Perspectives

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A chicago entrepreneur made a rather bold statement to me yesterday: 20 somethings in Chicago don’t get venture capital funding. I can think of one counter-example, but still- imagine being 24 and realizing that you live in a city  where only one or two people have accomplished your goal before. I don’t have a thesis for this blog post, but instead I want to explore the ecosystem of seed-stage Chicago.

I will preface the rest of this blog post with my current philosophy: creative people should always follow an eccentric path to success or failure, because even failure towards a creative end while you’re young will set you all the more apart from every other resume on the stack. And to succeed while you’re young will open every door imaginable.

That said, we must remember that venture capital only represents perhaps 0.1% - 0.2% of the GDP. Later-Stage Private Equity and Public Equity dwarf the sum of all funds invested in startups. Likewise, the sum of all capital owned by young (<30) entrepreneurs either by exit from a startup or by valuation of their startup is less than the net worth of all young US used car salesmen. It just so happens that the subset of high value young entrepreneurs garner more and more attention from the press each day.

I’ve never worked on the finance side of any business. But within 1.3 months of midVentures, I can identify the startups who raised funds from from”family and friends” investors (30% of my clients), from professional angel investors (less than 10%), from their own savings (at least 50%), from venture capital or private equity (2%), from corporate contracts (around 8%). Since I live in a seed stage web world with such friendly startups as Cameesa, Dawdle, InklingMarkets, Trumarx, EnergyResults, Contenture, Enproperty, CommonGrants, Zolio, etc, etc, over 80% of my clients and partners jumpstart their companies with their own cash, family, or friends. In fact most “deals go down” in my circles with the good ole’ fashion “My friend’s dad is the CEO of XYZ”.

Though 80% of the startups raising funds do so within a family and friend network, I would turn around and say that at least 80% of the sum of all capital invested in the startups I work with comes from VC, PE, or Corporate. This creates the typical startup ravine, over which the majority of my startup friends live. You have raised between $5k and $100k from personal savings, friends, and family. I know at least 20 chicago startups in that category. You have a product; which may be generating revenue. You have a business plan, but likely do not have the due diligence checklist or mature management team for a $2m VC round. You’ve probably talked to I2A, Hyde Park Angels, the Northwestern Incubator or ITA, the CEC, the business schools (Booth, Kellogg, Coleman), perhaps Heartland Angels, perhaps New World Ventures, Charles River Ventures, OCA Ventures, MK Capital, Origin Ventures or Illinois Ventures. Some investors told you that your style startup could not raise funds in chicago. Some investors told you to call them back when you have more traction. Some investors told you that they just don’t get your idea, or don’t like what they see. Admittedly, I’ve been a bystander in most of these situations - but I thank the UChicago Booth School NVC program for accelerating my exposure.

As a side note on this tale, I have accidentally crossed paths with more brick and mortar investors in Chicago than tech investors. For those who have never pitched to a PE, real estate, or commodities investor; plan on over-focusing on the terms of the deal and the equity ‘kickbacks’ for whomever put the deal together. Chicago is a city of brokers. Brokers make money on fees. SF friends introduce everyone to everyone without an NDA or patent, without a finders fee contract. I had a web entrepreneur who wanted to turn midVen into a finders fee business for matching startups to investors - “Venture Brokering”. Needless to say, his background was real estate. In SF, your information capital is your skill and your ability to execute an idea. In Chicago, there is a trend towards treating your contact list (not necessarily the relationship, just the contact) as undisclosed information capital. I am under the impression a VC firm will not take a deal seriously if there are 1 to 3 people with equity stakes simply because they helped put the deal together. I have seen that model work in real estate and commodities.

In any case, you’ve raised $5k - $100k, you have a product; a programmer, a designer, a lawyer who may or may not charge you for work, at least 50 people who support what you’re trying to do. You have customers, and you either have revenue or a growing community. But its not enough to support more than one person as a full-time job. What’s the next move?

If you’ve ever played the game GO - this is one of those ladders where you and the world are probably butting heads in a diagonal direction. If you cross the ravine and raise $500k (I know 5 chicago startups in that range) then you are equally nervous about raising your next $2m. Part of you hunkers down and says you can generate revenue internally. Another part thinks there is more risk capital in San Francisco. This- by and large- is the ethos of young tech chicago.

