BUCKING THE BACKLASH
E-TAILERS FACE TOUGHER TESTS TO SCORE VENTURE CAPITAL.

Byline: Evan Clark

The well documented Internet shakeout may have put a good scare into New Economy investors but it clearly failed to turn off the financing faucet.
Despite the of deluge of dot-com bombs, venture capitalists sunk around 80 percent of their investments, or $84 billion, into Internet and Net related players such as infrastructure providers during 2000 — a year that saw funding by the VCs climb to a record of roughly $105 billion overall, says John Taylor, director of research at the National Venture Capital Association.
Just about everything keeps shifting sharply in Net-land every six-to-12 months, and why should financing trends be any different? In both the business-to-business and business-to consumer sectors online, the kinds of companies currently obtaining VC funds vary greatly in their business model, expectations, and managerial experience than the types of firms finding financing a year ago.
For the most part, the types of Internet companies cornering money these days are those with a business model based on a transaction fee, the same types of firms that raised it during the back half of 2000. But that doesn’t mean the funds will be flowing freely this year, Taylor advises. Noting there are still a lot of “very high quality” companies and management teams with good ideas, who are in the market for capital, he cautions: “Considerably less money will be invested in 2001, because the venture capital firms are taking their time and investing responsibly.”
Indeed, funding for the B2C Net sector started to wind down during the first quarter of 2000, with the more than dozen dot-com ads that aired during the Super Bowl broadcast forming the high-water mark; this year’s ad lineup, slated for the Super Bowl at press time, featured only a few dot-com spots, in contrast. “A lot of the companies that were funded in late 1999 had to establish a national brand,” Taylor observes. “A lot of these companies burned through a lot of cash just trying to get to that point of just trying to move some revenue.”
Thus the shakeout, spurred further by the downward spiral of Net valuations that began in earnest last March is forecast to continue at least through the first quarter of 2001. Offers Rakesh Sood, general partner at Sprout Private Equity Financing, “Clearly, investing goes through cycles and we’ve seen the rise and fall of the B2C sector and the sort of rise and fall of the B2B sector from a valuation point of view, but from a market-opportunity perspective, I think B2B is still alive and kicking.”
The most effective B2B models, says Sood, are those integrating the supply chain, software programs and Web-based technology to create applications that can replace the phone, fax, and face-to-face mode in which most business-to-business communication is currently conducted. “With a supply solution using Web technology, you’re able to see how much inventory is sitting at your customer’s site and can know when to ship more,” he said.
Adds Jeffrey Harris, a member of the management and operating committees at E.M. Warburg, Pincus & Co. Global Private Equity Investing, “There are [B2B] business models being funded where there is a service being provided for the business and it reduces operating costs.” He pointed to models that use technology to slash costs from the supply chain as attractive ventures. Peter Brown, chief executive officer of management consultant Kurt Salmon Associates, for one, has estimated there are savings of roughly $34 billion to be reaped from online sourcing efficiencies in the apparel market, two-thirds of it on the vendor side.
Web watchers say things look much worse for the Internet’s B2C sector, though. “It’s very hard for many people to see B2Cs as being profitable,” Harris admits. “Before [funding for B2Cs] loosens up,” he projects, “there are going to have to be some tangible examples of successful companies, not just stock market successes. Once there are some examples the pendulum will head the other way.” A similar view was voiced by retail guru Walter Loeb of Loeb Associates, who predicts: “Once we see some real, solid EBITDA [earnings before interest, taxes, depreciation, and amortization] or just plain EBIT [earnings before interest and taxes], investors will become more interested in talking to new ventures.”
For now, plenty of B2Cs and B2Bs remain vulnerable as venture capitalists keep getting pickier about where to put their money, points out Howard Cox, a general partner with the venture capital firm Greylock. “There’s a lot of venture capital available, but it has to go into areas that are more unique and more protected,” Cox notes.
It takes more than a great idea, of course, to make a Net business fly, and the VCs are also on the prowl for online players with more seasoned management teams, or “adult supervision,” a cyber-catch phrase of the moment. Gone are the days when a 25-year-old greenhorn could get large sums of money on the basis of nothing more than a sketch on the back of a Starbucks napkin. In retrospect, one wonders exactly what could have made investors so giddy and loose with their purse strings for a three-year run, beginning back in 1997.
