Reality Check

The party's definitely over at the venture-capital well. Cash is still there, but the purse holders say it's the Net firms with "infrastructure" that will be allowed to dip in.

BY Vicki M. Young

The "killer app" can still get them the bucks they need from the venture-capital market, but Internet players now need the elements of real-world infrastructure - solid profitability models, strong management teams, even an on-land presence - before the money people will ante up.

While most venture capitalists will say that "just having a Web site was never enough," they are admitting now that they are examining those business plans much more critically. So while the well hasn't run dry, the climate is definitely favoring players with the ability to prove their via-ability in tangible terms.




As Stephen M. Nagler, a partner at the law firm Phillips Nizer Benjamin Krim & Ballon, who spends the bulk of his time introducing clients to investors, puts it, "Business-to-consumer is dormant, not dead. Business -to-business is alive, but struggling.

"The new word," Nagler said, "is infrastructure. Venture capitalists [prefer] firms with a new way of looking at an old problem." That "infrastructure' can mean anything from proprietary software to a link to brick-and-click firms - but it does not include being an Internet pure-player," he said.

During a firm-sponsored presentation last month that posed the question, "Raising Capital: Is It Back to Fundamentals?" Nagler disclosed that he turns away 60 to 70 percent of those looking for financing.

"Venture capitalists have always wanted profitable businesses….Internet firms with bricks and cement behind the Web have a darn good chance of getting capital. Just having a site was never enough."

Looking ahead, however, increasingly even the lure of profitability won't be enough to grab the attention of potential investors. A company seeking financing also needs a management team with strong credentials.

According to Nagler, "You want a company that invests in people rather than just the idea. Investors want a record of success." Leadership skills certainly play a role. "Does the board have confidence in you? Someone's presence on the board can encourage a venture capitalist to write a check.'

Seekers of financing, Nagler emphasized, "need to understand the business sector you're in. Who are your competitors? You need to know where you fit in and why you do it better."

That might all seem like sound business sense, but that attitude does represent a change from the investing climate of just a year ago. To be sure, there is still money flying around like heat-seeking missiles in search of hot young ventures.

VentureOne, a provider of venture-capital information and services, released second quarter numbers earlier this month indicating that the total amount raised by venture-backed Internet companies in the second quarter fell to $14.75 billion against the $15.39 billion raised in the first quarter. Still, that kitty was far larger than the $5.69 billion raised in 1999's second quarter. The biggest losers were e-commerce companies, down to $479.15 million in the second quarter from $705.79 million raised in the first quarter.

According to information compiled by the National Venture Capital Association and Venture Economics, a division of Thompson Financial Securities Data, a total of 54 venture-backed companies, not necessarily Net-specific firms, went public tin the second quarter, raising $4.3 billion in proceeds. That total was down from both the first-quarter's 77 venture-backed IPOs raising $8.5 billion, and the year-ago total of 70 deals worth $5.4 billion. In 1999, 50 percent of the 544 IPOs were venture-backed, up from 20 percent of the 373 IPOs in 1998.

For the first quarter, the most recent figures available at press time from National Venture Capital Association and Venture Economics, venture-capital funding to the larger category of entrepreneurial companies soared to $22.7 billion, a 266 percent increase, compared to the $6.2 billion invested in companies in the comparable 1999 quarter. The number of companies receiving venture-backed financing also skyrocketed to 1,557 from last year's 851 firms. In the quarter, 85.2 percent of venture-capital investments went to early- or expansion- stage firms - with 61.9 percent of that allotment focused on expansion-stage companies - compared with 64.8 percent last year.

For the full year of 1999, venture-capital investments totaled $48.3 billion, an increase of 151.6 percent over 1998. Last year, at least, Internet-related companies were the biggest winners, attracting $31.9 billion, or a 354.8 percent jump, compared with just $7.03 billion in 1998.

