Chicago Hopes for Second Wind

Read the Chicago papers, and you’re a lot less likely to read about a new entrepreneur on any given day than sales for fast-food giant McDonald’s Corp., based in nearby Oak Brook, Ill. It’s enough to make Eric Lefkofsky, a highly successful serial entrepreneur and investor, want to scream. “Chicago is an incredible city,” he says. “It’s also big business-centric.”

That may be changing, thanks to a growing number of entrepreneurs and investors who intend to make Chicago as well known for its emerging startups and talent pools as its famously extreme weather.

Lefkofsky and his business partner, Brad Keywell, former University of Michigan classmates, are certainly doing their part. In March the duo introduced Lightbank, a Chicago-based fund committed to investing up to $100 million in early stage tech startups over the next 10 years, most of them based locally.

Though New Enterprise Associates has committed an undisclosed amount of capital to Lightbank, the money is otherwise coming exclusively from Lefkofsky and Keywell, who’ve been collaborating on projects for much of the past decade, including founding the publicly traded logistics management company Echo Global Logistics, which went public last year after raising less than $20 million from NEA and others.

The pair also co-founded of invested in MediaBank, a media-buying platform that has raised $50 million from NEA and Steamboat Ventures; Lightswitch, which aims to be a 21st Century Yellow Pages; and Groupon, the popular group-discount site that last month picked up $135 million at a reported valuation of more than $1 billion from Russian investor Digital Sky Technologies and Battery Ventures. (Rob Solomon—once president and CEO of Sidestep and most recently a venture partner at Crossover Technology Ventures in Palo Alto, Calif.—moved to Chicago in March to be Groupon’s president.)

Another new effort that hopes to marry capital, talent and Chicago is Excelerate Labs, a Chicago-based training camp for tech entrepreneurs that is set to kick off for the first time this June. Excelerate plans to provide between five and 10 startups with a communal workspace for 13 weeks, as much as $20,000 in seed capital, and advice from VCs around the country, including August Capital, General Catalyst Partners, Point Judith Capital and Trinity Ventures.

Organized by native Chicagoan Sam Yagan, founder and CEO of online dating site OkCupid, Excelerate received nearly 300 applications from around the world. Yagan expects roughly half the winners to be from Chicago.

The success of Groupon has brought people to Chicago who are trying to figure out this really fast-growing social commerce platform. People are looking at the sheer growth of it and saying, ‘Where did that come from?’”

Eric Lefkofsky

Local investors say more entrepreneurs are choosing to stay in Chicago, rather than move to either coast to set up shop. Chicago-based venture capitalist Lon Chow says that his firm, 23-year-old Apex Venture Partners, didn’t do a single tech deal in Chicago until 2002, but since that time it has made 11 investments in local tech companies.

That talent is pooling locally owes partly to the “social graph” changing, says Lefkofsky. “There’s not as much emphasis around that explosive high growth that you see on the coasts,” he says, but mediums like blogs, social networks and Twitter are democratizing the process of accessing great tools and advice. Chicago entrepreneurs “are being exposed to many more ideas and businesses, and that’s fostering a new wave of innovation,” he says. “There’s a gold rush and they’re saying, ‘I want in.’”

Relationships between area entrepreneurs and investors are also improving thanks to a growing number of networking events and organizations, says Kapil Chaudhary, a partner at the $10 million i2a Fund, founded in 2007, which is an extension of the non-profit Chicagoland Entrepreneurial Center. (The entrepreneurial center is a spinout of the Chicagoland Chamber of Commerce.)

In addition to regular forums organized by the Center, the Illinois Venture Capital Association has begun hosting more get-togethers, an industry trade group called the Illinois Technology Association has been putting on more regular events for startups, and a 4-year-old group called Tech Cocktail has begun attracting between 400 and 600 Chicago-area investors and entrepreneurs to its local events.

Just three years ago, it looked like Chicago was finally establishing itself as a magnet for venture investment. The city’s startups raked in close to $700 million in 2007, in their largest haul since the dot-com bust, prompting a July 2008 VCJ story entitled “Chicago Hope.” But Chicago couldn’t keep the momentum going, especially in the wake of the financial crisis of 2008. Venture investment in Chicago companies has fallen for the past two years, hitting a 14-year low in 2009, according to Thomson Reuters (publisher of VCJ). VCs invested just $197 million in 46 Chicago companies last year, down from $530 million for 66 companies a year earlier. This year looks to be much stronger, at least in terms of dollars invested: As of April 19, VCs invested close to $460 million in 18 Chicago companies (see tables).

Relative to Silicon Valley, Chicago’s startup community has a lot of room to grow. Crunchbase says there are around 270 tech startups or investing outfits located within a 25-mile radius of Chicago, including venture-backed Web startups Threadless, which produces user-designed T-shirts, TicketsNow, an online ticket seller, and GrubHub, where users can locate and read reviews of restaurants offering free delivery. In contrast, about 1,900 startups and tech investors are based within a 25-mile radius of Palo Alto, according to CrunchBase.

Chicago has been home to a number of breakout hits already—including VC-backed Feedburner, which sold to Google in 2007 for $100 million, and online recruitment site, which went public in 1999—but there are a number of factors that work against the Windy City becoming a major center for tech innovation.

You can go into trading, you can work for a hedge fund, you can run your family’s small business. The reason tech hasn’t developed here as much as in other areas is largely the historic development of other industries.”

Lon Chow

Unlike Boston or the Bay Area, where the tech industry is dominant, or New York, known as the country’s financial services center, Chicago isn’t known for one thing. “In Chicago, there are lots of ways for smart, talented people to make money,” says Chow. “You can go into trading, you can work for a hedge fund, you can run your family’s small business.” Whether it’s a blessing or a curse, says Chow, “the reason tech hasn’t developed here as much as in other areas is largely the historic development of other industries.”

A bigger issue, says Chow, is the “real mismatch between the supply and demand of capital. There’s much more demand for capital than supply.” In fact, in conversations with numerous sources in Chicago for this story, only a handful of firms were named time and again as reliable funding sources for early stage companies, including Adams Street Partners, Apex and New World Ventures.

Merrick Ventures, formed by Michael Ferro, founder and past CEO of business-to-business software company Click Commerce, is also an active investor, but it mainly focuses on growth-stage companies.

Another knock against Chicago is that there’s “no specific place, like Google’s headquarters or University Avenue in Palo Alto, where you’re going to run into people,” says Chow. Despite Chicago’s huge business community, rife with law firms, accounting firms and other service providers, “you don’t have that same kind of startup infrastructure here,” he says.

That’s not to say Chicago won’t turn into a startup Mecca, especially with the help of true believers like Lefkofsky. “Chicago isn’t as early stage focused as the Valley but there’s no shortage of talent or money,” he says. “It’s all about shining a flashlight on it.”

Lefkofsky points to the “fantastic” revival of the tech scene in New York right now. “I think they’re starting to feel like, ‘We can compete with the Valley,’” he says.

Lefkofsky is hoping the same phenomenon can take root in Chicago. “Certainly the success of Groupon has brought people to Chicago who are trying to figure out this really fast-growing social commerce platform,” he says. “People are looking at the sheer growth of it and saying, ‘Where did that come from?’”