Chicago Startups Thrive on Zoom: A Venture Capital Shift

Chicago's Startup Scene Experiences Significant Growth

The startup community in Chicago is currently receiving the recognition it has long sought.

It is now widely understood that 2021 is proving to be a pivotal year for startups and venture capital, exceeding previous strong performances within a sustained bull market for technology-driven businesses. However, this growth isn't uniform across all regions.

Variations in Market Activity

Different markets are experiencing varying levels of activity, influenced by the maturity of their startup ecosystems and the accessibility of external funding. For instance, African startups are projected to achieve record levels of venture capital this year.

However, markets geographically closer to leading venture capital centers are witnessing even more substantial gains, as evidenced by the performance of Latin America. Conversely, China’s venture capital market is showing signs of moderation as other regions accelerate their growth.

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Even within the United States, there are noticeable differences in how individual markets are performing. Chicago is notably benefiting from the increased venture capital activity and the growing trend of remote investing.

Data compiled by CB Insights reveals that Chicago’s capacity to attract venture funding has reached unprecedented levels in the first half of the year.

Understanding Chicago's Success

While a positive outlook for startup investment was anticipated for Chicago, the actual results have surpassed expectations. To gain a deeper understanding of the situation in the Windy City, The Exchange consulted with M25, a venture capital fund specializing in the Midwest; Liza Benson, partner at Moderne Ventures (following her firm’s successful $200 million second fund raise); Scott Kitun, from the Technori community and investment platform originating in the city; and Brian Barnes, CEO of M1 Finance, a local fintech unicorn frequently covered by TechCrunch.

Their collective insights paint a picture of a city historically underserved in terms of capital, now capitalizing on a shifting investment landscape. Investors anticipate this positive trend will continue throughout the remainder of the year.

This indicates that Chicago-based startups are experiencing their most successful year for securing capital funding to date. Let's examine the factors contributing to this achievement.

An Unprecedented Surge in Venture Capital Funding

A new peak in capital raised by Chicago-area startups was achieved beginning in the latter half of 2020. Historical data reveals that Chicago benefited from a globally accelerated venture investment trend. This shift occurred as investors, initially worried about potential slowdowns in startup growth, overcame early concerns related to the COVID-19 pandemic.

Contrary to initial predictions, startups were not negatively impacted as widely anticipated. In fact, many young technology companies experienced accelerated growth during the first quarter of pandemic-related lockdowns. This was largely due to traditional businesses increasingly relying on software solutions and other services offered by these startups.

Record-Breaking Growth in Funding

The initial increase in Chicago’s venture capital totals during the last two quarters of 2020 was significantly surpassed in the first quarter of 2021. Subsequently, the second quarter of 2021 shattered the previous record.

Consider the following data:

A slight decrease in the number of funding rounds during Q2 2021 should not be a cause for concern. Round counts often lag behind in venture capital data reporting. We anticipate this number will increase as more deals are publicly announced.

Acknowledging the inherent challenges in venture capital data reporting, Chicago startups secured approximately the same amount of funding in Q2 2021 as they did throughout all of 2019, measured in dollar value. Each of the past four quarters in the city would have represented a record high dating back to 2016, were it not for the exceptional performance of subsequent quarters.

A Billion-Dollar Investment

However, it was the final data point in the chart that particularly stood out. Reaching $1 billion in quarterly investment for Chicago’s startups was remarkable. The fact that the city doubled its funding from Q3 2020 to Q2 2021 prompted an investigation: Which companies were responsible for this substantial influx of capital?

Chicago's Flourishing Startup Scene

A global trend indicates that increased venture capital investment correlates with the emergence of more highly valued startups – often referred to as "unicorns." This pattern is demonstrably unfolding in Chicago.

This year alone, ten Chicago-based startups have achieved a valuation of $1 billion or more. This represents nearly half of the city’s total of 21 unicorn companies, a significant increase in a single year. While company exits influence these numbers, the proportion of newly valued startups to established ones remains substantial, signifying a surge in leading startup creation within Chicago.

M1 Finance: A Case Study

M1 Finance serves as a prime illustration of this growth. Following an $11.2 million Series A funding round in 2018, as documented by Crunchbase, the company was recognized as a promising, though relatively unknown, venture. However, market conditions rapidly evolved.

In June 2020, M1 announced a $33 million Series B funding round. This was followed, just four months later in October, by the closure of a $45 million Series C round.

This momentum continued. A $75 million Series D round was secured in March 2021, culminating in a $150 million Series E investment this July, spearheaded by SoftBank’s Vision Fund II. From 2016, when M1 first received venture capital, through the beginning of 2020, the company had raised just over $20 million in total funding. Since mid-2020, however, it has secured over $300 million.

