Reading time: 2 – 3 minutes

Chatter in the media about Chicago’s status as a technology hub seems to be growing. In the last few weeks I have been quoted in a couple articles on the topic. The first was a Medill article by Melissa Aparicio that looked at some of the policy issues in the state focused on technology growth. The second was a piece in the Tribune by Wailin Wong that focused on the possibility that Motorola may move their handset division to the west coast after they split the division off in 2011 and what the move may mean for technology.

In both articles I consistently stated my thinking:

• Chicago shouldn’t try to be Silicon Valley.
• Chicago should focus on what it is good at (e.g. building companies that use technology to disrupt businesses like trucking and printing and companies that focus on online advertising, ecommerce, etc.)
• Early stage funding in Chicago is getting better but is still extremely lacking (we need family capital focused on supporting companies in the region).
• There is a lot of great development talent in Chicago but keeping them here is hard and building tech teams is equally difficult.
• What you really need to build the scene in Chicago is to have some home runs hit and then help the lieutenants from those companies start their own companies (we’re starting to see more of that now).

Chicago has a lot going for it but also has some holes that are tough to fill (since they are chicken and egg problems for the most part).

Matt McCall – my former boss and one of my mentors – has a great interview in Fast Company (source: VC Confidential) where he describes his thoughts on the technology scene in Chicago (he even mentions a study/chart on exits in the area that he and I prepared a year or so ago that shows how many billions the Midwest has generated in the past five years). I agree with him on most points but I will say that being an entrepreneur here in the earliest stages is still very hard (but not nearly impossible).

Reading time: 2 – 3 minutes

Matt McCall and I had a conversation a few days back about Dan Primack’s post on new VC models (I wrote about Dan’s piece a little over a week ago for those that missed it). I focused on the fact that too much money has been pushed into venture capital during both my conversation with Matt and in my blog post and I do believe that it is a main issue.  However, it appears that the increasing amount of money going into VC funds has a couple of underlying causes (if not more).

1. LPs are trying to push more money into venture capital funds to get lower their unfunded obligations.
2. Venture capitalists are only too happy to take the extra cash to bump up their management fees (since exits and carried interest are hard to come by these days).

Unfortunately point number two is causing a big issue.

VCs nowadays, at least the ones who have raised successive ~$500mm – $800mm funds (i.e. large funds) every couple of years, are in a position where management fees are so high that they can potentially lead to salaries to the main partners in the $6mm – $8mm range (give or take).

This fact, combined with the fact that the IPO market is essentially closed (meaning it is harder to generate exits and, subsequently, carried interest), means that VCs are content raising a lot of cash and deploying it fast so they can cash in on their management fees.  Any good investments that create some carried interest are simply a bonus.

For venture capital to work, carried interest, the amount the partners take of successful deals, needs to be the main driver.  Once management fees get too high they can become a primary driver and, as mentioned above, this scenario becomes even more pronounced when the IPO market is lacking and exits are harder to come by.

Matt just wrote about a post about his thoughts on the VC compensation issue, which, given his many years of experience, has a lot more meat to it than this post.  It is a must read post so please check it out when you have a chance. (Matt also talks about the structure of Warren Buffett’s first fund, which is interesting to note especially in the context of VC compensation.)

Reading time: 3 – 5 minutes

This is a question I have been hearing a lot lately and one that I have thought a lot about.  My initial reaction is simply that VCs are long term investors so we don’t freak out about these market fluctuations.  A couple other thoughts I had were simply that the limited partners in VC funds are so large that they will continue to be good for their commitments and that the IPO market is already non-existent so, from that perspective, things can’t get much worse with regards to the the IPO-as-exit exit strategy (however, they can get worse from the get-acquired-by-big-co exit strategy).

Matt McCall referenced a post today on his blog that came from PE Week.  The PE Week post did mention the “long term” comment and some others but also suggested that VCs and their portfolio companies have actually become smarter about business since the dotcom bust and that has helped them weather the current storm without too much worry.

Below you will find the four ways that VCs and portfolio companies have changed since the dotcom bust as published in the PE Week article.  The mindset is certainly different than it was in the bubble but in some ways it is still the same (just this week I saw a couple situations of startups acquiring startups which made me wonder a bit about exit strategies).

1. Better Money Management: Milestones matter to VCs. Ask any entrepreneur, and you’ll find it’s likely he or she are getting money in tranches based on deliverables. Most tranches go through, even when milestones aren’t met, but the process allows VCs a better way of keeping track of the progress of their portfolio companies. VCs are less likely to write mega checks in the early stages, many have raised the bar of proof points needed to get a big round. Money is also more likely to go to things that directly drive valuation increases as a smaller percentage of any round is going to PCs, servers and bandwidth.

2. New Sales Models: It used to be about “Big Game Hunting” and multimillion dollar site licenses. It’s a model that was great for vendors: get all the money up front, then worry about delivering the product. But Software as a Service permanently transformed the way IT was sold. Now new installations are cheaper and can be scaled slowly. It’s a model that’s been adopted by IT appliance and PC companies as well. So when Datamonitor finds that IT budgets aren’t going to rise in 2009 Datamonitor Survey , there’s less reason to freak out. Most IT buyers have already planned their spend out: it’ll be re-upping on the services they’re already subscribed to.

3. Decreased Addiction to Advertising: The banner ad was a big part of any dotcom business model. When advertising budgets fell, hundreds of online businesses shriveled on the vine. Now, online businesses look less to online advertising for real revenue. Google Adwords had a big hand in that. Suddenly it was a lot easier to install advertising on your site, but it was also less lucrative. Nobody ever got rich putting up Google Ads, but at least using the service saves companies from having to hire expensive advertising sales people. The addiction to advertising has been broken and many companies are looking for other ways to make real value online.

4. Moderate Exit Expectations: If you’re not looking to flip a startup to the public market, what do you care that Wall Street’s investment banks are falling like dominos? Had this same crisis had happened 10 years ago, you can bet VCs would be pulling their hair out. But when there are already no IPOs, it’s hard for the public market to get worse. When exit expectations are more reasonable, it’s easier to keep cash burn in check. Startups are less likely to build out sales teams, for example, planning perhaps to later plug in to an exisiting sales organization via aquisition.