Entrepreneurs seeking investors’ cash and support must position their e-commerce ventures for success.
Allison Enright , Editor
Back in the mid-90s, even Jeff Bezos knocked on doors asking for money. Bezos told TV journalist Charlie Rose last year that it took him 60 meetings to raise the $1 million he needed to launch Amazon.com Inc. and that "raising that money was very, very difficult."
Today's e-commerce entrepreneurs say the amount of work that goes into finding early investors—the cold calling, the scramble for meetings, the elevator pitches—hasn't changed much since then. "There are contacts and networks you have to make, and a lot of hustling to find people who are playing the game and interested in what you are doing," says David P. Dietz, a first-time entrepreneur and founder of Modavanti.com, an e-retailer of eco-friendly apparel that began selling online in January 2013.
Dietz raised $300,000 from friends and family to build the site and get initial sales. Throughout last year he raised another $300,000 from angel investors to develop Modavanti.com further, and he aims to raise more this spring so he can begin marketing the site in earnest with paid search ads on Google and targeted ads on Facebook. "We've done $50,000 in revenue with no marketing," Dietz says. "We need to show we can do that much more with marketing."
In November, Modavanti acquired Ethical Ocean, a marketplace that sells environmentally friendly products, in an equity deal. Dietz says the key asset for Modavanti in the acquisition was Ethical Ocean's database that contains 70,000 customers' information. Modavanti can market to those shoppers directly, and Dietz hopes that will give Modavanti more traction and make it more attractive to potential investors. "If this acquisition doesn't significantly boost our revenue we won't even get to an A round," he says, referring to Series A, the name typically given to a startup's first significant funding round, which commonly finds e-commerce companies raising money from venture capital firms.
Dietz is hardly alone in hustling for investors. Experts say there's more competition than ever for early-stage funding because technology advances have made it easier to launch an e-commerce business. An e-retailer can plug into software a vendor hosts on the web rather than building its own data center and rely on the growing number of suppliers that will drop-ship items to clients so that the startup e-retailer doesn't need to buy much, if any, inventory. These developments have driven down the cost of starting an e-retailing business, and driven up the number of entrepreneurs who think they've got what it takes to be the next e-commerce all-star. Modavanti, for example, carries no physical stock and relies 100% on drop-shipping at this time.
"A decade ago you needed $1 million set aside," says George Deeb, managing partner of Red Rocket Partners LLC, a firm that advises and invests in startups. "In today's day and age you could launch for a few hundred grand, and now everybody thinks they can be an entrepreneur. But what it means is your story needs to be better," he says.
Investors are open to listening to those pitches because they know how fast e-commerce has been growing: U.S. online retail sales posted a compound annual growth rate of 16.2% from 2003 to 2012, per U.S. Department of Commerce statistics. And although competition for startup funding may be tight, investors are putting a lot of money into e-commerce, particularly into e-retailers that have demonstrated consistent growth and a scalable business model. Venture and growth-capital firms alone announced e-commerce investments with a total value of $2.2 billion during the first half of 2013, according to investment banking firm Petsky Prunier LLC, which tracks e-commerce investment activity.
Unlike when Bezos was trying to get Amazon off the ground, investors no longer view online retailing as a risky, undeveloped arena. "In e-commerce, the market size is rarely an issue," says Sharon Weinbar, managing partner at Scale Venture Partners, a Silicon Valley venture capital firm, noting the growth in online retail sales. Weinbar says she cold calls or cold e-mails hundreds of companies a year looking for investment opportunities in the digital space.
Few investors today, however, are interested in investing in a startup whose business plan has it directly competing against Amazon, so entrepreneurs need to be sure their business idea brings something worthwhile to the e-commerce marketplace. "Of the 500 startups that have called me in the last five years, 80% of them are not ready for funding," Deeb says. "They are either targeting too small a market or want to enter too competitive a space."
Indeed investors say one of the first questions they consider when evaluating potential e-commerce investments is how the company wins against Amazon because "trying to out-execute Amazon would be extremely risky," says Josh Goldman, managing partner at Norwest Venture Partners, a Silicon Valley venture capital firm.
Few e-commerce ventures get off the ground without the largesse of investors, be they friends and family, angel investors or, usually further into a company's development, venture capital. E-commerce entrepreneurs looking for investment need to position their e-retailing business for success in today's and tomorrow's e-commerce market to capture investors' attention. And just as important to having the right business idea is selecting the right investors to help along the way. Early-stage investors often intend to hold their investment for at least five years, experts say, and startups are wise to choose investors that have the expertise and contacts to help accelerate growth.