The answer, says Carl Steidtmann, chief retail economist at PricewaterhouseCoopers, lies in the convergence of three factors:
Pension and mutual fund managers needed to make some big investments in a lot of new companies in order to put to work the money they’d made during the economic boom that began earlier in the decade.
All the media hype and excitement swirling around the Internet helped create and investment bubble, or the irrational belief that the valuation of dot-coms and Net-related companies would simply keep climbing. It’s a phenomenon known as the greater fool principal, or the belief that even if one is behaving foolishly, there’s a bigger fool out there.
Much of the money put into the banking system to cover snafus that might have stemmed from the Y2K bug ultimately was not needed. That created a lot of liquidity for the banks and VCs.
“Investors are adopting a wait-and-see policy,” says Steidtmann, who sees the broader financing climate loosening up during the second half of the year. “The key is to watch what’s going on in the banking system,” he adds, noting the venture capital industry is a lagging economic indicator and thus will be slower to pick up than other kinds of financing. With that in mind, Steidtmann doesn’t expect venture capital to start flowing more freely into the Internet sector until 2002.
“It will be quite a lot of time before we see B2Cs get any kind of money,” Steidtmann predicts. “So many companies went to market that shouldn’t have, and so much venture capital was lost. Although the situation is not quite as dire in the B2B sector, you’re not going to see anywhere near the kind of investment we’ve see up until now.”
It’s not every B2C that’s worried about their prospects, however.
Ben Narasin, ceo of Fashionmall.com, contends that with more than $35 million in cash on the balance sheet and a burn rate of about $1 million per quarter, the Web portal, live online since 1995, has the luxury of not having to run to the capital markets for more financing. “Before we went public [in 1999],” Narasin recalls, “we lived through three Internet corrections that were different from the one now only in intensity. If you don’t have a perfect business and you need money, you’re going to have an enormously difficult time getting through the next six months.”
Laura Eisman, ceo and creative director of indie fashion e-tailer Girlshop.com, said the three-year-old company has never received outside funding. “The venture capital firms were not interested in us because we’re mostly a B2C company,” Eisman said. “What’s so frustrating about the venture capital firms is they don’t see us as a successful three-year-old company,” she gripes.
Girlshop.com, which employees a staff of 15 people, transacted sales of about $1.5 million in 2000, but carries with it the stigma of selling apparel to a fickle audience as well as its B2C status. Online B2B and B2C companies that have been getting venture capital are generally those who have built a relationship with investors over time and have gained their trust. A case in point: Bluefly Inc., the fashion off-pricer that twice last year raised venture capital for Soros Private Equity Partners. Soros ponied up $15 million in March, and another $15 million in November.
Ken Seiff, Bluefly’s founder and chief executive, says the pure play was able to acquire those funds in what he called the “most constricted” lending climate for Net ventures he’s seen, in part, because it had “established some credibility with Soros, who had invested as early as 1999. Given how tight the investment market has been,” Seiff adds, “we are fortunate to have a partner like Soros who is not afraid to place performance ahead of the stock market psyche. That has been a rare trait over the last several years.”
Additionally, Seiff noted the traction Bluefly was gaining with its customers, its customer satisfaction and strong repeat business “indicated that our value proposition was relatively unique.”
Assessing the big picture taking shape in cyberspace, Seiff says, “The investor appetite for the Internet has been severely diminished and the prevailing presumption of the venture capitalists who look at making investments is to not bother, so a red flag of any sort almost always yields immediate rejections.”
Indeed, Sheree Waterson, president and ceo of enFashion Inc., a B2B sizing technology play aimed at apparel e-tailers that raised $3 million in venture capital and angel investments last March, acknowledges: “The financing world is generally a tough one right now, but I feel this sector is warming up. With e-tailers done shoring up their back ends for the fourth quarter, surely they’re going to be looking at enhancing their sites.”
However, she admits, that enFashion, which received $3 million last March in its first round of funding was “lucky” to have the backing of two small venture capital funds and angels.
Like Seiff, Waterson stresses the importance of having already received financing and not needing to coming to the capital markets, for the first time, in this cooler climate. “People are very cautious,” Waterson counsels, “and relationships in the business world can’t be underestimated in importance.”

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