Goin' to Kansas City

SAN FRANCISCO (03/17/2000) - As a startup, bizspace looks like a winner:

Three-and-a-half years experience, $1 million in revenue in 1999 and a dozen information Web sites serving the hot business-to-business market.

But when CEO Martha Gershun went looking for $3 million in venture capital for her Kansas City, Mo., startup last summer, the response was anything but overwhelming. The location, Kansas City, it seemed, was enough to scare off venture capitalists from Silicon Valley and the Northeast. "I'm worried about investing in your company for one reason," a San Francisco VC told Gershun before writing on a whiteboard two big, red letters: "K.C." Kansas City, like many cities once at the core of American industry, seemed shut out of the Internet boom.

Its own old-money culture was risk-averse. Outside investors fretted that it lacked the tech talent vital to Net startups. Besides, they asked, why fly to the edge of the Great Plains for a deal when half-a-dozen similar opportunities are available on the way to the airport? Almost overnight, though, things are changing. In a striking example of how the surge in venture capital is reaching and altering new regions of the U.S. economy, Kansas City is emerging as a regional hub for Internet startups and free-flowing capital. Not only have a half-dozen homegrown venture capital firms popped up here in recent weeks, but VC firms from both coasts, attracted by lower business costs and reasonable valuations, are finally starting to seek out overlooked startup investments.

"This is a very important time for Kansas City. The city has an opportunity to redefine itself," says Ronald Nolan, a principal in a $20 million venture fund set up by KC Venture Group and engineering firm Black & Veatch. "I've been in business a long time, and I've never seen anything as aggressive and as creative as what's going on right now."

And it's not just Kansas City. With competition for deals and ideas growing fiercer in Silicon Valley and the Northeast, money is moving into the hinterlands even as local sources of capital turn to the burgeoning opportunities in their own back yard. "The shift has been pretty incredible," says Jesse Reyes, managing director for Venture Economics, a Newark, N.J.-based venture capital research and information firm. "I don't think there's any part of the country now that has been untouched by the amount of money coming in."

For Kansas City, the nation's 28th largest metropolitan area, the transformation is picking up momentum. Built on the brawn and sweat of the railroad, cattle and agricultural industries, the city took slowly to Silicon Valley-style finance. In 1995, according to Venture Economics, the city saw $3.5 million in venture capital, a figure that grew to $37 million in 1998 and $143 million last year. This year, the cash flow is certain to pick up.

Old-line investment house George K. Baum is putting together a technology venture fund that reportedly hopes to raise $100 million.

Rodney Weary, a local entrepreneur who built the nation's second-largest DirecTV reseller, Golden Sky Systems, is now considering creating his own VC fund. Perhaps the loudest local buzz surrounds October Capital, an entity established in early February by the family of Ron LeMay, president of Westwood, Kan.-based Sprint Corp.

"My father has been interested in doing something like this for a while, and the timing was right," says Lance LeMay, Ron's son and the head of October Capital. "He's got resources and capital and contacts, but he's had a hard time leveraging them because he hasn't had the time." LeMay wouldn't disclose how much the family-backed pool has raised, but says the fund plans to bring in nonfamily investors. October Capital won't limit itself to Kansas City deals, but plans to focus on companies with the best knowledge of a variety of b-to-b applications, wherever they're located. "You can't just throw some Disney executives at an idea and expect it to work," says Ron LeMay.

October Capital's first major deal came in February, when it partnered with several local groups to invest $3.5 million in Gershun's BizSpace. Another new entrant is a group of 60 individuals that calls itself the Bi-State Investment Group, or BIG, which plans to start reviewing investment plans next month. Each investor kicks in between $50,000 and $200,000, and many will offer their business expertise. Regardless of their approach, virtually all venture players in Kansas City agree that there is no shortage of opportunities here.

LeMay, for example, has seen 200 business plans in October Capital's first month of operation. As if awakened by the rash of local venture funds in Kansas City, money from other regions is starting to pour in as well. Most of the recipients are established companies like NetSales, which helps traditional companies move their commerce online; Freightquote.com, an aggregator of shipping information; and Digital Archaeology, a provider of e-commerce customer metrics software. NetSales recently closed a $31.8 million strategic investment round that included Time Warner's Digital Media Investment Group and Chase Manhattan.

Likewise, Digital Archaeology raised $15 million in January with Citigroup Investments in the lead. "We asked for everything we could think of and we had to turn investors away. It was kind of embarrassing," says Sam Woodward, CEO of Freightquote, which raised $10 million from Morgan Stanley and Menlo Ventures late last year. As outside investors start to look for investments in the heartland, their initial concerns about a shortage of talent are proving wrong.

Like most areas where venture capital has taken root, Kansas City is surrounded by a strong academic environment. Five major universities are within two hours of the city, educating new engineers and programmers.

The area also benefits from the presence of Sprint, Kansas City's largest private-sector employer with 16,000 workers. Just as Silicon Valley startups have family trees linked to tech giants, many of Kansas City's telecom and dot-com firms, including BizSpace, trace their origins to Sprint alumni. "We could build five BizSpaces and not run out of people," says Gershun. "We've never had any trouble finding the talent we need. People that think otherwise are ill informed."

Tom Palmer, a principal with Kansas City Equity Partners and a pioneer in the local venture capital community, says the stability of the workforce is much greater in Kansas City than in Silicon Valley. Job-hopping isn't as frequent, making it easier for companies to hang on to valued workers. Most important, though, is the lower cost of doing business, entrepreneurs say.

According to ACCRA, a nonprofit economic development research firm, Kansas City ranked among the six least-expensive major metropolitan areas in 1998. In the third quarter of 1999, an average home cost $102,000, compared with the pricier $407,000 in San Francisco, $355,000 in San Jose and $185,000 in Boston.

"Everything is cheaper here," Gershun says. "People, rent, secretarial support, janitorial services." A former Californian, Gershun adds that time will tell whether the advantages of Kansas City's cost and people, along with the current venture boom, will nurture an expanding crop of new firms capable of advancing to the next level.

"There's a lot of momentum building right now," says David Frankland, CEO of Digital Archaeology. "The real telltale sign will be who gets liquid first and what the return will be. I think once that happens, you're going to see a lot more money and a lot more opportunities present themselves."

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