Angels in Chicago: Seed Investment for Startups Vol 1

Len Feldman

November 21, 2010 · 11 minutes read

Uncategorized

This post was written for Technori by Len Feldman.

Facebook, YouTube, Twitter, Yelp, Tesla Motors, LinkedIn, Zygna: Not all of them are household names, but they’re all highly-successful companies. They also have one thing in common: All of these companies were funded by angel investors who originally worked at a single Silicon Valley company, PayPal. When PayPal was sold to eBay in 2002 for $1.5 billion, the company’s founders, and some of its early employees, decided to make seed investments in other startups, along with providing advice, counsel and connections. Some of those investments have already paid off in a very big way; for example, Peter Thiel’s $500,000 angel investment in Facebook is currently valued at around $1.7 billion. (Thiel received approximately $55 million from the sale of PayPal to eBay.)

Silicon Valley’s angel community has become the lifeblood of startups there, and the fact that the angels exist in such numbers encourages more entrepreneurs to start their own businesses. It’s common for founders or employees of one company that’s been sold or had a successful IPO to fund others. For example, Chris Sacca, formerly of Google, was an angel investor in Twitter. Aydin Senkut of Google made an angel investment in Mint.com, which was sold to Intuit for $170 million. (As of late February 2010, Mr. Senkut had made more than 60 angel investments, ranging from $25,000 to $150,000.)

Chicago has its own network of angels, and most of them came to angel investing with very different backgrounds than their Silicon Valley counterparts. Who are some of these “Angels in Chicago”, what advice do they have for entrepreneurs looking for funding, and how can more investors be encouraged to become angels?

First things first: What is an angel investor? Wikipedia defines an angel investor as “… an affluent individual who provides capital for a business startup, usually in exchange for convertible debt or ownership equity. A small but increasing number of angel investors organize themselves into angel groups or angel networks to share research and pool their investment capital.” Missing from this definition are two important constraints: Angel investors almost always invest in initial (seed) funding rounds, and they usually invest a limited amount of capital—anywhere from a few thousand dollars at the low end to $500,000 at the top.

The terms “angels” and “venture capitalists (VC)” are often confused. They both provide debt and equity investments, but angels are individuals who invest their own funds, while venture capitalists raise funds from other investors, make investments in companies at a variety of stages, and are paid a management fee by investors for their services. Many years ago, VCs did seed funding, but as the size of seed rounds has gone down over time, VCs have focused primarily on later funding rounds (A and B rounds, mezzanine rounds, etc.) A group of so-called “super-angels” blur the line between angels and VCs—they invest their own capital as well as that of other investors, and they tend to fund seed rounds near the top end of the range—some super-angels will invest as much as $1 million in a seed round.

There are no good statistics on the number of individual angel investors in Chicago, but there are several active angel investor groups. Two of the best-known are Hyde Park Angels and Wildcat Angels. The Hyde Park Angels, with 76 current members, was formed in 2006 by classmates from the University of Chicago’s Booth School of Business Executive MBA Program and is based in the Booth School’s Polsky Center for Entrepreneurship on the University of Chicago campus. Wildcat Angels is based in Evanston but has no formal affiliation with Northwestern. AngelList, a website that connects startups with angel investors, lists 13 angel investors in Chicago.

There are also companies that do both angel-type seed and conventional venture capital investments. Sandbox Industries runs a seed-stage fund and also manages a $116 million VC fund that makes later-stage investments. Apex Venture Partners does everything from seed to late-stage investments. So, who are some of the people behind these organizations, as well as some of the individual angel investors in Chicago?

Meet the Angels

Jeff Carter is a co-founder and one of the seven original members of Hyde Park Angels (HPA), and he currently serves as the organization’s Treasurer. His “day job” is as an independent commodity speculator at the Chicago Mercantile Exchange (CME), which he’s done since 1992, and he was a member of the CME Board of Directors from 1999 to 2001.

Jeff and his classmates at the Booth School formed HPA to make money by filling what he terms a “donut hole” in Chicago financing—focusing on companies with a valuation of from $250K to $3MM before they receive outside financing. Companies smaller than that generally get “friends and family” financing, while companies with a valuation above $3MM before financing are generating revenue and usually have multiple sources of capital.

