For retailers on the cutting edge of Internet retailing,
investors have cash to spend.
By Paul Demery
Madrona Venture Group, one of the original backers of Amazon.com Inc. and still a major player in funding new e-commerce companies, considers its early support of what has become the world’s largest online retailer one of its smartest, if also one of its rarest, of investments.
“If somebody came to us today and wanted to start another Amazon.com, we’d be highly skeptical,” says Paul Goodrich, managing director of the Seattle-based venture capital firm, which focuses on early-stage capital to e-commerce companies.
It’s not that Madrona has lost faith in Amazon. It’s just that the Internet retailing game has changed and finding another rules-changing player on its way to trend-setting market dominance is far-fetched today, Goodrich says.
Today, venture capital firms have plenty of interest—and cash—for online retailers and technology vendors primed to take advantage of new-age e-commerce through trends like mobile commerce, online video and other rich media, and social networks, he and others say.
“We get approached weekly by venture capital firms,” says Shmuel Gniwisch, co-founder and CEO of web-only jewelry retailer Ice.com, which has been aggressively marketing itself through online videos distributed over YouTube.com and other social networks. Ice.com recently secured $47 million in a second round of funding, bringing its total venture funding over the past three years to nearly $60 million. “Investors have billions of dollars sitting around that they need to invest,” he says, “and they’re scouring the market.”
Even in the current economic downturn, consumer-oriented businesses that can demonstrate strong growth by capitalizing on the Internet can find support. “We’re very bullish on consumer-facing businesses over the next five to 10 years,” Goodrich says. “We see a lot of upside potential. But we’re not likely to look at a consumer-facing business without an Internet strategy.”
No more easy money
Easy money isn’t flowing into the retail e-commerce industry at the breakneck speed of the late ‘90s. Then, expectations were high that anything tied to the Internet would fundamentally change the world of retailing—and many new drivers of startups in the industry raced too fast without good business plans and within a short time crashed and burned.
Although there are plenty of venture capital providers today ready to invest, insiders say there are also many more contenders for that capital than ever before. David Kidder, co-founder and CEO of Clickable, provider of technology for managing search engine marketing which recently secured $14.5 million in funding from Founders Fund, Union Square Ventures and FirstMark Capital, says the ratio of venture capital funding deals to the number of proposals considered by VC firms has risen to at least 100 to one, compared to a much tighter field of venture capital contenders when he launched his former company, the mobile ad and consumer information platform SmartRay Networks Inc., in the late 1990s. “Venture capital firms see a lot more possible deals today because there’s been an explosion in the number of companies seeking capital,” he says.
Moreover, investors can benefit from hindsight in judging players in a relatively mature e-commerce industry—something they couldn’t do before—and better determine what will produce profits over the long term. Venture capital in the early days of e-commerce was largely directed at the promise of Internet technology itself and anyone involved with it, experts say. “In the late ‘90s, investors were backing people using the Internet to try to fundamentally change how retailing was done,” says Bill Bass, former head of e-commerce at Lands’ End and Sears, Roebuck and Co. Now co-founder and CEO of Fair Indigo, a 2-year-old retailer of organic and fair-trade apparel, Bass has raised more than $5 million in venture capital, most of it in July from Highfields Capital Management.
Today, he and others say, investors want to see how prospects can build a brand and a profitable business. ”Venture capitalists are looking at retailers who are smarter at retailing,” says Mark Jensen, who advises capital-seeking retailers as national director of the venture capital services group at consulting and accounting firm Deloitte LLP. Smart retailing, he adds, means providing a shopping experience that gets consumers hooked on what a retailer has to offer.
Compelling offers
If there’s one common sign of success, it’s conjuring up a new way to address an old retailing theme: offering consumers a compelling shopping experience and value proposition. “Venture capitalists today are open to hearing an online retailing idea, but it has to be a new concept, it has to be smooth, and it has to entice customers in a way different from other online or store retailers,” Jensen says. “As smart online retailers have figured out, it’s all about the customer experience. To get venture capital, you have to be able to demonstrate that you have an approach to the marketplace to attract customers rapidly and a way to keep them.”
Adds John Prunier, partner of investment banking firm Petsky Prunier LLC, which advises Internet-related companies on the multiple stages of venture capital, “Now is not a bad time to attract venture capital, but it depends on the quality of the story companies present to investors, and whether they can demonstrate use of new technology and capabilities to capture market share.”
That argument holds whether capital-seekers are startups looking for initial funding or players with years of market experience and in search of later-stage funding to finance ongoing growth, experts say.
“Retailers have a huge challenge and opportunity ahead of them,” Jensen says. “Every customer experience has to be almost perfect, because exposure on social networks can make or kill a retailer’s success.”
Netflix of handbags
For early stage investment, new retailers can attract attention by offering a unique shopping experience, Goodrich says. Madrona, for instance, has joined venture capital firm Steelpoint Capital Partners in investing in Bag Borrow or Steal, which Goodrich likens to a “Netflix for high-fashion handbags.”
Like the online DVD rental company, Bag Borrow or Steal rents its products, though under a more complicated pricing model. It charges rental fees by the week or month for handbags, jewelry and sunglasses, plus shipping fees on each order. Customers pay discounted rental fees if they buy a membership at fees ranging from $9.95 per month to $59.95 per year. Members can rent a Louis Vuitton handbag on BagBorroworSteal.com for $43 per week or $125 per month. Non-members pay $66 per week or $166 per month. If customers feel they can’t part with a rented item, they can purchase or “steal” it a current market price determined by the retailer.
The formula has enabled Bag Borrow or Steal to grow from $250,000 in revenue four years ago to more than $15 million projected for this year, Goodrich says.
