Inside 1871, ground zero for Chicago’s burgeoning tech “ecosystem”
 

On a late-July afternoon, a 50,000-square-foot space on the 12th floor of the Merchandise Mart buzzes with activity. Just past the reception area, baristas whip up frothy lattes at a sleek Intelligentsia coffee bar. At tables scattered about the main room, knots of people lean into intense conversations and tap away at laptops. Scruffy-chinned, T-shirt-wearing 20-somethings zip across the concrete floor on Razor scooters.

This place, with its whiff of freewheeling Silicon Valley, is a digital entrepreneur’s fever dream. Shared office space for as little as $250 a month? Check. Deep-pocketed venture capitalists strolling the halls? Done. Sessions with seasoned advisers—lawyers, marketers, academics—right onsite? Got that too. Toss in a programmers’ academy and the kind of cheek-by-jowl proximity to fellow entrepreneurs that can foster serendipitous collaboration and you’ve got just about everything a promising tech startup could need to succeed.

That’s the plan, says former Google executive Kevin Willer. He heads the nonprofit Chicagoland Entrepreneurial Center, which runs the five-month-old space, called 1871 (the year the city started rebuilding after the Great Chicago Fire). When Willer talks about 1871—home to more than 160 startups and backed by the likes of venture capitalist J. B. Pritzker and the State of Illinois—his urgency is palpable. “We’re competing with New York, we’re competing with Silicon Valley, we’re competing with everyone,” he says of Chicago, “and we’re behind.”

Why this matters so much to so many people here right now is clear when you look at the numbers. A record 193 tech companies were launched in the area last year, five times as many as in 2008, according to Built in Chicago, a networking site for tech pros. This boomlet is happening against a sobering backdrop. Since 2000, the Loop has lost 18 percent of its jobs. The city’s 9.8 percent unemployment rate, while improved from last year, still exceeds the national average by 1.5 points. And let’s not get into the massive government deficits piling up in the city and the state.

A thriving tech sector could add thousands of jobs and millions in tax revenue, helping to turn those numbers around. And there is still considerable room for growth. Chicago-based tech companies attracted $488 million in venture capital in 2011, according to Dow Jones VentureSource (see chart at right). That’s scarcely a fifth of what flowed to New York City ($1.8 billion) and a fl yspeck compared with what got invested in Silicon Valley ($8.2 billion).

No wonder Mayor Emanuel told a crowd gathered at the Techweek conference in June that he intends to make Chicago “the digital mecca of the Midwest”—sounding remarkably like his predecessor, who once declared that he would make the city “the nation’s high-tech hub in the 21st century.”

Since Emanuel uttered those words, however, much of the tech news has been less than rosy. In mid-August, Google announced plans to cut 4,000 jobs worldwide at recently acquired Motorola Mobility, which is preparing to move its headquarters from Libertyville to River North. A week later, Groupon, Chicago’s great digital success story, saw its stock price scrape $4.65, less than a quarter of its November 2011 IPO price. All of which has Chicagoans wondering: Is our city capable of building a sustainable and dynamic tech sector, or is Silicon Prairie just an eternally distant fantasy?

Photography: Anna Knott

The Tech Ecosystem: No city's digital economy can thrive without these five crucial elements—all of which Chicago has recently put into place.
 

Chicago is no stranger to innovation. As far back as the 1880s, Western Electric Company, headquartered in the West Loop, pioneered advancements such as the operator-assisted telephone switchboard. A few blocks away, an Illinois Institute of Technology grad named Paul Galvin founded a company—eventually called Motorola—that developed the first successful car radio in 1930 and the first two-way walkie-talkie in 1940.

Two thousand miles west, Indiana-born Fred Terman was just as gripped by the promise of tech. The dean of engineering at Stanford University from 1946 to 1955, Terman was interested in more than just educating students. He also wanted to foster technologies that would benefit the public. So he helped the school open a research institute to draw a community of tech pioneers and an industrial park to provide space for the companies they later founded. The blizzard of innovation that followed—the invention of the silicon-based integrated circuit, the microprocessor, and, in the 1980s, the personal computer—marked the birth of Silicon Valley.