HPA focuses on companies in that $250K to $3MM range, whether or not they’re generating income. It limits its investments to Midwestern companies, with one exception: It will consider investments in startups that have a University of Chicago connection, even if they’re not located in the Midwest. According to Jeff, HPA focuses on seed rounds, right after friends and family. The group will consider later rounds, depending on the business and valuation. Overall, the business is more important than the specific round in making the decision on whether or not to invest.

In addition to group investments made by Hyde Park Angels, Jeff has personally made angel investments in tallgrassbeef.com and windetergent.com. When asked about the angel investing environment in Chicago, he said: “Opportunities in Chicago for angel investing are sort of sparse. There are ad hoc groups of private individuals that pass deals around. HPA tries to institutionalize it a little; there are other angel groups, but I think we are the biggest. Chicago needs to create a culture of entrepreneurship. The people that have been successful (as investors and in their own businesses) need to join an organization like HPA and mentor and invest in new firms. That is the essential ingredient of Silicon Valley–the successful guys (there) continue to participate. We are trying to build that culture. HPA is full of people that successfully started their own business. We also have some people that are pretty cagey investors, and are not afraid to take some risk and write a check. The other thing that we have is diversity. We have knowledgeable people from a lot of different industries. They can look at a deal and give an opinion that is not typical, and that forces you to look at a deal through a different lens.”

Andy Hagans is a co-founder of and strategic advisor to Best Online Universities. He recently joined HPA and invested in FeeFighters (http://feefighters.com) through that group; prior to joining HPA, he made an angel investment in ETF Database (http://etfdb.com). When asked about what got him interested in angel investing, here’s what he said: “Having founded a few companies myself, and closed a few rounds of funding as well, I’ve found it’s a challenge that I enjoy. As an angel investor I have to try to pick winners, when the odds against any given startup succeeding are long indeed. So I would say startups, speaking as both a founder and an investor, are an intellectual riddle that I have fun trying to “solve”, and they are also one of the biggest passions that help me get out of bed at 8 am every morning.”

“So there’s my passion for startups, but on the investor side, I started out angel investing informally when I funded another Chicago startup, ETF Database. My experience with that team (and investment) was going so well, I thought, well, why not keep going? But as some point you realize that your time and your capital don’t scale past a certain level and that’s where a group like Hyde Park Angels really helps you. I should also add that I don’t think a lot of angel investors are doing it to get rich–a normal angel allocation is maybe 5 or 10% of your portfolio–but it’s fun, and you get to meet people in the Chicago startup scene, so that’s a big element of it. Of course, it isn’t charity, so you want to achieve positive returns on your capital, too!”

Andy believes that the Chicago angel community is near, if not already at, the tipping point: “I think the team at HPA, and especially the associates from the University of Chicago Booth School, are a huge asset for any potential angel investor in the city of Chicago. You need a certain critical mass of capital and startups to make something like that possible, and HPA seems to be growing quickly and growing awareness of the whole Chicago startup scene. I know that a lot of folks in the startup ecosystem think that critical mass is in California, Boston, Seattle, and maybe even in Austin, but I think they would be surprised at the size and talent of the community here. I won’t even mention Groupon, because I think the breadth is much larger.”

Lon Chow is a General Partner with Apex Venture Partners, a Chicago-based venture capital firm with more than 25 current investments. (Apex generally invests from $200-300K at the low end to $4MM maximum in a single company, and typically leads the funding rounds in which it invests.) Prior to joining Apex, Lon was a partner with Mercer Management Consulting. Apex sometimes has to pass on a seed investment (for example, the partners may already have their hands full with other investments, or Apex’s latest fund may be reaching its end), but if Lon believes in the company, he may make an angel investment with his own capital.

Lon’s angel investments range from $10,000 to $50,000, and he’s made personal investments in Viewpoint Networks, YCharts, Tap Me! Games, BrightTag, BringIt and Solmentum, among others. In fact, it was his experience with Viewpoint Networks that encouraged him to make his own angel investments. He was first approached to be an advisor to the company, then asked to join its Board of Directors, and he invested in order to have a personal stake in the business. However, unlike his role at Apex where he sits on several Boards of Directors, he almost never takes a Board seat at his angel investments.

