The Money Spigot Opens

When Mike Golden decided earlier this year it was time to take Home Décor Products Inc. to the next level, he had no trouble at all finding backers. "Almost everybody came to us; the bigger question was deciding who we wanted to work with," he says.

Home Décor Products in July received $7.1 million in financing from venture capitalists Kinderhook Partners. "We had a pretty easy time of it," says Golden, Home Décor`s CEO. "E-commerce has become a very, very hot category."

Indeed it has. Home Décor is one of dozens of online retailing businesses and support companies that have received infusions of capital in the past 18 months. The flow of money builds on a trend that started in mid 2003 and has surged since then. "The market is red hot today," says Nancy Albertini, managing partner of Pagemill Partners, a merger-and-acquisitions company that brings buyers and sellers together and invests in companies on its own.

The list of companies receiving money includes representatives from all areas of online retailing, including retailers themselves (Home Décor, SmartBargains.com, Napster and IPOs by Harry & David and Odimo Inc. this year), their technology support providers (ChannelAdvisor Corp., Offermatica Corp., Omniture Inc.) and marketing companies that focus totally or in large part on e-retailers (SilverCarrot Inc.).

In addition, there were a number of outright acquisitions this year, many of which were big bucks and high profile. They include the $620 million that eBay paid for Shopping.com in early June, followed only days later by the $525 million that The E.W. Scripps Co. paid for comparison shopping site Shopzilla, and the $425 million acquisition that Japanese Internet portal Rakuten Inc. paid for LinkShare Corp. in September. "The Internet has come into its own," Albertini says.

Loosening up

Everyone knows this business has seen a great inflow of capital before--with disastrous results. And everyone says that investors are focused on the fundamentals today--profitability--as opposed to pipedreams a few years ago. But the truth is that investors are getting excited about the possibilities and so aren`t as tight-fisted as they were when the spigot began trickling out funding about two and a half years ago.

"It`s getting looser," says Scot Wingo, president of ChannelAdvisor Corp., which develops technology that assists retailers to sell at eBay, Amazon, Yahoo and other online marketplaces. ChannelAdvisor took in $7 million in investment money in January 2004 and another $18 million in April of this year. ChannelAdvisor is using the funding to expand its global marketing and sales, expedite development of its technology platform and to be ready to make acquisitions. "Venture capitalists have become more open-minded and are focusing on metrics other than revenue and profitability," Wingo says. "18 months ago, they were 99% focused on results; today, results are 40-60% of their focus."

That shift represents a forward-looking investment climate, investors and retailers say, with investors looking at such factors as scalability, a solid business model and an approach with built-in barriers to entry for the competition.

Many of the companies that have received funding in the past 18 months are established businesses, as opposed to the companies that received funding in the late 1990s, which were a lot of start-ups. "The rules have changed since 1999 and 2000 when all you needed was an incredible business plan," says Bruce Sellers, CEO of Shop.com, a shopping portal formerly known as CatalogCity.com that received $25 million in funding in September. The company, which will use the money for marketing and customer service initiatives, had been self-funded since its start-up in 1999. It`s been profitable on a GAAP and cash flow basis since 2003, but potential investors wanted assurances that that would continue--and improve. "We hit profitability in the fourth quarter, like most other retail sites, but investors did a lot of research related to whether we could sustain that in the first quarter," Sellers says.

Shop.com eventually reached a funding agreement, using Pagemill Partners, with Oak Investment Partners, a venture capital company with $5.8 billion in committed capital. "We liked the people and they got our model--they had been tracking us," Sellers says.

Deep understanding

That approach--deep understanding of the business model and familiarity with how a company operates--goes hand-in-glove with another development on the VC front since the Wild West Days--venture capitalists are looking for companies that fit into their existing portfolios. "The biggest change we`ve noticed with venture capitalists has been the level of specialization--it`s really become extreme," says Matthew Roche, CEO of Offermatica, a company that optimizes and tests web pages for performance, which received $7 million from Baker Capital. Offermatica will use the money to expand its sales and marketing efforts and fund product development initiatives. "Decisions used to be based on more general information, like who got the most press," Roche says. "Today, they`re specializing."

