When should a startup start worrying about making money?
Chicago's startup revolution is in full swing. And that is causing some concern about whether the city will see déjà vu all over again from the dot-com boom and bust at the end of the last century.
Last year, Chicago companies raised $654.1 million in venture capital, according to Dow Jones VentureSource, more than any year since the peak of the dot-com bubble in 2000, when nearly $1.8 billion was raised. The number of investments: 70, the most since 2001.
Whether history will repeat itself in another boom-and-bust cycle is anyone's guess, but—Groupon Inc.'s famous profitability challenges aside—there are key differences between the dot-com glory days and now.
Chicago investors, already more conservative than their coastal counterparts, are asking about business plans, revenue and profits earlier and in more detail than ever before.
Some Chicago entrepreneurs are responding to those investor demands, as evidenced by a presentation at one of last summer's key startup events, incubator Excelerate Labs' Demo Day. Food Genius co-founder Justin Massa started his pitch to the audience with this: “All right, you're saying to yourself, ‘Food Genius, this is kind of cool. I get it. Dishes. But how in the world is it going to make money?' “
It's a question Mr. Massa, 33, started answering during Excelerate's summer program. Food Genius collects data on restaurant dishes, data he plans to repackage and sell to the grocery and restaurant industry. Mr. Massa, unlike some other early-stage entrepreneurs, says developing a revenue model before pitching investors was important to him. He initially started the process of raising $700,000 to $1 million at the end of the summer but says he pulled back last fall to refine his model.
“When I do go back out to raise money a few months from now, we will have the potential to be a company that generates money, and that gives us the opportunity to raise money from the right partners for us and give us a great valuation,” he says.
"For most companies we look at, I think they are too slow in deriving business models." — Paul Lee, Lightbank“I do think that entrepreneurs from here are much more pragmatic, and I look at that as a positive,” says Lon Chow, general partner at Chicago's Apex Venture Partners, whose portfolio includes Chicago startups like Appolicious, Sittercity, Ifbyphone and Trunk Club. “Most of the businesses that are created here in Chicago tend to be solving a real problem or addressing a real need or one that didn't exist before.”
Mr. Chow adds that he is not seeing any of the “insanity” of the dot-com bubble days, when companies like Pets.com, an online pet supply store, and Webvan, an Internet grocer, grew too big too fast and flopped.
Perhaps Chicago's most memorable dot-com bomb: Internet incubator DivineInterventures Inc., a one-time symbol of the city's technology aspirations. Divine raised $129 million in a much-anticipated IPO in 2000 at a time when most of its 54 companies were not profitable.
“The model used to be get big—regardless—and lose a lot of money,” says Tribeca Flashpoint Academy President and CEO Howard Tullman, who in 2000 ran Xceed Group Inc., a Chicago-based Internet design and strategy business. He contends that things have shifted since then. “I'm very encouraged that real major businesses are now being created.”
OPPOSING VIEWS
Still, there are differences of opinion in Chicago's technology community about at what stage a startup should be concerned about revenue and profits over all-out growth.
No early-stage investor will say a startup should push for profitability immediately, says Paul Lee, a partner at Lightbank, the Chicago tech investment fund founded by Brad Keywell and Eric Lefkofsky, Groupon's co-founders. Even so, “for most companies we look at, I think they are too slow in deriving business models. So you see them chasing something that sounds impressive on paper but doesn't really yield anything relative to West Coast investors, who are more inclined to track traffic and engagement metrics rather than a business model.”
To be sure, for some companies, like Pinterest and Twitter, matters like functionality and attracting and retaining users take precedence—at least in the near term—over profitability.
Daily-deals giant Groupon has been at the center of some of the profits-vs.-growth debate over the past year. The fastest-growing startup ever, the Chicago company is still not profitable. But Groupon, which raised $700 million in a November IPO, the biggest for an Internet company since Google Inc. went public in 2004, was able to generate revenue early on and posted more than a half-billion dollars in sales in the latest quarter.
Jason Fried, co-founder of Chicago software firm 37Signals LLC, preaches that profits should be the focus from day one. He also served on Groupon's board for about a year, leaving in January 2011.
“They were more successful in growth than probably any other company that has ever been in that short period of time,” Mr. Fried recalls. “But for me, that is not a measure of success for a business. My measure of success is, ‘Are they profitable?' Currently, Groupon doesn't fit that mold, but they might.”
A BETTER BOOM
Fast-growing firms like Groupon and restaurant ordering service GrubHub Inc. are unproven from a profit perspective. But, unlike their dot-com predecessors, they don't have to prove the Internet works. That's an advantage today's dot-com startups have over their late-1990s forerunners.
Industry observers say today's tech startups are able to build businesses cheaper and more easily, with access to experienced entrepreneurs, mentors and investors.
“The current boom has been fueled largely by very professional businesses . . . with solid business models,” says George Deeb, managing partner of Red Rocket Partners LLC, a Chicago-based startup consultancy. “There's much more sanity in the marketplace today than there was in the late 1990s.”
© 2012 by Crain Communications Inc.