(Bloomberg) -- U.S. technology investors have traditionally fixated on scouring the two coasts in search of the next startup ready for the big time. Now, instead of flying over Chicago en route to Silicon Valley, private jets are increasingly touching down in search of targets.
Chicago’s startup scene -- with a lift from some hometown boosterism -- has carved out an expanding niche in technology services that’s attracting outside investment.
A two-year dealmaking spree has helped position the city and its suburbs as a hub for technology services through transactions like MSD Partners’ October purchase of a 50% stake in West Monroe, which valued the IT consultant at $2.4 billion. Since 2019, private equity firms have executed tech services deals valued in excess of $7 billion in the city, according to data compiled by Bloomberg.
Chicago’s broad economic base, dominated by legacy stalwarts such as McDonalds Corp. and Archer-Daniels-Midland Co., has contributed to its newfound focus. In contrast to cities like Boston and Detroit, which have largely built upon life sciences and auto making, respectively, Chicago’s wealth has been spread across multiple sectors; from agriculture and business services to finance and publishing.
What those industries have in common, Guggenheim Securities’ James Suprenant said in an interview, is that they’re all being disrupted by technological innovations -- and a lot of them are tapping outside expertise to catch up, instead of building it internally.
That’s helped foster deals such as Apax Partners’ acquisition -- and subsequent IPO -- of IT consultant Thoughtworks, CDW Corp. buying Sirius for $2.5 billion, and Centerbridge Partners’ and Berkshire Partners’ backing of Ahead at a $1.25 billion valuation.
The rise of tech services follows years of largely frustrated efforts to craft a Midwestern version of Silicon Valley, abuzz with software and ecommerce startups. Shopping site Groupon Inc. was arguably the last such local champion to garner blockbuster attention ahead of going public, back in 2011.
That drought didn’t go unnoticed by Penny Pritzker, the founder and chair of the investment firm PSP Capital Partners, when she returned to Chicago after serving as commerce secretary in the Obama administration.
In 2018, Pritzker, whose brother is Illinois Governor J.B. Pritzker, was instrumental in setting up and leading P33 Chicago, a nonprofit organization dedicated to advancing the city’s tech expertise. The group took its name from the 1933 World’s Fair that celebrated the city’s centennial by showcasing its technological prowess. P33’s goal is to again make Chicago a center of innovation by its 200th anniversary in 2033.
Pritzker, the heir to a civic legacy that began with her great-grandfather, and whose father co-founded the Hyatt Hotels chain, sees a continuing bias that a stint on the West Coast is a must-have on a tech resume.
“There’s an under appreciation of the ecosystem that exists here,” she said. “If you’re in technology or not, people tend to move around from business to business or project to project. And you want a vibrant ecosystem that allows people to do that.”
That’s starting to happen in Chicago, with 17 venture capital funds based in the city raising a combined $7.42 billion in 2021, compared with just three funds raising $977 million in 2016, according to data compiled by Pitchbook in partnership with World Business Chicago.
The count of closely held companies valued at $1 billion or more has jumped to 26 from just eight in 2016. Last year alone, 13 of them reached that so-called unicorn status. That included the owner of the celebrity video app Cameo, and investment management software firm Enfusion Inc., which went public in October and is now worth almost $2 billion.
From an investor’s point of view, the numbers also favor Chicago’s cadre of up-and-coming tech services firms, which are gaining in value but still generally remain cheaper bets than the software stars that dominate Silicon Valley and sell for much higher multiples.
“High growth services-focused business, we’ve historically seen those trade for between 2 1/2 and 3 1/2 times trailing revenue,” said Scott Stevens, a senior managing director at Guggenheim. “Now that has risen to four to five times and a couple of instances above that, particularly if there’s exposure to cybersecurity, data or public clouds like AWS.”
A Chicago headquarters has been an overall boon to attracting talent and acquiring smaller peers, said Daniel Adamany, founder and chief executive officer of Ahead, the technology services firm backed by private equity firms Centerbridge Partners and Berkshire Partners.
Ahead, which helps companies build digital business infrastructure, has been acquiring smaller firms, such as Vertical Trail, which it bought last April. Ahead is focused on companies with about $15 million in revenue as it looks to be a consolidator in a growing sector.
Adamany sees a rising tide, specifically for advanced services.
“Fortune 2000, 3000 companies that have been around for a long time -- they have more traditional environments,” he said. “They’re going through this transformation.”
To keep Chicago tech on an upward trajectory, Pritzker’s P33 is keenly focused on the city’s top schools, which already lure the bright and ambitious from neighboring states and leave them with a taste for urban living.
Northwestern University and the University of Chicago, along with others in the area, graduate 24,000 students a year with degrees in science, technology, engineering and mathematics, or STEM. Nationally, the city’s universities rank third in the number of computer science grads and fourth for MBAs.
“I think it’s under-noticed what’s happening in our city; that’s why I’m so bullish on the future of our tech leadership position,” Pritzker said. “I think we have an authentic right to win in, particularly, areas like quantum computing, AI and electric vehicles.”
©2022 Bloomberg L.P.