Venture capitalists look to bet on tried, true entrepreneurs

To some observers, Patrick Spain looks like the type of entrepreneur Chicago needs to attract more venture capital.

Spain, co-founder and former chairman and chief executive of Hoover’s Online business information service, is a proven winner, investors say.

By Ann Meyer
Special to the Tribune

http://www.chicagotribune.com/business/chi-0404260078apr26,1,4655052.story?coll=chi-business-hed

That’s a big reason why even in the tough market of 2002 and 2003, Spain’s new Chicago-based online research company, Highbeam Research LLC, raised $4.3 million, half from venture capitalists and half from individuals, including himself.

In a business environment that has pushed venture capital standards to a new high, only proven entrepreneurs are getting funded.

"Three or four years ago, venture capitalists had much higher risk tolerance," said Bob Dorf, general partner at 1 to 1 Venture Partners in Stamford, Conn., which is backing Highbeam.

It’s a vicious cycle for many entrepreneurs seeking venture capital: Without funding, how do you get your first company off the ground?

It’s been a particular problem in Chicago, which lags the coasts and many other metropolitan areas in early-stage venture capital funding.

Some suggest it’s because Chicago doesn’t have the necessary talent.

"If you look at Boston and California, you see more high-tech employers, which are the nucleus of the venture capital start-up process," said Al Wiegman, a partner with HLM Venture Partners in Boston.

Midwesterners, on the other hand, suggest that Chicago, with its major universities, Fortune 500 companies and national research centers, has plenty of talent, just not enough early-stage venture capital firms.

"Chicago should be a great venture market, but no one has emerged at taking a leadership role in early-stage venture," said Travis Winkey, general partner at BlueStream Ventures in Minneapolis.

It’s a problem because locally based venture firms are four times more likely to invest in Illinois companies than are venture capitalists from out of state, said Maura O’Hara, executive director of the Illinois Venture Capital Association.

In the fourth quarter of 2003, Chicago ranked 18th among major metropolitan areas throughout the nation in the number of companies receiving venture investments, according to the MoneyTree Venture Capital Survey.

Now the issue is getting new attention from politicians who see venture capital as one way to stimulate business development and create jobs.

Gov. Rod Blagojevich is supporting legislation that would create a $200 million Illinois Opportunity Fund to invest in Illinois venture capital funds, which would back start-ups in the state. The bill passed the state Senate in March and is pending in the House.

"Venture capital in Illinois is a very conservative industry," said Jack Lavin, director of the Illinois Department of Commerce and Economic Opportunity.

"We need to be more proactive in making sure the infrastructure is here in gaining access to venture capital," he said.

In the meantime, the problem is exacerbated because venture capitalists prefer to back repeat entrepreneurs, such as Spain.

"But that’s a lazy way out," said Scott Meadow, professor at the University of Chicago Graduate School of Business.

"Any monkey can back a guy who’s taken four separate deals public," Meadow said. "What we need are venture capitalists that can help talented executives realize their entrepreneurial potential" for the first time.

Like movie producer

Meadow likens the role of the venture capitalist to that of a movie producer who finds a script, recruits a director and supporting cast and raises the funds to make it successful.

"It’s very difficult for a brilliant scientist with a breakthrough idea to commercialize that idea. It’s akin to the writer producing and directing his own script," Meadow said.

Attracting venture capital is a little like selling a screenplay. The odds are against the first-time entrepreneur, though submissions have declined somewhat.

For example, 1 to 1 Venture Partners receives 20 to 25 business plans a month, about one-fourth as many as in the ’90s. But it funded only one company last year and three the year before, mainly because the economy had walloped the marketing industry it generally focuses on.

"Things were melting down," Dorf said.

And 1 to 1 Venture is hardly unusual. BlueStream Ventures received 1,500 proposals last year, took a "good look" at 200 or 300 and generally funds two to six a year, Winkey said.

HLM Venture Partners typically makes investments in four to six companies out of 400 to 600 business plans received, Wiegman said.

With those numbers, how do they pick the winners? "Our deal flow principally comes from people we know," Wiegman said.

1 to 1 Venture liked Spain’s idea of combining several underperforming online research companies to produce a more user-friendly research service at a price individuals could afford. But more important than his business concept was his experience building a company from scratch, Dorf said. In Spain’s decade-long tenure at Hoover’s, annual revenue climbed to $31 million. Dun & Bradstreet Corp. acquired the company for $119 million in 2003.

Seasoned CEO

"Patrick was a seasoned CEO who had done it before in a related space in Hoover’s. He was a knowledgeable, proven leader with a vision of what he was going to do with the raw clay," Dorf said.

But as business in general picks up, Dorf and others expect to see more venture capital deals.

"There are billions of venture capital dollars sitting on the sidelines waiting to go to work," he said.

"It’s going to get better," agreed Steve Vivian, partner at Prism Capital in Chicago, which also is backing Highbeam.

"People are more willing to look at earlier-stage companies than they have been," he said.

Although more venture capital likely will be deployed this year than last, it will not be close to 2000 levels, experts say. Venture investment nationwide in 2003 totaled $18.2 billion in 2,715 companies, according to the MoneyTree survey. That’s a fraction of the $105.9 billion invested in 6,400 companies in 2000.

In Illinois, 43 companies received a total of $401.5 million in 2003, down from $2.4 billion invested in 157 Illinois companies in 2000.

O’Hara of the Illinois Venture Capital Association also says the picture is brightening.

The group’s Midwest Venture Summit this week, providing a forum in which young companies can make their business pitches to venture capitalists, will have 26 presenting companies, far more than expected, O’Hara said.

And once funded, Illinois venture-capital-backed companies have been performing better than their counterparts, with 28 percent achieving a positive outcome compared with 24 percent nationwide, O’Hara said. Later-stage venture-backed firms, traditionally Chicago’s strength, do better, with 56 percent having positive outcomes compared with 26 percent nationwide.

Some suggest the fact that Spain moved to Chicago from Austin, Texas, to start his business is promising.

"We need to attract more CEOs like Spain," said Vivian, who hopes he will stay here and start up more than one new enterprise, luring more venture.

But besides attracting more venture-backed entrepreneurs, the state needs to lure more venture capital, experts say. The governor’s Illinois Opportunity Fund is aimed at doing that, Lavin suggested.

But the program will not be successful unless it attracts experienced venture capitalists who know how to coach young entrepreneurs, Meadow said.

"It all depends on who are the professionals running those funds," he said. "Experienced venture capitalists make experienced entrepreneurs."

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