Capital Ideas From The Internet

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Capital Ideas From The Internet

Investors look for companies that aim to use proven technologies in creative new ways

By Eric Chabrow,  InformationWeek
Jan. 2, 2006
URL: http://www.informationweek.com/story/showArticle.jhtml?articleID=175800133

Dozens of financiers seeking to profit from new technology ventures crowd into a sun-drenched suite at the law firm of Morrison & Foerster 39 floors above midtown Manhattan. Standing behind a lectern in front of the room, pointing to a PowerPoint presentation partially washed out by the sun's glare, James Haft has just 15 minutes to persuade these investors to fund his nascent venture. The fact that the core business of the startup--U.S. Condo Exchange, or USCondex--is selling condos doesn't seem to bother the crowd of angel investors and venture capitalists looking to make money off of IT.

USCondex, which bills itself as the eBay of the condo industry, is the type of business many investors will bet on these days: a provider of business and consumer services in which the Internet serves as a foundation. Haft doesn't describe USCondex as a realty brokerage or a technology company, but as a media and digital venture that employs an array of acronym technologies--XML, SQL, ASP, RSS, and PHP, to name a few--as the platform of its business.

More money is made from using technology than creating it, USCondex CFO Haft says. Photo by Sacha Lecca

The payoff for tech investors today is in the exploitation, not the creation, of technology. "At the end of the day, there's far more money made from people who figure out how to use technology than create it," says Haft, CFO and co-founder of USCondex. "It's not the sheer technology that's interesting, but the know-how in a business sense to create a compelling venture."

What many had dreamed would happen during the go-go days of the Internet boom in the late 1990s is being realized now: the creation of viable IT-based businesses that exploit the Internet platform. Back then, investors pumped billions of dollars into Net-based ventures only to see their equity evaporate into the ether of the dot-com implosion. Now, with tens of millions of consumers having broadband access, and open-source tools such as XML and Really Simple Syndication, businesses that were a mere pipe dream a five years ago can become viable.

Funds received by Internet ventures accounted for nearly half of all venture investments in the United States in 2005, according to Dow Jones/VentureOne, which tracks venture-capital investments. VCs pumped $7.64 billion into Net-based ventures in the first nine months of 2005, up 16% from a year earlier. That's still below the levels of the heyday of the Internet explosion when more than $8 of every $10 invested in new ventures went to Internet-based companies. In 2000, more than $77.5 billion of the $94.6 billion that VCs invested went to Internet companies.

Use Of Technology

The fastest-growing segment of the Internet market is E-commerce sites, which experienced threefold growth during the first nine months of 2005 compared with the same period the year before. Still, E-commerce investments represented a mere 4% of all VC Net investments. The second-biggest growth area, business services, leaped 14.5% in a year. In both sectors, it's the use of technology that's spurring interest, not the technology itself.

That doesn't mean investors shy away from companies that develop cutting-edge technology. Newbie Internet software and database companies raised nearly $3.2 billion in the first three quarters of the year; that's 42% of all Net investments. Yet a year earlier, when software and database businesses raised virtually the same total amount, that represented half of all VC Internet investments.

"Not that investments in Internet ventures guarantee a big return--no such assurance exists--but the risk has been mitigated. New ventures face four risks: technology development, funding, market penetration, and the ability of partners to get along. Ironically, the easiest risk to take out of many tech investments is technology. A common characteristic of many of these ventures is the use of proven technologies.

Silicon Alley Venture Partners invests in companies at which time-tested technologies are used. A prime example is Critical Mention Inc., a Web-based TV search and monitoring service that lets users search, track, and view critical video clips from television news. Among the proven tech services the venture has incorporated into its CriticalTV service are a customized delivery of Web-based news using a network of journalists who gather information from Lone Buffalo Inc.; a dashboard that aggregates and analyzes data on brands, companies, people, and relations from Cymfony Inc.; and market-intelligence tools from Biz360 Inc. that provide real-time insight to large corporate and government decision makers. "There's nothing new there," SAVP principal Hugh Cullman says. "It's a combination of [technologies] put together in a novel fashion that provide a unique product differentiated in the market."