For Ice.com, attracting venture capital has required a long road of ongoing improvements since it launched in 1999, Gniwisch says. The retailer suffered through early years marked by uncertainty over how it would approach the retail market—first as an independent online jewelry retailer, then as part of a broader merchandising strategy planned by Idealab, which acquired shares of Ice and other web retailers in late 1999.
When the mass merchant idea fell flat, Gniwisch and his partners bought Ice back a year later for the assumption of about $600,000 in debt, then gradually built the company on product selection and customer service. By 2005, in an effort to fund faster growth, it secured $12 million from Ignition Partners, followed by $47 million late last year from Ignition and Polaris Venture Partners
Ice has used some of the capital to expand its e-commerce technology beyond its home-grown platform to include Blue Martini software for content management and order processing, and it plans to continue upgrading technology as well develop customer acquisition and retention programs, Gniwisch says.
Vendors of e-commerce technology have also modified their business plans on the way to venture capital. SellPoint Inc. launched in 2000 under its former name of Tentoe and offered a range of product information services that enabled manufacturers to distribute product specifications and image files to online retailers. But it decided to focus on a core competency in online instructional product tours, including videos and product manuals, which SellPoint sells to manufacturers and displays on retail sites at no charge to merchants.
The product tours have won over customers like Calumet Photo, a Chicago-based retailer of cameras and related equipment. “They’re helping our conversion rates while providing a wow factor among customers who say the tours are great,” says Joe Henson, Calumet’s chief technology officer.
SellPoint’s new business model, meanwhile, has sparked the technology company’s growth and pushed it within reach of profitability, enabling it to secure nearly $20 million in venture capital, SellPoint CEO Rick Martin says. The funding has included early seed capital from unnamed angel investors and two institutional rounds of funding, the first from Menlo Ventures and the second from Menlo and Granite Ventures. “That new strategy attracted Menlo Ventures and Granite Ventures,” he says. “The expectations by venture capital firms for growth are very high.”
Focus on financials
After their experiences in the ‘90s with online retailers that started out with great fanfare but then faltered because they couldn’t score with customers, venture capitalists are looking hard today at financial fundamentals that indicate a retailer’s basis for continued growth.
“Many retailers run on thin profit margins, so they have to watch all operations—it’s not just about revenue,” Jensen says. “They need to show a clear path to profitability, but a lot of times that gets forgotten.”
When advising retailers in seeking venture capital, Jensen looks at criteria such as growth in number of customers, number of month-to-month repeat customers, number of customer complaints, and the number of product returns, he says.
E-retailers also should take advantage of their Internet presence to improve back-end operations like inventory management and accounting, putting them in a better position to improve financial performance and attract outside capital investors, experts say.
Peeling the onion
“A lot of retail web sites look sexy, but if you peel the onion you may find they operate with old-fashioned accounting,” Jensen says. “If your business is done electronically, you should take advantage of it to automatically update your back-room applications.”
Investing in the right web site technology can also go a long way toward making an e-retailer more attractive to financial backers. New Web 2.0 technologies that give shoppers more control over an interactive and even entertaining shopping experience—for example, online merchandising displays that let shoppers rotate or enlarge product images—are important in many retail environments to provide the kind of shopping experience customers have come to expect. But such features can also be crucial to supporting a retailer’s profit margin and attractiveness to continued financial backing from investors, Jensen says.
“One of the big problems in online retailing is that shoppers can too easily order the wrong size or color dress or pair of shoes, and that creates a lot of two-way traffic through orders and returns,” he says. “That’s good for UPS, but it’s bad for the online retailer. Technologies that show what a color really looks like and virtual models that help shoppers see the exact size they need can really put an online retailer on the map and support its profitable growth.”
Investors will also consider a retailer’s ability to capitalize on multi-channel retailing and other strategies to build on an Internet presence, experts say.
Multi-channel deals
“Deals have been done where investors say, ‘We’ll give you money if you develop a multi-channel strategy,” says Jim Okamura, senior partner at retail consultants J.C. Williams Group.
Bass, however, cautions that start-up retailers may need to become established in a single channel first before getting funding to address multiple channels simultaneously. “Many investors want to fund Internet pure-plays or just catalogs or just stores,” he says.
Even if a company has a well developed plan and a clear execution, investors still want to see who’s in charge. In Fair Indigo’s case, it helped to have a personal connection at Highfields in addition to a Fair Indigo management team of former retail executives from Lands’ End, Bass says.
Likewise, SellPoint’s CEO Martin is a former retail executive from Sears and Gap Inc., and Bag Borrow or Steal is headed by CEO Mike Smith, a former CEO of Lands’ End who also served in senior executive positions at Nordstrom.com and Classmates.com.
Madrona Ventures, which had recruited Smith to serve as CEO of Classmates, decided to back Bag Borrow or Steal partly because Smith was already its CEO when Madrona entered the picture. “An e-commerce company can have a good plan, but if it doesn’t also have a good top executive it can still lose out,” Goodrich says. “We like to back people we’ve had experience with, and with Smith’s experience in e-commerce and the Classmates.com subscription model, we figured he was a natural for Bag Borrow or Steal.”
Learn from the past
Indeed, e-commerce companies and their executives striving to get established on a growth curve today and attract venture capital can learn from the success stories from the early days of online retailing, when e-retailers like Amazon and web-only jewelry retailer Blue Nile Inc. worked through the downturn of the Internet investment boom, Goodrich says.
“If you deliver the right product and the right customer experience, customers will come,” Goodrich says. “Amazon and Blue Nile continued to grow even when times were tough, and Google raised its last round of funding in 2001, when it was unclear it would succeed and everyone thought the e-commerce sky was falling. A lot of companies had their early stages in periods of economic turmoil, but those who live through it experience the greatest benefit once the economy improves. ” l
paul@verticalwebmedia.com
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