Chicago Hope

Ever since the futures industry was established at the Chicago Board of Trade more than 150 years ago, the city’s business leaders have prided themselves on being forward thinking.

The catalog houses constructed by Montgomery Ward and Sears Roebuck and Co. at the beginning of the 20th century ushered in the modern retail industry. Ray Kroc’s vision to franchise the Golden Arches worldwide later inspired younger generations to grind out business plans of their own. As is the case with Chicago’s famed skyline, there is no shortage of new venture ideas from area entrepreneurs that reach for the stars.

Despite (or perhaps because of) Chicago’s solid and diversified economy, venture capital activity in the Third Coast trails other national hotbeds. Yet the $406 million invested in the region’s companies last year is the largest amount VCs have put to work since the dot-com bust, according to the MoneyTree Report, whose data is provided by Thomson Reuters (publisher of VCJ).

Local VCs attribute the increase largely to the area finally returning to normal after several slow years following the bust. They also say they’re seeing more seasoned entrepreneurs and solid business plans than they have in past years.

“The whole ecosystem of Chicago is in much better shape in 2008 than ever before,” says J.B. Pritzker, who founded Evanston, Ill.-based New World Ventures in 1996. New World, along with DFJ Portage and Adams Street Partners enjoyed a nearly $300 million exit earlier this year when local portfolio company TicketsNow was acquired by TicketMaster. Pritzker, whose legendary family started the Hyatt hotel chain, was one of the first investors in town to focus on early stage deals and has been influential in recruiting other local angels to fund young companies.

A common lament among Chicago area entrepreneurs is that there is not enough funding for their companies right out of the gate. Many—including University of Illinois computer science graduate and Netscape/Ning founder Mark Andreessen—have moved their companies to Silicon Valley to get funded. In an effort to keep entrepreneurial talent from fleeing town, Pritzker helped to establish the Illinois Innovation Accelerator Fund in 2007. The $10 million seed stage fund also includes commitments from Merrick Ventures, Duchossois Technology Partners and several high profile angel investors and family offices.

Outsiders more interested

Oftentimes what you will find for better or worse in Silicon Valley are people who think about profits as kind of a secondary offshoot. [In Chicago], more people think about how I can take a legacy business and squeeze margins out of it.”

Peter Barris

New Enterprise Associates, which is based in Baltimore and Menlo Park, Calif., is bullish on Chicago and has invested more than $135 million in six area companies since 2004. In April, NEA invested $30 million in MediaBank, a 2-year-old developer of media procurement and analytics software.

MediaBank to date has raised more than $40 million from NEA to compete with incumbent Donovan Data Systems. The company was founded by 38-year-old serial entrepreneurs Brad Keywell and Eric Lefkofsky. The partners are also behind Echo Global Logistics, which raised $13 million from NEA before filing to go public in May, and, a website for organizing groups that raised $5 million from NEA earlier this year.

In addition to sharing an address at the old Montgomery Ward catalog building along a quarter-mile stretch on the Chicago River, these companies possess a common business-to-business disintermediation-oriented business model that appealed to NEA managing general partner and Chicago native Peter Barris.

“They think about their model in terms of, ‘How do I get this business profitable quickly,’” says Barris, who first heard about InnerWorkings and the entrepreneurial team during a football game at his alma mater Northwestern University. “Oftentimes what you will find for better or worse in Silicon Valley are people who think about profits as kind of a secondary offshoot. [In Chicago], more people think about how I can take a legacy business and squeeze margins out of it.”

While Echo Global and MediaBank can be described as meat-and-potatoes businesses, the style and ambition of their founders, says one local VC, is more akin to what you would find in Silicon Valley. Dan Malven, a Chicago-area angel investor who was with Flatiron Partners when it backed Kewell’s and Lefkofsky’s first company, Starbelly, says the duo’s fast approach to building businesses is something atypical to the region.

“They absolutely have the attitude that speed is more important than precision,” says Malven, who has invested in successful Chicago-area venture-backed companies such as FeedBurner and TicketsNow. “That attitude is required for startups to create significant value, and it’s baked into the culture of Silicon Valley, but not so much in other regions.”

Pub networking

The whole ecosystem of Chicago is in much better shape in 2008 than ever before.”