That's what sports and e-commerce entrepreneur T.K. Stohlman aims to do with his e-commerce startup, TheFanTree.com. The e-retailer uses the flash-sale model to sell apparel designed by professional athletes and promoted by them through social media. Stohlman raised $700,000 over a seven-month period to help fund the company. Most of that money came from angel investors—angel investors are wealthy individual investors—some of which Stohlman met through Tech Wildcatters, a Dallas-based technology accelerator that accepted FanTree for a three-month residency in 2012. TheFanTree.com was one of 10 startups accepted for the program out of nearly 400 applicants. Tech Wildcatters provided $25,000 in seed capital in exchange for 6% of the company. "We received mentorship and were introduced to potential investors," Stohlman says.
Introductions, however, don't automatically equal investors. "We still had to hustle," Stohlman says. As the TheFanTree.com began to take shape, Stohlman began sending potential investors he'd met through the program weekly e-mail updates about the site's progress. "I would show them screenshots of the platform, inform them who we were meeting with and the interest level we were getting from potential partners," Stohlman says.
Those updates helped convert some introductions into investors who provide TheFanTree.com with more than just cash. David Humphrey, the former CEO of the Massage Envy spa chain, became an investor and advisor who helps oversee TheFanTree's financials. Investor Guillermo Marmol, who sits on Foot Locker Inc.'s board of directors, helped bring in David Heath, former vice president of global sales at Nike Inc. as an investor and advisor—all good people to have on speed dial when you're an e-retailer that aims to bring together athletes and fans, Stohlman says. "We wanted to get people to invest who would make strategic sense to our business," he says.
"Not all capital is the same shade of green," Deeb of Red Rocket says. "There are different variations. Are you getting a check, or a check, a Rolodex and management support? You want to make sure you get smart money that will help move your business."
Investors in TheFanTree received convertible notes in exchange for their investment, which is a standard investment tool for angel investors, Goldman of Norwest Venture Partners says. "They're simple and fast, and they set aside the valuation discussion," he says. Holders of convertible notes can exchange the notes for equity, usually at a discounted rate, based on how much investors value the company at in later rounds of funding.
TheFanTree is currently on a push to raise another $1 million, and Stohlman says the weekly updates to investors and potential investors help sustain interest in the venture. "All our investors have done follow-on investments," he says. "Through our updates they've seen how we've performed over the last 18 months and they see where we are going."
Once a startup can demonstrate that it has a business model that could scale if it had the money to ramp up, one path to major funding is to go after venture capital, where investment firms will look at an e-retailers' operating data, such as margins, current growth and growth potential to evaluate the risk involved in an investment.
"For us, once we've brought someone in for a meeting, it's not magic," Goldman says. "We're looking for a passionate, skilled team creating something highly valued for users in a big market. We like authenticity; instances where people say 'I've had this problem and I am determined to solve this problem.'"
These are among the points that drew Goldman to invest in ModCloth Inc. last year. ModCloth sells women's fashions inspired by vintage looks. Norwest led a $25 million investment round for the e-retailer, which was about 10 years old at the time. ModCloth arose out a problem—Susan Gregg Koger's surplus of thrift store apparel buys and Eric Koger's, her then-boyfriend, plan to help her sell the excess online. ModCloth's unique product base quickly found traction with consumers and in 2012 the e-retailer generated more than $34 million in online sales, up about 20% from $28.3 million in 2011, according to Internet Retailer estimates.
Goldman now sits on ModCloth's board. "They've selected products that are not competing with anyone," he says.
Scale Ventures' Weinbar, whose investments include subscription e-retailer BeachMint Inc. and mobile gaming network PlayPhone, says how a company differentiates its offering from other successful e-commerce companies plays a big part in her investment decisions. "What it really comes to for us is the business model and differentiation," she says. "How are you doing something unique?"
Scale Ventures likes to invest in mid-stage companies, not young startups, and entrepreneurs that come calling have a better chance of getting Scale's attention if they can demonstrate past success. "With early-stage e-commerce sites, you might know the person is scrappy, but you don't know if he can repeat that yet," she says. "For our firm, we really want a high reliability."
E-retailers who learn how to bootstrap their way to success early may find more investment interest in their future.