Just as the game GO is often decided within the first several moves; so do your decisions on day one of your venture dictate how far a bridge you will build over your ravine- or how wide your ravine is. (I say Ravine instead of CHasm because ‘Chasm’ is a common startup term for the void between a funded startup’s early adopters and early mainstream custoemrs) Crossing the ravine means raising over $2m to run a company with a permanent team; or perhaps crossing the ravine means organic cash flow. Chicago produces far more internal cash flow ’small businesses’ with linear growth models such as law firms, consulting firms, hosting providers, data warehouses, web development shops, and ad agencies. Those have a small ravine. And there are no VC shops in Chicago that can jump a startup over a large ravine- say $10m+. You need to change cities. In other words, knowing your landscape and knowing the rules is just as important as the engineering of your train.

The ratio of entrepreneurs within linear growth startups (ad agencies, IT consulting) who make over 6 figures in Chicago to entrepreneurs with exponential growth high risk startups who make over 6 figures is likely 99 to 1 - I would like to see real research on that subject. I hear the phrase “his finance firm just raised funds” far more frequently than “his web company just raised funds”. Many of my entrepreneurial friends are reconsidering their business models to accommodate linear growth within a lifestyle business. If there was a class in Chicago on “consulting for companies” - it would fill its seats every day with web entrepreneurs who need to reposition themselves.

I can feel the seeds of the ’self-aware’ proletariat of Marx’s communist revolution being sown in a new class of web entrepreneurs who either implemented a good idea at the wrong time and in the wrong place, or implemented a bad idea. There are few riskier career paths than to be a web entrepreneur in Chicago - especially if this is your ‘first startup’. Within our self-awareness, there may be an opportunity to evaluate the landscape, the opportunities, and the new forms of capital we are accidentally producing. Techy conversations create social capital as ideas are exchanged and implemented within a startup and then within a corporation. In fact, Chicago corporations may be the biggest winners from our fledgling tech scene, as their developers experiment and converse in coffee shop hackathons. An app that cost 80 hours and several cups of coffee could see its true value in the intangible human capital of a developer who implements the right social media strategy in the office.

I have an intuition that the experimenting conducted via the web startup directly benefits the bottom line of corporations within 2 degrees of separation of the cofounders or developers. In the same sense, playing on the playground directly benefits your social, career, and athletic life outcomes through the discovery and distribution of skills and knowledge. Capital is not directly reaching the cofounders of web / tech startups in Chicago. Perhaps the startup is simply the experiment of human risk capital in a larger ecosystem - or perhaps young entrepreneurs move between cities with more fluidity than the stationary investors.

Back when Brian and I created midVentures, we always intended on becoming an ‘incubator’ in one sense or another. Though we do have ownership stakes in 5+ of our peripheral startups, trading services for equity tends to ‘over-leverage’ our own time.

Alex Wilhelm, Jon Pasky, and Nikhil Sethi have done a great job watching the national tech incubator scene, and we all resonated on this article

http://www.pchristensen.com/blog/articles/what-would-a-chicago-style-ycombinator-look-like/

What I find interesting about this article is the truth that we in Tech Chicago tend to forget- Chicago does not have the early stage capital, the tech media, or the web 2.0 jobs that other cities have. What we do have is corporations. Ironically, corporations might just be a startup’s future best friend.

Blue Cross recently put another $18m into Sandbox Industries’ seed stage tech startup fund. I see that as a shining example of how chicago corporations can benefit from our fledgling tech entrepreneurship scene. Web 2.0 talent stays in chicago, and big corps get to outsource (or crowd-source) their R&D to 24 year olds willing to work for $2-3k a month. Some of chicago’s lowest paying jobs might become a corporation’s highest long-term return on investment.

Two of my friends have came to me holding y-combinator applications for their own ideas. And Chicago cannot compete with Y-Combinator for social capital, technology resources, or entrepreneurial connections. But some startups just need a corporate partner or a corporate sponsor. The cost of one VP’s salary can fund 10 startups a year. Beyond Blue Cross, who else will take this initiative?