Chicago companies continued to make breakthroughs. In 1983, Motorola introduced the first commercial cellular phone, which may look today like a balky monstrosity but was a considerable achievement at the time. In the 1980s and ’90s, Chicago video game makers developed huge hits like Pac-Man and Mortal Kombat; 1995 saw the launch of CareerBuilder, a pioneering job website. But the city had already been eclipsed by Silicon Valley, and smaller technology hubs were booming in Boston, Seattle, New York City, and Austin, Texas.

Those places had begun to develop what tech industry veterans like to call an ecosystem: a combination of strong educational institutions, determined young entrepreneurs, willing mentors, talented developers and engineers, sharp-eyed investors, and a culture of collaboration and enthusiasm. “The ecosystem has a lot of parts,” says Peter Wendell, founder of Sierra Ventures and an instructor on entrepreneurship and venture capital at Stanford. “You can replicate one or two of those parts in Chicago or Des Moines, but it’s hard to replicate all of them.”

Chicago tried. In 1999, Mayor Daley made his bold “high-tech hub” promise, outlining a $250 million plan to transform part of the former Lakeside Press complex on the Near South Side into the largest Internet and telecom facility in the country. That same year, the ponytailed digital impresario Andrew “Flip” Filipowski raised $400 million from a slew of heavy hitters—among them Michael Jordan, Microsoft, Dell, and the Tribune Company (Chicago’s publisher)—and announced he would develop an eight-acre high-tech campus on Goose Island.

Within two years, of course, the soufflé had collapsed. Filipowski sold the Goose Island site. Small telecoms, Internet firms, and tech consultancies such as Arthur Andersen cratered, laying waste to the Silicon Prairie dream.

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“They say experience is falling on your ass a few times and being able to get back up again,” says Pritzker, who’s been investing in technology in the Chicago area for nearly two decades. “I think this whole community has done that.”

The plainest sign of that new get-up-and-go is the increasing supply of cash. Successful digital startups are typically funded by venture capital firms, which supply the dollars that fuel growth in exchange for an ownership stake in the business. Most of the nation’s biggest VC firms are based in Silicon Valley or Greater New York; because they want to keep a close eye on the companies they fund, they have traditionally been reluctant to invest outside their region.

That is changing. In the past few years, a handful of Chicago-area startups, including Analyte Health, Belly, Braintree, GrubHub, and Trunk Club, have attracted multimillion-dollar commitments from big leaguers like Accel, Andreessen Horowitz, Kleiner Perkins, and Sequoia.

Meanwhile, homegrown VC firms such as Lightbank (run by Groupon founders Eric Lefkofsky and Brad Keywell), Hyde Park Venture Partners (affiliated with the University of Chicago’s Booth School of Business), and Pritzker’s New World Ventures have pumped tens of millions into local startups. Even the State of Illinois has gotten in on the act. Last year, Governor Quinn launched the Advantage Illinois program, which is authorized to offer $78 million in federal funds and loan assistance to an array of local startups with high growth potential.

Chicago entrepreneurs have also been boosted by the rise of the incubator—basically a mash-up of VC firm, office park, and entrepreneurial academy. (1871 is a slightly different breed: A nonprofit, it does not take equity in the companies it houses, though it helps to facilitate deals.)

Among these incubators is Excelerate Labs, founded by Sam Yagan and Troy Henikoff (who made millions from startups OkCupid and SurePayroll, respectively). Each summer, Excelerate gives a group of ten promising entrepreneurs $25,000 in seed money (in exchange for a 6 percent stake) and $50,000 in convertible debt, plus workspace, accounting and tax help, and “more mentorship than you can possibly handle,” says Henikoff.

