Why California Is Bad For Innovation

It's now stupid to start an innovative business in California.

Here's why one business I direct should leave. It's got a sweet electro-optical product that delivers superior images. But sales stayed flat until production left California for China in 2004. Three things happened:

First, costs dropped--but only by 15%, since many of the components were already produced in Asia. Second, quality improved--there's something few people get. Third, turnaround times got quicker. Yikes.

So in 2005 sales ticked up, they doubled in 2006, we showed first profits in 2007 as sales doubled again and ditto for 2008. This meant management could hire more engineers. It did. And the products got better and better.

Then: Oops! Toward the end of 2008, our Sacramento geniuses decided to "temporarily" suspend all net operating loss carry-forwards. They did this retroactively, to the beginning of the year, and 2009 sales growth slowed to 10%, putting the brakes on new hires. Burial services were held for a few interesting new products. Some of this was the recession. Some of it was not. Final inspection is now leaving California for Hong Kong. Better. Quicker. And since half the products go to Europe, they can simply chug up the Suez Canal and deliver even faster. Then you've gotta ask, why keep headquarters here? Moving to Hong Kong could cut corporate taxes in half and income taxes by more. Many businesses with international customers improve results when they leave the U.S. Others, with national markets, improve results when they leave California.

Example No.1: US Press was a roll-up of printing businesses. I ran it from 1980 until 1986, when Continental Graphics bought us. They shifted work from our Los Angeles and San Diego plants to Portland, where union rules were almost rational, and boosted profits.

From 1986 until 1989 I was CEO of a troubled software company, Checks To-Go. We fixed it, and Rocky Mountain Banknote bought us. Rocky Mountain shut down California operations and moved Checks To-Go to Utah, where workers' compensation rates helped make the company even healthier.

In 1989 I took over Smiley Compact Industries, an aerospace manufacturer. Precision Aerotech bought us in 1990 and moved all the work to Phoenix, where productivity improved.

Do you see a pattern here?

I became chairman of Knight Protective Industries in 1990, and this outfit was bought by Protection One ( PONE - news - people ) in 1996. Knight moved operations to Oregon, where four-day work weeks were permitted by the state, as employees wanted. Simultaneously, I co-founded Teledesic, and dabbled with it until 1996 when Craig McCaw invested and moved it to Washington state in anticipation of better capital gains (that happened, finally--at profits to the early shareholders--in 2006. Bill Gates now owns Teledesic.) In 1996 we started @Backup, an online data storage service. I retired rather abruptly after a board meeting during the bubble burst of 2000, and three CEOs followed me in rapid order. The business was acquired by a Virginia-based software company for reasons I do not know. I do know those later buyers made over $100 million when they nursed it along and finally sold last year.

Are my experiences aberrations? Probably not. If, instead of Chamber of Commerce or government statistics, we look at U-Haul rates, we can see what's really happening on the left coast. As of July 31, the price for a 26-foot truck going from San Diego to Dallas is a steep $1,940 one-way. Business must be good in that direction. But to return on the same day, in the same truck, Dallas to San Diego, costs a mere $654. Nobody's returning to California. Going back to global examples, another business I direct delivers half its service in the U.S. and half elsewhere. Headquarters are in California. In 10 years it's grown from a dozen employees to over a thousand, many international.

The Federal IRS guys decided that our foreign subsidiary--with real people and real operations, doing real things and being 10 time zones closer to many customers--should be taxed as a U.S. company. Retroactively. For five years. This is after approving the setup and no cash coming back from the foreign sales. So tell me, why should that Compact business stay in California? Or the U.S.? When you've got U.S. citizens as shareholders, leaving the country is becoming the most patriotic thing you can do for them.