Another way SAVP limits risk is by investing in young companies that have begun to generate revenue. Among Critical Mention's clients are Associated Press Television News, CNBC, and The News Hour on PBS. Having customers lets investors judge whether the product or service is really needed. "All you have to do is talk to the customer, and you're going to know about market acceptance," Cullman says. "Otherwise, you really don't know what you're getting yourself involved in."

Not surprisingly, many of the ventures receiving funding are Web-based because the Internet provides ubiquitous and cheap communication that furnishes access to devices everywhere. "When you put that combination together, you've created an infrastructure that allows you to create these new business services on a platform that's, in effect, free," Cullman says. "We've barely scratched the surface in terms of how companies can utilize in-place infrastructure to do their work cheaper or more thoroughly, and with better and more complete knowledge. The opportunity for these service businesses to expand exponentially and in an extremely rapid fashion is huge. It's only limited by the ability of the service itself to create value for the ultimate user."

Sometimes the added value can surprise the investor as well as a venture's founders. Critical Mention was created with the public-relations industry as a primary market, but the company soon discovered that politicians wanted its service, too. "They created another revenue stream never anticipated in the product," Cullman says.

Serial Entrepreneurs

Joining Cullman at the Manhattan presentation to scout startups to invest in was Robert Gailus, managing member of Lenox Capital Group LLC. Before investing, Gailus looks for a company with leaders who've had experience running a new business, so-called serial entrepreneurs. Too often, startups boast of nifty technology ideas but have little perception of how customers will use them.

"Many early-stage companies often have brilliant ideas, but they don't spend enough time doing the research required to position a product in front of investors and articulate the competitive landscape," Gailus says. "Oftentimes, you find someone who is a brilliant inventor or developer, but they don't quite understand the nuisances of the market, like developing price models."

And investors don't discount the importance of customers in the success of a new tech venture. In his 20 years as a venture capitalist, Gailus says only one of 75 companies he backed failed because the product didn't work. Most often, customers didn't feel comfortable with change, showing reluctance to adopt new technology. "We're all bombarded with more and more technology every day, making it more and more difficult to get people to adopt new things," Gailus says. "So the adoption issue becomes a critical element in an investor's perspective on the viability of the company."

Still, Gailus has his eye on companies such as VCinema Inc., which provides subscribers with on-demand access to feature films, TV shows, music performances, educational series, and children's programming via PCs, laptops, cell phones, portable media players, and TV set-top devices. VCinema's virtual library furnishes unlimited storage of the digital-video rights purchased by subscribers in a centralized Internet repository and remotely delivers the content to their viewing devices via broadband Internet or high-speed wireless networks. Children watching a movie at home on TV can continue watching the same program on a laptop while driving to Grandma's.

Be Realistic

But investing in vertical businesses means expectations of backing ventures that will grow into megabusinesses have been dampened. "These markets are smaller, meaning the companies when they grow up may be, realistically, $25 million to $50 million companies, as opposed to $250 million companies," Gailus says.

Still, there are plenty of growth opportunities for the entrepreneurs who use their imaginations to capitalize on existing technologies. That's Haft's hope at USCondex. Not only will USCondex serve as an online broker, but its technology can be tailored at little cost to offer online sales and marketing services to other brokers and condo developers. USCondex is a media portal, too, selling ads not only to condo sellers but to realty lawyers, title companies, and other businesses interested in attracting the attention of condo buyers and sellers. And then there's the data created by all who use the Web site, with untold opportunities for new offerings.

The technologies that are enabling me are really becoming common tools that you can start to use as a nice palette to intro-duce how you turn your business into data, and how you turn that data into content, and how you turn that content into cash flow," Haft says. "And that's really what we're all about."