Three of Excelerate’s first 20 graduates have shut down; the rest have gone on to raise $25 million and create 125 jobs. Among the early successes: Food Genius, which delivers trend data to customers in the food industry ($1.2 million in funding in August), and Tap.Me, which embeds advertising within mobile games ($3.2 million in March). Tap.Me cofounder Josh Hernandez, 37, is now a “founder in residence” at Lightbank, where he is preparing to launch his fifth business, a photo-based mobile commerce platform. “I came over here because these guys are the best entrepreneurs in the Midwest and probably in the top 20 in the world,” Hernandez says of Keywell and Lefkofsky.

Just as notable as improved access to funding: the formation, in River North, of the sort of buzzing tech cluster that helped make Silicon Valley an innovation machine. “There’s an incredibly fast-growing community here, and it’s a genuinely helpful community,” says Logan LaHive, a San Francisco native who moved to Chicago in 2006 and went on to found Belly, a digital loyalty rewards firm based in the old Montgomery Ward headquarters at 600 West Chicago Avenue. “There are hubs you can go to and walk around and meet ten people starting companies and working through similar challenges.”

One of those hubs is 600 West Chicago itself: Some 4,000 tech workers are in residence, including 2,700 Groupon employees. The four-million-square-foot Merchandise Mart is another anchor. In addition to 1871, it houses the digital marketing firm Razorfish (more than 360 employees) and the health care tech firm Allscripts (160); if all goes as planned, it will be home to 2,300 Motorola Mobility employees next year. In fact, according to Built in Chicago, more than 70 of the area’s 100 largest tech companies are headquartered within a mile of the Mart.

Across the neighborhood, a steady stream of industry events—including regular happy hours organized by 1871, Lightbank, Built in Chicago, and Technori (an online publication for tech entrepreneurs)—offer networking and cement relationships.

“The community is so damn collaborative,” says Raman Chadha, a professor of entrepreneurship at DePaul University. “That didn’t exist ten years ago, when it was a bit more competitive, a bit more siloed. Today, when we hear of a startup thinking about leaving, we rally around them to get them to stay. This would never have happened in the past, to do a sort of intervention. Now there’s a civic pride that wasn’t there before.”

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But Chicago still has challenges to overcome before its tech sector can truly take off. The greatest, according to Dag Kittlaus, a Chicagoan who worked in Silicon Valley helping to develop Siri, the voice recognition technology used in Apple’s iPhones, is its lack of a reliable pipeline of engineers. “If Chicago doesn’t figure out how to plug in the engineering talent from the region,” Kittlaus said at a Technori event in March, “they’re going to get left behind.”

We’ve seen it a thousand times: A small Chicago tech firm decamps to one of the coasts for more access to programming talent. It happened with Bump Technologies (founded by a Booth School grad) in 2009, Adaptly (founded by a Northwestern grad) in 2010, and AllTuition (founded by a Booth student and Excelerate grad) last year. Even Groupon put a 300-engineer development facility in Palo Alto, California. “If we had to choose only among the people within Chicago,” says David Hansson, a partner in 37 Signals, a web-based business tools firm, “[we] would undeniably be a worse company with worse products.” (His answer: hire developers to work remotely from other parts of the world.)

It’s not that the region lacks the means to educate techies. For example, the University of Illinois has top-notch engineering and computer science programs (alumni have been prime movers behind YouTube, Netscape, PayPal, and Firefox). And new tech vocational schools, including Code Academy, which teaches programming to adults at 1871, and Tribeca Flashpoint Academy, are pumping out several hundred qualified developers and high-tech designers each year.

The problem is keeping them here. “If you go down to Champaign and ask computer science graduates, ‘Where are you going to go?’ ” notes Yagan, “most will say New York or San Francisco.” One lure is greater pay. The average tech job pays nearly $105,000 in Silicon Valley versus roughly $84,000 in the Chicago area, according to a 2012 survey by the career site Dice.

Lefkofsky sees greater funding and other support for promising startups as the solution to the talent retention problem. “You have to have companies that are pulling these people in, bringing in these engineers, giving people a reason to stay,” Lefkofsky says. “Then it starts to feed off itself.”

