August 27, 2008, 12:00 AM

New capital wave

For retailers on the cutting edge of Internet retailing, investors have cash to spend.

Madrona Venture Group, one of the original backers of 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, 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, which has been aggressively marketing itself through online videos distributed over and other social networks. 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.”

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