The NVCA-Venture Economics data also showed an escalation in the torrid pace of fund-raising by venture-capital firms, to fill an even bigger pot for investing in entrepreneurial firms this year. One hundred firms in the first quarter raised more than $12.4 billion, representing an 85 percent increase from last year's tally of 70 firms raising $6.69 billion.

John Kiernan, chief executive officer of Alley Capital Partners, who also spoke at the Phillips Nizer event, observed, "Venture capitalists are sitting on hundreds of millions, not tens of millions. They can't do nickels and dimes [deals because] there's a lot of money to work in. Most start-ups looking for seed capital from the $1 million up to $10 million or $15 million range should be looking to friends and family."

To get funding these days, Kiernan noted, a business has to be profitable on a long-term basis. "You can't expect the venture capitalist to rescue you, "he said. "We [also] look for companies that have a good management team and the right board composition. The business model should be such that the head is willing to sign his life away if need be, because he knows that the numbers are correct."

Venture-capital funding, he observed, is still progressing despite the market's roller-coaster rides during March. "However," Kiernan noted, "an early-stage company probably can't demand a $100 million deal. Six months ago it probably could have."

Richard Marcus, senior adviser to Peter J. Solomon Inc., said, "It's no surprise that there's been a shakeout in the overheated e-commerce initiatives. A lot of the business plans were ill-conceived, and those with good models were ill-executed with no management team in place."

As for entrepreneurs considering infrastructure plays, Marcus predicted, "We'll see a variety of companies emerge. There won't be [just] one system or platform for a certain part of the equation….. Competition is good. You don't want to be the only one thinking that [a particular] space is worthwhile."

Apparel companies have always found the going rough when seeking financing in any market, virtual or otherwise. However, some Internet firms with a fashion bent have managed to attract the attention of venture capitalists even in the sober climate. Nabbing financing just this year are e7th.com, a B2B site focusing initially on the footwear industry supply chain with plans to expand into apparel; and 7thOnline, a B2B e-commerce portal that integrates trade among fashion-industry players.

Richard Fishman, senior vice president at MacAndrews & Forbes Group, which provides private financing to early-stage Internet companies, said his firm sees about 100 plans a week. MacAndrews has made investments in WeddingChannel.com and e7th.com. The firm was attracted to e7th's concept, Fishman said, because of its potential to improve efficiencies in the supply chain.

The e7th taxonomy has shoes classified under 30 different features to enable people to select what they want, Fishman noted. "There are tremendous problems with inventories, large numbers of returns and changes in styles. The independent shoe store is limited in styles [it can carry]. What e7th is doing is a far more efficient way for vendors and it opens a new distribution channel. You can't cover 18,000 independent stores with your salesmen, but you can go to the site and get more product."

David Chazen, co-founder of Chazen Capital Partners, an early-stage Internet investment firm, said his firm looks for top management and strong industry expertise. The firm, founded in 1997 by David and his father, Jerome Chazen, (former chairman of Liz Claiborne Inc.) along with family member Sid Banon, invests in companies located in New York's Silicon Alley. Besides an investment in 7thOnline, the firm has also provided $2 million in funding to Fashionmall.com.


According to Chazen, there are several important elements his firm looks for when evaluating potential investments. "First, if it's an apparel firm, we'd want to know what contacts the management team has. The team at 7thOnline has tremendous contacts in Hong Kong. It's customers are retailers and the suppliers are in Hong Kong. Second, the business model is also important. For a B2B - and we believe in bringing the retailer together with the manufacturer - 7thOnline has the early-mover advantage and there are no fringe players," he said.

A third element, Chazen said, concerns the in-house abilities of the management team. "You want to see what the team can do in terms of technological building. If the company [such as in 7thOnline] can do it in-house without any major outsourcing to build out, that's less money than if they had to use a third party."

Lastly, Chazen said, he is also concerned with how board a B2B is focusing; the narrower the better, apparently. "For companies that we invest in, we want to work closely with the leaders of the value chain. You don't want a company to bite off the whole value chain. We are looking for real, genuine services. A company that takes on too much of the value chain is too superficial."