SMALLER DEALS

In a typical venture-capital operation, the fund manager gathers investments from a collection of limited partners, then uses the money to invest in young companies believed to have high growth potential. The funds generally have a 10-year lifespan. During the first several years, the fund manager is identifying and investing in portfolio companies, then developing them and, in the later years, looking to deliver a return to investors.

A VC firm can focus on only so many companies at once, so firms with large funds prefer to make large investments. (A $10-million fund likely would prefer to make 10 $1-million investments rather than 200 $50,000 investments.)

The problem for firms interested in web-tech startups is that the cost of launching an Internet-based business has plummeted as technology has evolved. Entrepreneurs can develop beta products and, in some cases, even establish market demand with shoestring budgets of $50,000 or $100,000. That has created an opening for individual angel investors and smaller operations to step forward as initial investors.

Later, when the startup is ready to scale its operations and is in need of a larger infusion of cash (in other words, when the company better fits the traditional profile for VC investment), it is likely to turn first to its existing syndicate of investors, potentially boxing out the larger VC firms.

VC firms have responded. Some have begun making smaller initial investments—New World Ventures put $25,000 last year into Chicago-based fundraising website GiveForward Inc., a dramatic departure from what Mr. McCall terms its “sweet spot” of $10 million to $12 million.

Investors such as Apex Ventures’ Mr. Chow have made personal angel investments in companies; later, as a company grows, he could invest through Apex. “That’s been a big trend,” says Maura O’Hara, executive director of the Chicago-based Illinois Venture Capital Assn. Fund managers “have to make sure there is a flow of deals for when they do raise their next fund, and the angel investments keep the pipeline full.”

CALIFORNIA CASH

Benchmark’s $11-million investment in GrubHub signaled that not only are Chicago’s tech startups becoming more compelling to local investors, they are on Silicon Valley’s radar.

After years of campaigning to get investors to pay attention to Chicago startups, Ellen Rudnick, executive director of the University of Chicago’s Polsky Center for Entrepreneurship, says she’s getting weekly calls from investors on the coasts scouring Chicago for the next big tech company.

“Suddenly, people there are noticing that there’s a lot of good stuff going on in Chicago and not every company wants to” relocate to Silicon Valley, she says. “The VCs there are saying, ‘If we want to stay on top, we might have to get on an airplane.’ “

It’s not just established companies such as GrubHub attracting attention, either. Three of the Excelerate startups’ investment syndicates included out-of-towners: Tap Me, Fee Fighters and GiveForward.

© 2011 by Crain Communications Inc.”