May 7 2014, 5:16am CDT | by Forbes
In San Jose or Mountain View there would be nothing notable about venture capitalists Mark Kvamme and Chris Olsen in a glass-walled room debating whether or not to write a multimillion-dollar check to Aver Informatics, a startup that shows businesses where health care is cheapest. But the trainloads of coal crawling by outside are a stark reminder: This isn’t California. It’s Columbus, Ohio, a city that had rarely hosted these sorts of discussions before Kvamme and Olsen arrived.
At a time when more than half of the country’s venture capital–some $33 billion annually–is going to startups in California, two alums of Sequoia Capital, Silicon Valley’s most successful VC firm, are making the mother of all contrarian bets: that West Coast money is getting dumb chasing the next Facebook and overlooking opportunities in the heartland. Investors think the two are onto something–in January Kvamme and Olsen’s Ohio-based Drive Capital closed a $250 million fund, the second-largest inaugural fund anyone has raised anywhere in the country in the last year.
The math behind their thinking is straightforward. The Midwest makes up 19% of the country’s GDP and comes up with 19% of its patents, yet the region draws only 5% of America’s venture capital. That discrepancy suggests that midwestern entrepreneurs are starting fewer businesses not because they don’t have good ideas but because they don’t have access to the people who fund good ideas. “Ultimately, when we looked at the data, it was very, very compelling,” Olsen says. “I think people will look back and say that was so obvious that the Midwest was about to emerge because the numbers had swung so far against it.”
Kvamme, 53, is as California as they come. The son of legendary VC Floyd Kvamme, he grew up in Sunnyvale and got a programmer job at Apple as a 19-year-old Berkeley student, then left to found four companies, one of which, advertising agency CKS Group, went public in 1995 with a $218 million valuation. He merged it with another company in a $340 million deal three years later and then became a partner at Sequoia, where he invested $5 million in LinkedIn the year the networking giant launched (a stake now worth $2.6 billion).
But in 2010 Kvamme started taking trips to Ohio to advise John Kasich, an old banker friend who was running for governor. On one of those trips Kasich invited Kvamme to his home in the Columbus suburbs, poured him a big glass of wine and extended a job offer: Leave sunny California, come to gray Ohio and take a $1 salary to run Ohio’s economic development agency.
Kvamme’s marriage was falling apart, and he’d always wanted to try his hand at public service, so he accepted on the condition that he could commute from Menlo Park. He took a leave from Sequoia and told his partners he would be back in six months. “And then something strange happened–I kind of fell in love with the place,” Kvamme says. “The opportunity that I saw in Ohio and the rest of the Midwest, I really felt like there was something happening here.”
Crisscrossing Ohio on state duties, he stopped at places like the Brandery, a startup accelerator in Cincinnati, and ran into unknown, underfunded entrepreneurs like James Fisher, founder of Roadtrippers, a website that attracts 3 million travelers a month who want directions between two points with the most interesting restaurants, parks and sites marked along the route. It was the sort of company Kvamme had backed in Silicon Valley, and he sensed someone could make a lot of money funding similar startups in the Midwest.
He called Olsen, a Cincinnati native and 35-year-old rising star at Sequoia, who told Kvamme he would start a fund only if they went in together. Kvamme agreed, and leveraging connections in California and Ohio they set about persuading investors like Santa Clara-based Silicon Valley Bank and Columbus-based Ohio State University to put money behind a couple of well-pedigreed guys making a big bet. “It’s not just that, hey, we love these guys, we’d back them anywhere they’d go,” says Sulu Mamdani, partner at Silicon Valley Bank. “They have put together a really compelling thesis around opportunities that we buy into.”
Not everyone bought it. “We have seen many states try to do something like this,” says Jonathan Hook, Ohio State’s chief investment officer, who argued against the school’s $50 million investment in Drive but was overruled by the university’s president and CFO. “Usually it doesn’t come off as successfully as they hope. I think the fund was too large.”
With a quarter-billion dollars in the bank Drive is now putting the money to work. Its first two checks: $2.5 million to Roadtrippers and $5 million to CrossChx, a software company that links fingerprints with medical records, preventing identity thieves from gaining access to health information that they could use to, say, fill prescriptions of painkillers.
Signing checks is the easy part. Luring top talent to work for their companies–and not head to Silicon Valley–is tougher. Last month Kvamme piled seven of his eight employees into an RV for a recruiting trip to schools like Carnegie Mellon, Ohio State and the University of Michigan. They brought along all of the companies they are backing, including FarmLogs, an appmaker based just off the Michigan campus that combines information about the weather, fertilizers and crop yields to let farmers make smarter decisions, like which square meter of their field needs more of a certain fertilizer. Five percent of U.S. row-crop farmers use the app, and the company is constantly searching for new talent.
Recruiting is not the only challenge in the Midwest. The region’s entrepreneurs, more cash-strapped and risk-averse than their Silicon Valley rivals, often sign bad agreements or sell huge stakes in the seed-funding stage. “Since there has been no capital, investors have been able to extract terms,” Kvamme says. In order to further motivate diluted founders Drive comes up with ways to restructure the ownership, like buying extra shares and giving them back to the founders as stock options.
The only way to give midwestern entrepreneurs and investors more confidence, Olsen says, is to build companies that produce huge exits. There have been a few: Indianapolis-based e-mail marketer ExactTarget sold for $2.6 billion last year to Salesforce.com, and Chicago’s Groupon and GrubHub are both publicly traded with multibillion-dollar market caps. Olsen and Kvamme are staking their careers on the belief that their money will feed the next Midwest giant.
“The opportunity is taking the raw ingredients that are here and just energizing them with a little more capital, a lot more know-how and really spending time pulling talent back to the Midwest,” Olsen says. “When that happens, you’re going to see great companies emerge here.”
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