REGIONAL VCs: ILLINOIS

From the World's Slaughterhouse to it's Business-to-Business Hub
By Scott Tyler Shafer
From the October 30, 2000 issue


Red Herring Magazine

In December 1998, the stock price of Chicago-based online auction company uBid (Nasdaq: UBID) rose from an offering price of $15 a share to $188 in two weeks. The 1,153 percent increase set a record at the time, yet the news went uncovered by the city's press. Others, however, did take notice, and quietly, as the Windy City's collective interests expanded beyond box scores, the button-down shirt-and-tie business community gave way to a vibrant high-technology scene.

Leading the city's transition from a benchwarmer to a player in the technology game are Chicago's many venture capitalists. From seasoned graybeards like Steve Lazarus of Arch Venture Partners and Len Batterson of Batterson Venture Partners, to newcomers like Keith Bank of KB Partners and J.B. Pritzker of William Blair New World Ventures, the city has been shedding its deeply ingrained caution and its aversion to change.

Chicago VCs are investing in dozens of local and national startups, with money raised from a large pool of rich individuals, including old-line business leaders who have finally come to see the tech industry as legit. Area entrepreneurs are scoring record amounts of venture capital from local and national sources. In the first half of 2000, a total of 256 Illinois firms received a sum of $1.6 billion, according to research firm Venture Economics. By contrast, in the first half of 1999, 142 companies collected approximately $495.8 million in funding.

In step with the venture capital growth, hundreds of would-be entrepreneurs have left behind their pension plans at established Chicago-based firms like Motorola, Tellabs, and the Big Five accounting firms to try their hands at startups. "The early success of the Internet has legitimized the idea of joining a startup," says Dick Reck, a partner at KPMG. "It seems Chicagoans have finally grown weary of being content."

The recent downturn in the stock market has done nothing to diminish this enthusiasm. Local VCs say they expected and braced for the fall. Chicago VCs have a strict investing philosophy, and even in their embrace of high-tech startups, they are hardly reckless. They tend to invest only in companies with strong fundamentals and management teams that have "a core competency" in the area of their venture. Caution may no longer be considered a virtue in Chicago, but risk is still a four-letter word.

Long known as a town with a work ethic that borders on morbid, a low cost of living, and strong Midwest values revolving around loyalty and family, Chicago boosters have said since the early '90s that they were poised to become the next technology hotbed (see "The Heartland," September). Certainly, the city has a lot going for it: four large, respected universities; a diverse, steady economy from profitable offline businesses such as Allstate, Ameritech, Andersen Consulting, Bank One, Motorola, Sears, and United Airlines; and a regional specialty in services, distribution, and transportation. But the same traditional values that helped to distinguish Chicago have also slowed the city's entry into high-tech entrepreneurism -- until now.

The town has gone gaga over the second wave of the Internet business-to-business companies. Startups are gobbling up downtown office space. BlueMeteor, Divine Interventures, Participate.com (Proposed Nasdaq: PRTP), Perceptual Robotics, and hundreds of other companies have formed to offer services to businesses. The local attitude is that nobody knows the business-to-business industry better than Chicago, given its historical strength in transport and service.

In step, venture capital firms have become more visible. The city's traditional leveraged buyout firms and banks, like ABN-AMRO, GTCR Golder Rauner, Madison Dearborn Partners, and William Blair Capital Partners have coyly converted themselves into early-stage venture firms. And in June, Silicon Valley powerhouse Draper Fisher Jurvetson opened a Chicago office, amidst rumors that other well-known Silicon Valley firms like Benchmark Capital and Kleiner Perkins Caufield & Byers would soon follow. However, most noticeable is the buzz surrounding local venture capital firms like KB Partners, founded by Keith Bank in 1996 to fund technology companies within 300 miles of its headquarters. "In the past two years, the city has changed. Before, there were no networking events. Now, there are three to four a night," says Mr. Bank from his company's gleaming new offices in the Chicago suburb of Northbrook.

Like half a dozen other Chicago VCs interviewed, Mr. Bank is modest about his firm's success and prefers to brag about the city itself. Noting that Chicago has a lot of the business-to-business market's critical component -- businesses -- he believes the city finally has the community and the network to support its rise as a tech center. Humility aside, the firm's first unofficial fund, which Mr. Bank used to lend him credibility as an investor, has seen two exits in its three deals. KB Partners is closing a second round of around $100 million.

Meanwhile Arch Venture Partners recently closed a $175 million seed and early-stage fund, the firm's fourth fund, bringing its capital under management to approximately $325 million. And William Blair New World Ventures (founded in 1996 as a strategic partnership between New World Venture Investors and the investment bank William Blair & Company and its subsidiary William Blair Capital Partners) closed in late 1999 a $100 million fund aimed, again, at early-stage high-technology firms.

Chicago still has a way to go before it is seen as a major league tech player. For one, the city's press has yet to come around. Still using profitability as the standard for deeming a company worthy of ink, local newspapers continue to miss the opportunity to tell many great stories of the city's tech successes. Plus, Chicago collectively seems to object to tooting its own horn. For instance, most of the city's VCs despise Andrew "Flip" Filipowski, outspoken CEO of Divine InterVentures, for his brashness and salesmanship. But they praise him for putting Chicago on the map with his first company, Platinum Technology, which he sold to Computer Associates for $3 billion in July 1999.

Perhaps it will take a tech hero, like Chicago sports favorites Sammy Sosa of the Cubs or Michael Jordan of the Bulls, before the city is taken seriously in technology. Then again, even if Chicago is deemed a technology mecca, its residents would still work hard and worry that they weren't getting the recognition they deserve.

© 1997-2000 Red Herring Communications. All Rights Reserved.