Educational institutions can play a key role too—for example, by following Stanford’s 60-year lead in establishing and supporting research institutes and technology parks. Over the years, Chicago-area schools haven’t made that enough of a priority. One result: According to the Association of University Technology Managers, 461 patents were issued to researchers at California universities in 2010 (the most recent year for which data is available); only 142 were issued to those at Illinois universities.

The schools seem to be getting it. The Illinois Institute of Technology plans to break ground on a $30 million innovation center on the South Side next year. Northwestern has recently strengthened its entrepreneurial training for engineering students, helping them launch companies like the mobile music app maker Groovebug. DePaul University has in recent years built one of the country’s best video game developer programs. The University of Chicago’s Booth School of Business, once known mostly for its finance and accounting programs, has been gradually gaining a strong reputation for entrepreneurship, particularly in the digital realm. It is now the second most popular concentration behind finance, says Steve Kaplan, a professor of entrepreneurship there. And the school’s annual New Venture Challenge competition has helped launch several local successes, including GrubHub and Braintree.

Mayor Emanuel also feels the urgency. “I am 100 percent focused on building an environment in Chicago that attracts young talent and offers them the ability to find high-paying, exciting work,” he said in August.

One of the ways Emanuel plans to make the city more appealing to such people is by adding new bike lanes in the Loop. That may sound laughably small-bore, but don’t knock it, says Richard Florida, head of the Martin Prosperity Institute at the Rotman School of Management at the University of Toronto and author of The Rise of the Creative Class. “Focusing on quality of place, quality of life, especially when it doesn’t cost too much, is a good idea,” he says. He adds that there’s a trend among digital startups to move away from suburbs like Palo Alto and toward the dynamic living in cities—which stands to benefit Chicago.

More vexing than the talent shortage may be what critics call the Midwest mentality: an alleged predilection among local tech entrepreneurs and investors to play it safe. Even Chicago veterans concede there’s some truth to it. “There are, in general, less risks taken on speculation about mass-market consumer products here,” admits Yagan, who has worked in New York, Boston, and Palo Alto. “What is our Google or Facebook or Twitter? I can’t think of any.”

Those three companies were revolutionary; the typical Chicago tech startup isn’t. Instead, it uses technology to enable more practical nuts-and-bolts services, like delivering food (GrubHub), finding jobs (CareerBuilder), or booking travel (Orbitz). The growth potential is inherently limited. That’s part of Groupon’s problem. After all, who among us is not feeling a bit of daily-deal fatigue?

While there is no easy answer, Florida suggests that we can take hope from the past. “Chicago has had a phenomenal history of innovation,” he says. “I think that inventive DNA got squelched in the era when companies got too big. But now we’re seeing around the country a return to this entrepreneurial mindset, and I think Chicago is well placed. It’ll take a little while, maybe the better part of a generation, but it’s happening.”

Back at 1871, a polo-shirted young man sits in the main shared space by a translucent glass wall filled with unfamiliar business names—Kaboom, RentStuff, Toodalu—in bubble letters. He scratches his head and stares wide-eyed at his laptop screen. Behind him, a broad white pillar looms. “We are a city of builders, makers, and doers,” it reads in large black letters near the top. “We are here,” the message concludes, “for the promise of what can be.”

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Three Startups to Watch

THE PROMISING UP-AND-COMER: Food Genius
FOUNDER: Justin Massa, 33
WHAT IT DOES: Delivers trenddata to food industry customers
FOUNDED: 2010
FUNDING SO FAR: $1.2 million

THE BREAKOUT STAR: Belly
FOUNDER: Logan LaHive, 30
WHAT IT DOES: Runs customer loyalty programs for retailers
FOUNDED: 2011
FUNDING SO FAR: $11.4 million

THE RELATIVE VETERAN: Braintree
FOUNDER: Bryan Johnson, 35
WHAT IT DOES:  Helps businesses accept online payments
FOUNDED: 2007
FUNDING SO FAR: $34 million

ALSO SEE: A sampling of startups at 1871 »

Photography: Anna Knott