The “Semantic Web” is supposed to give meaning to information by identifying relationships between websites, media, news, events, outcomes, etc, and as such, deliver information that is more meaningful or relevant to us. What I find interesting about the Semantic Web or Web 3.0 is the concept of ‘me’ on the web, which is why I wanted to write about Identity 2.0.

It will soon be easier for an unrelated person to find your life history online. Between public records, social networks, professional experiences, and general website use: we leave fingerprints all over the internet. I am likely registered for 100 different websites and perhaps 5 of those accounts are ‘interoperable’ allowing me to log in using a single identity. But Identity 2.0 is about more than logging in with a single account, Identity 2.0 involves how the web gives meaning to our identity.

• Reviews: If we reviewed books, movies, colleges, jobs, restaurants, articles, consultants or investment opportunities with a single unique ID, the ‘weight’ attached to each review, its impact on the object, and its impact on ourselves would all be more contextual and meaningful. Imagine reading book reviews weighted by the set of person who like the same books as you. In the same light, “expert reviews” would be able to more quickly identify merit or fraud over large data sets of objects.
• News: I admittedly don’t read any news sites except TechCrunch, Facebook News Feed, and France24.com in french. Sometimes I leave BBC running on my TV, but not since I lived in India. If the internet ‘knew who I was’ it would both route me more meaningful news, and it would route my own user-generated news to relevant end users. In order to route me news, the internet needs to know more about me: perhaps my job, interests, travel plans, education, entertainment, or pressing concerns. The only news I receive based on who I am and what I am doing comes from other people within facebook or linkedin.
• Career: It is ridiculous that one employer should have a monopoly over the specialized skills of an expert employee. Identity 2.0 enables managers to hire specialists for short-term high-paid work based on who they are and what they know, without having to build in-house teams or core competencies. Likewise, 50% of the workforce would need to structurally change their jobs, because 50% of work performed is nothing else but the training, selection, filtering, and distribution of non-digital human information. The more human information is digital, the easier it is to find and reward, and the less redundant information will be between organizations.
• Government: The ability to connect people with shared problems or concerns is still an act of phone calls or facebook groups. The ability to connect people with shared concerns and translate those concerns into actions that affect the greatest number of people through legislation, collective action, policy reform, publicity pressures, or direct litigation is in its infancy because we only tie problems to our online identities when we are directly solicited. If we tied our critical issues to our identities in a way that the internet could meaningfully connect us: publicity would more quickly translate into reform.
• Health: Our health care system is a system of crisis response. Our health identity is consigned to our medical records in the filing cabinet of a hospital, and all subtleties of our lives that might clue in a physical or mental problem are lost to the digital world. Identity 2.0 will enable the digitalization, tracking, and analysis of passive health data from travel plans to family dynamics to financial situations. But more than just tracking us, health care should be talking to us. There will be red flags if a new diet disrupts my sleep schedule or new medications are causing excessive weight loss. Our concept of health insurance will change as we update our online identity, and it updates us.
• Social: The implications of identity 2.0 on the social sphere is a real blue ocean of possibility. Within 10 years, social networks allow us to ’stay in touch’ with thousands of weak relationships, as opposed to the few dozen strong relationships we meet in person. The more identity we have online, the quicker we can establish trust, plan events, exchange media, and transfer our identity to mobile phones or GPS locations. If you move to a new city, within a month of joining a building, finding a job, joining a gym- you can connect to new like-minded groups in a low-risk environment. Online identity also implies online activity, where our reviews, comments, tweets, articles, and portfolios represent more of our social lives.

When we search Google, we are searching the same Google as a neighbor with a completely different identity. Personalized advertising aside, the internet itself is not personal. Ideally, searching the internet would weigh search results by your identity, social network, and professional network. If I’m a University of Chicago student and I search for apartments, results should be weighed by my location, by peer reviews of other students, perhaps even by independent review firms specializing in matching college students to apartments. If I search for “Brian Mayer” the search results should be weighted by network and context relevancy. But all of this depends not only on me searching the internet but on the internet searching me.