After years of drought, financing starts flowing into web-based technology companies again. But there’s no irrational exuberance this time.
Web-oriented technology companies are not quite partying like it’s 1999, but at least it’s not 2002.
Since last summer, investment money has started returning to web-oriented companies. Companies ranging from Multimedia Live, a web site design company, to Performance Retail Inc., provider of web-enabled software for c-store operations, have attracted venture capital. And even the IPO market is starting to come back. Provide Commerce Inc., which operates Proflowers.com and two other retail web sites, went public last December; RedEnvelope Inc. went public in September. Blue Nile Inc., which operates the BlueNile.com jewelry site, and Google.com both announced IPOs for this year.
“Starting early last summer, venture capitalists noticed the Internet wasn’t going away and so they said, ‘We’re nuts for staying away from it,’” says Jeff Dunn, CEO of Active Decisions, which provides content management technology for web sites and which received $8 million last summer from Sierra Venture Partners. “They took their heads out of the sand.”
They came out of the sand to the extent that some are competing to finance certain companies. “There’s a noticeable pick-up in deal flow and competitiveness for these deals among VC companies,” says Todd Marcy, principal of Dolphin Equity Partners, which was part of a round of funding for web performance monitoring company Gomez Inc.
Gomez ended up in the happy position of having competing would-be financiers, with the benefit that the company’s valuation went up 46% in the course of seeking funding, says Alex Stein, president and CEO of Gomez. “We talked to venture capitalists who hadn’t made an investment in over a year and they were getting nervous,” Stein says.
In fact, some companies like Multimedia Live are getting unsolicited offers from VCs. “We got approached last April; we weren’t really looking for funding,” says Ken Burke, president. “That stimulated us to start the formal process and by the time we got out to investors in September, the response was phenomenal. We were getting meetings with any venture capital companies we wanted to.” Multimedia Live ended up with an investment from Sequoia Capital.
With this uptick, though, no one is expecting a return to irrational exuberance of 1999. “During the bubble, investors were funding anybody that could spell Internet,” says Dunn, who has raised funding for four companies in his career and made nearly 200 funding presentations. “Then the trough came and no one would talk about funding anything. Now people are getting rational and saying if the company has a good business model and something that’s special that customers want, then they’ll take a look at investing.”
Back to the basics
What’s different now from 1999 is that the companies are being judged on the basis of sound business principles, not on whether they have a great idea. “The biggest change in the companies that we finance today is that they are run by people who aren’t going to the Internet Gold Rush,” says Sameer Gandhi, partner in Sequoia Capital. “They’re not young, inexperienced MBAs just out of business school. They are entrepreneurs building a company for the long run.”
For that reason, most investors these days look for sound business approach and practices. “We like good fundamentals-high growth and high profit,” says Tim Connors, general partner of U.S. Venture Partners, which has invested in StorePerform Inc., which provides demand management software for retailers, and Performance Retail. “Fundamentals are back,” says Marc Hafner, CEO of Performance Retail.
In addition, VC firms today check out companies’ claims with their customers to ensure that the revenue stream is widely applicable throughout an industry and that the technology has enough impact on the customers’ business that other retailers are likely to need the same technology. Connors says U.S. Venture Partners interviewed some of StorePerform’s customers and in the process solidified its belief that StorePerform had a long-term business plan. “When we looked at their impact on their customers, we concluded that there were income-statement-changing impacts,” he says.
But while investors are eschewing the Internet Gold Rush mentality as they look for a strong business case, they are not overlooking the web as an important component of any business they invest in. “Every VC company that we talked to got that e-commerce is back,” Burke says. “We didn’t have to explain that e-c is hot.”
But they also are looking past the kinds of companies that lit up the skies in 1999. “What has really happened in the past three years is that the web has gotten beyond the very obvious consumer applications like Amazon and eBay and has become a ubiquitous part of everybody’s business,” Marcy says. “There are a lot of web companies that consumers don’t see. They are the true engines behind the whole Internet economy that we see taking off. They’re not as splashy as they were in the 1990s, but they’re a lot more legitimate opportunities than some of the ‘90s companies were.”
That focus on profitability and sound business practices is a cautionary note that not just any web-based company can get funding. “The bar is still pretty high,” says Scot Wingo, president and CEO of ChannelAdvisor Inc., which received a $7 million investment from Kodiak Venture Partners and eBay Inc. in January. “It’s only after you have 20 or 30 customers and you reach break even that investors will even consider you.”
Adds Bill Stauss, president of Provide Commerce, “If you’re an Internet company without profits, it will be tough.” He attributes the run up of Provide Commerce’s stock price from $13.25 at the time of its IPO the week before Christmas to $24 by mid March to the strong fundamentals and a business proposition that takes advantage of the unique properties of the Internet to bypass the middleman.
The right DNA
In retrospect, the dry spell in funding was good, some observers says, although it may not have seemed like it at the time. “There’s character built when you don’t know where the next payroll is coming from,” Connors says. “It helps get the DNA right. In a world where capital is easy to come by, you don’t run the business the way you should.”