 20: America's Best Places to Start a Business , evaluated the likelihood of start-up success in 107 metro areas across the United States, taking into account factors including tax rates, regulatory environment, cost of living, cost of labor, unemployment level and population growth. No California city made the top 20. But five California towns were among the 10 worst metro areas — among all 107 — to launch a business .



That's a noteworthy corrective for a state synonymous with start-up star power.

"There are big gaps in many parts of the country — and also within many states," said entrepreneur and AOL co-founder Steve Case in an email to CNBC. "Yes, the U.S. continues to be the most entrepreneurial country in the world, but there are some pockets where there is momentum and many places that are lagging. ... California is the classic example," Case said. In 2005, Case co-founded investment firm Revolution, which focuses on start-up activity outside of Silicon Valley and other nationally known start-up hubs.



The five California metro areas that fell within the bottom 10 nationally: Fresno, Santa Rosa, San Bernardino, Modesto and Stockton.



U.S. venture capital investment is heavily concentrated in three states: California, New York and Massachusetts. Those three states receive more than three-quarters of the nation's venture capital dollars, according to the National Venture Capital Association. On its own, California receives more than half of the nation's venture capital dollars. But overwhelmingly, those funds go to start-ups in either Silicon Valley and San Francisco or Los Angeles and San Diego, Case said, adding, "Most of California is in fact not getting much investment." And without access to capital, entrepreneurship communities stagnate.

One reason the smaller cities in California fell to the bottom of the CNBC Metro 20 ranking is because of the elevated cost of living. By contrast, in Austin, Texas, the No. 1 city, the cost of living was cited as very low.



Anna Mason is director of Revolution's investment campaign, called Rise of the Rest, which focuses on start-ups outside Silicon Valley and New York. She claimed that cost of living is the one data point that jumped out at her. "High costs of living can impact a founder's (and early employees') desire and ability to stay in/move to a region to start a business," Mason said via email.

Another factor that affects a city's appeal to start-ups is the tax burden. In Texas, there is no state income tax. That's great news for entrepreneurs, many of whom are operating on bootstrapping budgets, particularly in the early days. Meanwhile, the Sunshine State has some of the highest income-tax rates in the country, according to The Tax Foundation. That means that all of the metro areas in California were penalized across the board for their state tax rates.



Further, the five California cities cited are all experiencing population growth that is sluggish compared to the best business cities, ranging from 3.78 percent in Santa Rosa to 5.95 percent in Stockton. Austin is seeing 16.58 percent population growth. Start-up activity not only depends on low cost of living and a healthy pipeline of capital but also on companies having access to talent. Provo, Utah, No. 2 on the Metro 20 list, has a population growth of 11.2 percent — Provo also has one of the lowest unemployment rates among all U.S. cities. Much of the top from smaller towns in California heads to San Francisco. Mid-size cities in other states can keep some of their talent, while California towns, like San Bernardino and Modesto, don't have enough to keep talent rooted.

"No question, there is clustering happening around cities. The second-tier cities are rising (more than most realize), but the third and fourth tiers are struggling, and that may continue. For example, cities like Atlanta, Nashville and Raleigh-Durham are showing strong momentum, in part because they are regional talent magnets. But some of the smaller cities in those states/regions suffer," Case said.



Story continues