When I co-founded Hyde Park Angels, I did it with the hope of eventually doing a fund. I saw the writing on the wall for pit trading where I had made a living since 1986. Little did I know how high hurdle would be to go from angel to actual operating venture capitalist. It is a lot higher than you think. Building a fund is a lot like building a startup. We recently did a first close on our fund and are looking to raise more money along with finding deals to invest in.
If you are thinking of doing any kind of fund, I think there are four gigantic problems you have to solve for.
- A partner
- Raising money
- Deal flow
Finding a partner is extremely hard. It’s the most important part. Other VCs have blogged about it. Each partnership is unique because the people in the partnership are unique. In my case, I spent my entire career basically solo. I was my own boss, with my own money. The only person I had to be accountable to was my wife.
Partners aren’t something that you can just advertise for. This isn’t lego block building. It’s organic. In my case, a mutual acquaintance introduced me to Kenny. He was interested in doing a venture fund too. We talked a long time about it. We talked about focus. We also had to be very clear about what each of us was good at, and most importantly what each of us wasn’t good at. We also had to have an open dialogue about expectations.
Kenny was the fifteenth employee at Getco. Getco was one of the first high frequency trading shops in the world. He grew up in the north suburbs of Chicago. He is a computer scientist. He is very process orientated. He’s done some things with Bitcoin and Blockchain. Interestingly, he had an appointment to the US Air Force Academy, but decided not to go when Truman State offered him a full ride. There are a lot of HFT guys that have come out of Truman State. He triple majored down there and worked at Getco. Kenny helped set up Getco’s London office and traded in Europe. That’s also where he met his bride. They have a young son age 2.
Kenny hasn’t interfaced a lot with the mainstream startup community in Chicago, but they will appreciate getting to know him. I remember in 2007 when we first introduced Hyde Park Angels and the mainstream community wondered, “Who the hell are these guys?” If you go into the engineering rooms of just about any HFT shop in Chicago, they know Kenny.
Fred Wilson has blogged about being a theme vs thesis driven venture capitalist. When Kenny and I got together and started talking, we initially focused on themes. What were we going to invest in? Part of that strategy is figuring out how to separate yourself from other firms in the market. For example, if we said we were going to invest in B2B businesses, how would we look any different from 100 other venture funds?
Part of figuring out where to invest is also where you see the opportunity to earn return. Just like a business, you cannot throw things at the wall to see what sticks. Putting constraints on yourself is a good idea. “Investing in great people” is not a thesis, theme or strategy. Of course, all the academic data shows you need to invest in good jockeys at seed stage.
In figuring out our strategy, we not only had to figure out focus, but check size, where in the funding cycle we wanted to play, geography, industry, and all the other things that go into building a business. We had to be able to give limited partners alpha. Here is where we landed when we thought about position:
“WLV invests in business to business fin tech firms that are revolutionizing the backbone of finance.”
Back in the mid-nineties, some people saw that the capital markets were going to change. They did. It was a massive upheaval. The lion’s share of it happened in Chicago. There were winners and losers and money was made. We see the same thing happening in the next five to ten years with the backbone of finance. Interestingly, my wife and I were out with friends last night and Robin told me their firm sees the same exact thing.
The firms we invest in will have institutions as their customers. We like businesses that can be platforms. We see many walled gardens in B2B finance, and we think they can be unbundled. We see many functions in finance that are still done on paper or Excel, that can be put in the cloud and done more elegantly. We see many functions where businesses throw more people at the problem to solve it. Yes, we think Bitcoin and Blockchain will have a role in the revolution. We also think that regulation is going to play a big role in how companies innovate.
This fund will only invest in seed and Series A. We will not write a Series B check. Those rights get passed along to our LPs. As venture firms know, getting a seat at the Series B table is often pretty hard. It’s a different style of investing. Kenny and I know what we are good at, and what we aren’t good at. We are great at spotting companies early-and adding value at that stage. The data also backs up our strategy. Investing in Series seed and A brings more value than investing later in the cycle. Of course, it comes with more risk but that is part of the venture game.
When we settled on where we were going to invest, we also looked at history. Chicago wouldn’t be the city it is without finance. When the warehouse receipt was created it paved the way for the CBOT in 1848. The CBOT built Chicago. It is the most important institution in Chicago’s history. CME Group, and CBOE attract all kinds of talent from all over the world. Chicago is the center for risk management. Chicago also happens to be strong in insurance, data, accounting, and other industry verticals. Kenny and I are not interested in B2C companies. It’s not that they aren’t cool or fun or great or have huge potential. They do. But, like a good business, we can’t be all things to all people. The segment we are focusing on is huge, and it’s complicated.
An ancillary part of our mission is to build a thriving B2B Fin Tech community in the greater Midwest. I have been to Detroit, and been to places like Cleveland. There is B2B Fin Tech talent in those towns that is untapped. Did you know the most talented human capital for financial custodial services resides in Cleveland? Neither did we until we did some research.
Chicago’s cup runneth over with talent in finance. Not only that, but Chicago is a traditional draw for every Big Ten school. Recently, the Polsky Center at the University of Chicago has put an emphasis on fin tech. When we started Hyde Park Angels, the number one concentration at Chicago Booth was Finance. Now it’s Entrepreneurship. Northwestern is ramping up its entrepreneur program. In Champaign, Illinois is focusing on entrepreneurship at both its engineering college and business school. Wisconsin, Michigan, Michigan State, Purdue, and Indiana are all building a focus on entrepreneurship. In 2001, when the internet blew apart, HFT firms in Chicago hired talented engineers. In 2008, HFT firms hired gobs of engineers.
The next thing you have to do is raise money. So far, all of our money has come from people that spent their careers in finance. They experienced the same problems we see and are acting on it. It’s gone pretty well so far. Raising money is extremely hard, especially in the Midwest. It can be a slog. People are used to Private Equity and Real Estate. Venture is a whole new ball of wax. I can empathize with entrepreneurs.
The data backs up that Chicago and the greater Midwest is the best place to be placing a bet on the future. We have had people ask us why they should invest in Chicago. Chicago investors had exits that averaged 3x-10x over the last fund cycle. Origin Ventures 2005 fund of $15.5M returned $194M in capital to LPs. Chicago has had more venture backed success in the last five years than cities like New York. Chicago had $23.5B in exits, NYC had $10.8B. Rent is far cheaper here. Teams can go further on less capital. With the massive revolution that is going on in Fin Tech, we think it’s going to happen again.
However, like any early stage venture situation, you have to be on the ground and in the midst of it to invest in it. A lot of firms don’t want to be here. Heck, it’s going to be below zero wind chill today. The weather scares a lot of people, but it makes us tough.