And that specialization makes investors a lot smarter about what they`re getting into, Albertini says. "Investors today are very knowledgeable," she says. "They absolutely understand the business, the metrics that are important, how the companies work and how large they should be. Many investors are as knowledgeable as the CEOs running the company."

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But the focus on profitability and sustainability doesn`t mean the market for start-up money has dried up. Start-up Become.com, a shopping search engine and comparison-shopping site that launched in February, received $7.2 million from Transcosmos and Silicon Valley Angels in May. But unlike the early days of e-commerce, investors were careful about evaluating the opportunity. "They wanted to know our traffic, revenue, competitive advantage of our technology and if there were barriers to entry," says Michael Yang, founder, president and CEO. Of course, it probably helped that Yang has a track record--he was a founder of one of the first -comparison--shopping sites, MySimon.com, in 1998.

With so many investors now pursuing opportunities in this market, companies receiving funding are in a position of being able to improve the proportion of the company they retain ownership of. "There will always be a discount in private company valuation," Golden says. "But the discounts get smaller in times like this." Adds Wingo: "The market is more competitive and that leads to better deals for entrepreneurs. There are a lot more dollars chasing fewer deals."

Valuation sensitive

That doesn`t mean investors are giving away the shop, though. "Investors are still valuation sensitive," Yang says. "There`ll always be that tension between VC investors and entrepreneurs. Investors want to pay as little as possible for as much ownership as possible and entrepreneurs are the other way around." That was one of the questions that Become.com asked in investor meetings, he says. "We met with a bunch of investors to see what kind of investment and valuation was available," Yang says.

Today`s investment market is a direct outgrowth of the previous huge investments, participants say. "Funds have a limited lifespan," Golden says. "A lot of big funds were raised in the late 1990s and early 2000s and many have run their lifespans. Venture capital firms need to invest those funds somewhere else now or give them back to their investors."

In addition, with a strong economy, the funds are growing bigger and thus need more places to invest their money--or they want bigger deals. "More venture firms are raising larger funds," Albertini says "What would have been a $1 billion fund is now $3 billion, or in the case of Warburg, they went from $3 billion to $5.2 billion and are now an $8 billion fund. Therefore size of the deals they are investing in is now larger."

While private money is flowing, the IPO has been revived as well. After the crash of high-profile public companies, investors were skittish about buying into public companies and retailers were cautious about taking their companies public and subjecting themselves to the pressures of being a public company. But in just the past 18 months, public offerings have come from online jewelers Blue Nile Inc. and Odimo Inc., catalog and online gourmet food retailer Harry & David, flower and gift retailer FTD.com, among others. Ritz Interactive, operator of RitzCamera.com, BoatersWorld.com and other web sites, also announced an IPO earlier this year.

To IPO or not to IPO

With the market opportunities as they are, there is no one-size-fits-all approach. While IPOs built to a crescendo in 1999 and 2000 with entrepreneurs eyeing the quick riches to be gained by going public, today`s market does not seem to be creating a stampede to IPOs. While some retailers are going public, others are going in the opposite direction. Investment company The Mustang Group LLC, for instance, took Vermont Teddy Bear Co. Inc., which sells online at VermonTeddyBear.com, private in May. And SmartBargains.com withdrew a proposed IPO in February, deciding to go with private financing because the effort to go public would have distracted the company. "The opportunity for growth is so great that doing anything that does not help us accomplish that growth was not in our best interests," says Ben Fischman, president and CEO. "We had to go no farther than our existing investors who realize that they have lightning in a bottle."

SmartBargains plans to use the $18 million it received to expand online and offline marketing, including creating a loyalty program, and to expand its merchandise.

When the Internet investment bubble burst in 2001, everyone said the next time would be different--and it is. Investors are looking carefully at P&Ls, long-term prospects and the competitive landscape before they hand over any money. And retailers are making sure that they have a solid foundation with a plan to get where they want to go. But one thing hasn`t changed and that`s the eagerness of investors to buy into e-retailing businesses and the technology and services companies that support them. "I don`t see any reason that this market won`t continue to grow," Albertini says. "As long as investors are making money, this market will stay hot."

kurt@verticalwebmedia.com