How Midwest Startups Beat Silicon Valley at their Own Game
They Play Moneyball
In his book Moneyball, Michael Lewis popularized the story of the 2002 Oakland A’s reaching the playoffs despite having one of the lowest budgets in Major League Baseball. Last spring, our friends at Hyde Park Angels (“HPA”) updated their Midwest Startup & Venture Capital Market Analysis and concluded that today’s Midwest region is a venture capital desert, having received only 4% of U.S. investment. Yet during the last decade, Midwest startups generated the highest financial returns in the U.S., with an average multiple on invested capital (MOIC) of 5.6x versus a range of 3.3x-4.8x for other major metros. The Midwest outperformed the Bay Area by 33%.
It’s Not the Cost of Living
This return advantage is not fully explained by the Midwest’s lower cost of living or “investor mindset.” HPA’s analysis shows that Austin, Texas underperformed other metros despite having a similar cost of living to Chicago. Further, the Midwest’s reputation for a conservative investor mindset is moot, as outsiders are setting valuations — according to Pitchbook, between 2016 and 2019, 84% of the venture capital received by Midwest startups had a lead investor from outside the region.
The Midwest Plays Moneyball
The 2002 A’s team succeeded by assembling a more efficient offense with scarce resources. Likewise, Midwest founders who generated high returns intentionally allocated capital more efficiently than Silicon Valley:
“We’re building a different kind of business, one that actually likes to make money, which may be foreign to some of the companies out in the valley”
– Jon Oberhide, Co-Founder of Duo Security (Ann Arbor, MI) July 2017
“For us, it has just been slow and steady growth sustained through reliable sales and returning customers rather than trying to be the biggest player by stealing market share with expensive marketing campaigns that require multiple rounds of financing or going public”
– Rich DeNardis, Chief Revenue Officer, Home Chef (Chicago, IL) January 2018
Duo Security and Home Chef played Moneyball in the way they approached the marketplace, favoring consistent singles and doubles over swinging for the fences, and these weren’t isolated examples. During an era when 90% of venture-backed companies lost money at the time of IPO, the top four Midwest exits — Ceridian, Duo Security, Cresco Labs, and Home Chef, were profitable at the time of IPO or acquisition.
“Most companies in Chicago are cash-flow focused, which, despite resulting in much fewer deals, is a big reason why they have the highest VC returns in the country”
– Yazin Akkawi, Founder, MSTQ (Chicago, IL) May 2017
Smaller Rounds Can Be An Advantage
Some see the Midwest as a victim in this scenario — that it is somehow “missing out” on its fair share of venture capital despite producing 25%-33% of the nation’s R&D, new patents, and top tech talent. On the surface, Midwest valuations have been roughly half that of their coastal counterparts. This tradeoff between profitability and sales growth impacts valuations, but the strategy has worked while unicorn returns have declined over the last five years. The Midwest’s “respect” for cash flow also boosts a startup’s survival rate, which is double the national average in places like Ann Arbor, Michigan.
Of course, there are examples of Midwest startups that swing for the fences, and the Silicon Valley model has its place. It has worked well for putting large amounts of capital to work and for startups that are in “winner-take-all” markets like Facebook, Google, and Uber. But if Midwest startups have proven anything, it’s that a pragmatic approach to capital allocation can work equally well or even better for investors on a percentage returns basis.
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