According to Brian Barnes, CEO of M1, “M1 is one of ten Chicago companies to attain unicorn status in 2021. This places Chicago as the third-highest U.S. hub for unicorn creation, trailing only the Bay Area and New York.” This achievement signifies that Chicago has surpassed Boston, a historically prominent venture capital center.

M1 Finance’s success extends beyond venture capital; its consumer-centric fintech platform benefited from the increased public interest in saving and investing, similar to Robinhood. However, unlike some competitors, M1 was able to secure substantial funding rounds in quick succession, a feat previously unattainable before the pandemic.

Other Chicago Unicorns

Beyond M1 Finance, several other Chicago startups have reached unicorn status. These include consumer video platform Cameo, which raised $100 million earlier this year, and e-commerce logistics provider ShipBob, securing $200 million in June.

ActiveCampaign raised $240 million this year, achieving a valuation exceeding $3 billion. Project44 obtained $202 million from Goldman Sachs, doubling its valuation to $1.2 billion. Fintech company Amount secured $99 million at a $1 billion valuation. The list continues to grow.

Future Growth Prospects

Local experts anticipate an acceleration in the rate of unicorn creation. Barnes notes that since the founding of the current generation of Chicago unicorns, “a considerably larger number of companies have been launched in Chicago, following a similar growth path, albeit at an earlier stage.” He predicts that Chicago will soon rival any major U.S. tech hub in terms of high-growth startup activity.

Victor Gutwein and Mike Asem of M25 investors highlighted transport and logistics, fintech, and insurtech as particularly active sectors.

Kitun of Technori also pointed to insurtech, alongside real estate startups and fintech. Additionally, Kitun mentioned media, food technology, and robotics as areas of emerging interest.

Benson of Moderne Ventures emphasized “SaaS and technology-enabled businesses across diverse industries.” The overall assessment suggests a broad spectrum of activity across numerous startup niches within Chicago, rather than a concentration in a single area. The city’s startups are actively innovating across a wide range of market segments.

Chicago Benefited from the Shift to Remote Venture Capital

Having examined which companies and investors experienced gains from increased funding and attention, it’s important to understand the factors that led to this outcome. M25 succinctly summarized the situation: “A robust, yet historically underfunded and undervalued group of Chicago-based startups suddenly gained nationwide visibility during their fundraising efforts, attracting a wide range of potential investors.”

Essentially, the widespread adoption of virtual meetings and investment processes – driven by the pandemic – proved advantageous for Chicago startups seeking capital.

However, it’s crucial to first consider the landscape prior to the pandemic. M25 noted that “Chicago, and the broader Midwest region, consistently faced challenges in securing venture capital due to a limited presence of local investment resources.” Consequently, Chicago startups often exhibited distinct characteristics compared to those in more prominent tech hubs.

To appeal to local investors and justify the attention of those further afield, these companies “typically demonstrated stronger performance indicators – such as revenue, user base, and unit economics – than similarly valued companies in San Francisco or New York City,” the firm explained.

Superior metrics at comparable valuations indicate that Chicago startups were, and to some extent remain, undervalued, according to Benson. “While valuations are increasing, they still lag behind those seen in established technology centers.”

This undervaluation undoubtedly contributed to investor interest during the era of remote deal-making. However, M25 emphasized to TechCrunch that it wasn’t the sole factor. When “conducting a deal becomes equally convenient whether you’re in a Silicon Valley suburb or Chicago,” a clear advantage emerges for “efficient, high-growth Chicago and Midwest startups that don’t carry the same hefty price tag.”

Kitun highlighted that this situation incentivizes Chicago startups to demonstrate a higher potential return on investment.

“Previously, the focus was on securing any available capital to satisfy investor demands. Now, it’s driven by the recognition that fiscal prudence combined with growth is highly appealing to external funding sources… because these funds aren’t accustomed to witnessing such robust revenue and profit margins at the seed and Series A stages.”

Investors are also now recognizing promising opportunities they may have previously overlooked, particularly in later funding rounds. M1 Finance could be an example of this, Barnes suggested. “M1 was initially somewhat underestimated in its early years, partly due to its location outside of the West Coast.”

Over time, this perception shifted: “As we achieved greater scale, investors began to acknowledge M1’s potential to become this generation’s equivalent of Charles Schwab. They embraced the Chicago-based approach of systematic and disciplined practices to build a substantial and lasting institution.” Over the last eighteen months, M1’s user base and assets have increased more than fivefold, demonstrating that its Chicago headquarters was not a detriment.

M1 also discovered the benefits of Chicago’s skilled workforce. “M1 has successfully recruited 80% of its employees from the Chicago area, with a significant portion being recent graduates from local universities.”