J.B. Pritzker

Investors who prefer having their term sheets with a twist adjourn every three months to the John Barleycorn Pub in Chicago’s Wrigleyville neighborhood (located five miles north of downtown) to attend the popular TechCocktail networking events. Founded in 2006 by 25-year-old DFJ Portage Associate Eric Olson and AOL executive Frank Gruber, TechCocktail regularly brings together hundreds of Chicago’s virtual movers and shakers who appreciate new deals almost as much as an open bar.

In 2008, TechCocktail began producing daylong educational conferences that showcase the area’s venture-backed success stories. Investors from firms including DFJ Portage, Illinois Ventures, MK Capital and Origin Ventures joined hundreds of Chicago-based entrepreneurs and executives recently to learn the ways of “The Wizard,” aka Dick Costolo, founder of FeedBurner, the region’s poster child for a successful Web 2.0 investment. Backed by DFJ Portage, Mobius Ventures of Boulder, Colo., and Union Square Ventures of New York, FeedBurner was acquired by Google last year for a reported $100 million.

“The best thing about being in Chicago,” Costolo told the crowd, “is that you don’t have engineers looking over their shoulder for their next job. We had very little turnover.”

With Abbott Laboratories and Baxter Healthcare located in Chicago’s northern suburban backyard, it is of little surprise that the medical device, health care and biotechnology sectors collectively drew the largest amount of investment in the region last year, capturing $139 million, or 34% of the total, according to the MoneyTree Report.

Still, the deep talent pool of research and executive talent need to look outward to raise capital, as there are few life sciences-focused venture firms in the Chicago area and neither Abbott nor Baxter manages a VC fund.

Palo Alto, Calif.-based Vivo Ventures, formerly BioAsia Investments, backed the two biggest pharma deals in Illinois last year, funding Sagent Pharmaceuticals ($53 million total) and NextWave Pharmaceuticals ($40 million total).

“Because of the currency situation, U.S. technology is cheap right now,” says Michael Rosen, a founder of the Illinois Biotech Industry Organization and vice president of Forest City Enterprises.

I long for the days when we can talk about too many early stage investors in Chicago.”

Steve Miller

The struggles of youth

Rosen believes it is still difficult for the majority of young companies in the area to raise money because angel investor tax credits in Illinois are not competitive with other states in the Midwest. He adds that “the one bright spot” is in the area of nanotechnology, where organizations like The Lurie Group “and other previously successful nanotech entrepreneurs are making money investing in the sector.” Elevance Renewable Sciences, which manipulates plant-based oils on an atomic level to create “green” chemical products, last year raised $45 million in a round led by TPG Biotechnology Partners.

While mobile communications pioneer Motorola struggles to yet again reinvent itself, the wireless sector in Illinois remains active with three companies attracting a total of $48 million last year. Novarra Inc., which develops software for wireless handheld devices, last year raised nearly $40 million from Qualcomm Ventures and previous investors JK&B and Kettle Partners, both of Chicago.

Despite recent turnover, Motorola Ventures remains active focusing on global investment opportunities in the communication space. The company’s founding Galvin family also recently established Harrison Street Capital to fund new businesses. Harrison Street Capital last year funded dispersed storage company Cleversafe, which is also backed by Chicago-based OCA Ventures in addition to NEA, San Francisco-based Alsop Louie Partners and Santa Clara, Calif.-based Presdio STX, Sumitomo Corp.’s early stage investment vehicle.

OCA Ventures was founded more than 30 years ago by O’Connor & Associates, pioneers in derivatives trading. The firm’s investment focus includes emerging financial technology companies in many cases founded by traders and engineers who cashed out after the $11 billion merger between the Chicago Board of Trade and the Chicago Mercantile Exchange. OCA, which has three funds and is among the most prolific early stage venture firms in Chicago, was the lead Series A investor in CohesiveFT, a “fin-tech” company cited by Information Week as one of the top U.S. startups in 2008.

Despite the gradual up-tick in VC activity, there is little worry that more investment activity will spoil what have been to date friendly valuations for growth stage companies.

“I long for the days when we can talk about too many early stage investors in Chicago,” says Steve Miller of Origin Ventures. Ten years ago, Miller’s family sold Quill Corp. to Staples for ten figures. He has since been an active angel investor and backer of companies including, ClaimForce and iNest (which sold to InteractiveCorp in 2004) through Origin.

“We would much rather have a more robust early stage investing community with many more folks who do this kind of thing,” Miller says. “Success will breed success.”