According to Lon, he appreciates the level of startup activities in Chicago: “There’s a deep talent base, especially in online.” Over time, he’s also seen that more people in Chicago are willing to take risks, both in starting businesses and in funding them. On the other hand, he noted that there’s still a real lack of seed-stage capital: “The reason is that Chicago investors don’t have much history, or experience, with this kind of asset class.” If investors don’t know how to value an investment or how to measure its risk, they tend to stay away. Lon also said that the Chicago angel community, while growing, is still small and somewhat fragmented.

Nick Rosa is Co-Founder and Managing Director of Sandbox Industries. He and Bob Shapiro started talking about the concepts behind Sandbox as early as 2003, and formally co-founded the company in 2005 when they hired their first employees. Bob and Nick were colleagues at G.D. Searle, with Bob coming to Searle in 1978, and Nick in 1980. They both moved to the NutraSweet division of Searle, where Bob rose to the CEO position. In 1985, Monsanto acquired Searle, and Bob became the president of Monsanto’s agricultural business, while Nick ran the Food and Nutrition sector. Bob eventually became the CEO of Monsanto, and when the company decided to divest itself of a number of non-agricultural businesses, Nick led a buyout of NutraSweet.

After Monsanto was sold and Nick had run NutraSweet for a couple of years, he and Bob reunited to decide what they wanted to do next. They both wanted to start new businesses and bring new technologies to market. Said Nick, “We spent a couple of years talking to people about why new businesses fail, and why, in the corporate development/business development world, most new projects fail. We then tried to develop a system for creating businesses that wouldn’t fail. One of the principles we adopted is that you need to have a large number of businesses to evaluate, because most of them are not going to be successful. So, it’s a numbers game.”

“The second principle is to test things cheaply, and to ask the ‘killer’ questions early. So many entrepreneurs and business development departments avoid the ‘killer’ questions: For example, ‘If the business fails in a year, why will it fail?” We can then put our resources behind answering that question early (in the process). Corporate environments and entrepreneurs often take care of the ‘easy’ stuff—‘Let’s build the product, let’s build the website, can you manufacture it’—and avoid the hard questions, which more often than not relate to how to cut through the clutter and get through to the business or consumer who wants to buy it.”

Sandbox currently invests in startups four ways:

  • Its initial approach, an incubator that develops and funds its own business concepts (although it has brought one startup into the incubator from the outside). Six businesses are currently in the incubator and are awaiting the decision for additional funding.
  • An $18.5MM seed-stage venture fund that invests in both incubated and outside startups. At present, the largest single investment that the seed-stage fund has made is $100K, although it would consider investments as large as $500K or $1MM.
  • A $116MM venture fund that Sandbox manages for BlueCross BlueShield. This fund focuses on A and later rounds of financing.
  • A $20MM co-invest fund.

Sandbox’s primary emphasis is on starting and funding new businesses, but since taking on management of BlueCross BlueShield’s fund, “We’re finding that there’s a really interesting circle that goes with innovating your own businesses and being in the fund world, because you get to see a lot of what’s going on, (and) you get to see trends,” said Nick. Between its internally-incubated businesses and the startups that it has invested in, Sandbox now has 17 active businesses. Sandbox’s emphasis is not on the financing, but rather, on how to build and grow the businesses, whether they’re internal or external.

Nick believes that the quantity of deal flow has increased a lot over the last 18 months—in his words, “There’s no shortage of people looking for advice and possible funding.” He also thinks that there are a lot of good-quality opportunities: As an example, he points to the Excelerate program (modeled on Y Combinator) that Sandbox participated in last summer. Over 300 entrepreneurs submitted proposals for new products and services.

He sees the challenge for angel investors in Chicago to be the same as it is in many other cities: “At such an early stage, how can you identify a potential winner? That’s why there’s such a high beta (risk) for early-stage investing. Also, how well can you work with the management team? We place a lot of emphasis on how we can help the business, so what’s difficult for us (and for other investors) is, how can you find businesses to help? That’s pretty much the only kind of investment we make—can we do something (beyond just investing money) to help the business move forward. Quite often, we can help with forming the team, finding customers, going to market, and similar things.”

Read Part 2 to find out how to find angel funding in Chicago, what to ask, where to find them, and what the typical investment sizes are.

1 Comment

Leave a Reply

Your email address will not be published. Required fields are marked *

Post comment