However, others have observed a growing competition for talent. “With the rise of hybrid work models nationwide, we are now competing for employees not only with Chicago-based companies but also with firms in New York, the Bay Area, and those offering fully remote positions.”

Furthermore, Kitun cautions that “the traditional expectation of in-office work remains strong” in Chicago, and the city risks “losing a significant amount of talent if founders, investors, and CEOs don’t fully embrace remote work options.”

Fortunately, Chicago also possesses the capacity to attract talent, Barnes stated.

“We are able to recruit individuals from across the country, attracting candidates who are passionate about our product regardless of their location. Chicago has effectively collaborated with local universities through initiatives like P33 and fostered the growth of startups through incubators and accelerators such as 1871. These programs provide M1 with a consistent pipeline of talent, which has not diminished over the past year and a half. We are now receiving a larger volume of inbound applications, enabling us to make more local hires.”

In conclusion, Chicago’s prior investments and initiatives are now yielding positive results, and these efforts are likely to translate into future successful exits.

Capital Reinvestment is Now a Reality

During a recent examination by The Exchange of the Brazilian startup investment landscape and exit strategies, local experts indicated that funds generated from successful exits are being reinvested into the country’s burgeoning early-stage companies. This trend is fueled, in part, by an increase in initial public offerings and a rise in mergers and acquisitions involving startups.

Capital recycling is a crucial element that has sustained Silicon Valley’s dominance in the global startup arena for many years. By reinvesting profits from previous successes into new ventures, regional ecosystems can maximize their returns and gain greater autonomy.

Chicago's Emerging Cycle

M25 reports that a similar phenomenon is now occurring in Chicago. Their investment professionals highlighted that while Chicago has historically experienced occasional significant successes, such as those achieved by Groupon, Grubhub, and Braintree, the reinvestment of capital was initially delayed.

They explained that the slower pace of capital recycling stemmed from a limited presence of venture capital firms within the Chicago region.

However, the situation has evolved. According to Asem and Gutwein, “Funds are now being reinvested, experienced team members are joining or launching new ventures, and a positive cycle is emerging.” This development is particularly significant for those who were involved in Chicago’s tech community during the early 2010s, a period when this type of reinvestment was notably absent.

Evidence of the Growing Momentum

What indicators demonstrate this flywheel effect in action? The M25 team points to the substantial amount of local capital that has been invested in prominent unicorns.

Examples include Chicago Ventures’ support for Project44, G2, and Cameo. Furthermore, other regional investors have provided funding to companies like M1 and ShipBob.

M25 is also an investor in Kin Insurance, which is preparing to become a publicly traded company through a SPAC (Special Purpose Acquisition Company). TechCrunch previously reported on this company in 2017.

• The reinvestment of capital is driving growth in Chicago’s startup ecosystem.
• Experienced entrepreneurs are leveraging their successes to launch new ventures.
• Local investors are playing a key role in funding promising startups.

This cycle of investment and innovation is creating a more robust and self-sustaining startup environment in Chicago.

Venture Capital Momentum in Chicago

A significant deceleration in Chicago's venture capital activity isn't anticipated in the near future.

According to Benson, the third quarter is demonstrating substantial strength in venture capital investment. Moderne anticipates this positive trend will persist into the fourth quarter, fueled by the considerable venture capital secured by Chicago-based companies.

Should the final two quarters of 2021 perform at least as well as the first, or even approach the exceptional results of the second quarter, Chicago will likely overcome its historical perception of lagging behind other tech hubs.

While the Chicago venture capital landscape isn't without its challenges, opportunities for improvement always exist, particularly in increasing early-stage funding availability.

Furthermore, Chicago may experience similar inequities to other markets regarding funding distribution based on gender or race. However, these concerns do not diminish the impressive financial figures the city is currently achieving.

Potential for Further Growth

The possibility of additional mega-rounds of funding is on the horizon. M25’s analysts concur with Benson’s assessment of continued deal-making momentum.

Although the most readily apparent opportunities – those with the largest gap between strong performance and valuation – have largely been capitalized on, the firm believes numerous promising startups in Chicago and the broader Midwest haven’t yet secured mega-rounds.

These companies, however, could potentially attract substantial investment later in 2021, or in the years 2022 and 2023.

Therefore, the Midwest should prepare for continued growth. Chicago has emerged as a formidable venture capital center, capable of competing with any other major hub.

• Strong Q3 Performance: Venture capital activity remains robust.
• Continued Momentum: Q4 is expected to follow the positive trend.
• Mega-Round Potential: Several Midwest startups are poised for significant funding.

This represents a significant milestone for the region.