How To Stand Out Amid the E-Commerce VC Rubble

Although venture capitalists poured billions of dollars into startups in 2001, the vast majority of that money did not flow to e-tailers.

According to the Yankee Group’s Rob Lancaster, a business model must now be proven to work in other markets before it will get funded in the online arena.

“They have to have market validation before they can get in the door,” Lancaster told the E-Commerce Times. “The dot-coms getting funded are the ones modeled after the Amazons or the big dot-coms. But they still are not getting funded in the traditional sense. The types of companies I’m seeing getting funded are software companies that are a result of the dot-com boom.”

Silver Lining

But the news is not all bad for e-tailers.

“The truth is that overall (e-commerce) venture capital is not bad at all, but when you benchmark 2001 against 1999 or 2000, it looks bad,” Kirk Walden, national director of venture capital at PricewaterhouseCoopers, told the E-Commerce Times. “By any other historical measure, it’s doing very well. E-tail did suffer, but not as much as it appeared to.”

According to the latest numbers from the National Venture Capital Association, Venture Economics and PricewaterhouseCoopers, 81 e-businesses received venture funding in the fourth quarter of 2001.

Sell, Sell, Sell

So, what made those 81 e-businesses stand out amid the rubble of so many online VC disasters?

“The single differentiator is whether the company can generate revenue from their operations as opposed to [receiving revenues] from selling advertising on their site or simply getting eyeballed [by visitors],” Walden said. “For first-time businesses, it would be a matter of having a business model that relies on early cash-flow generation from ongoing operations [as opposed to selling advertising or mailing lists].”

In other words, e-businesses are being put to the same simple test as every other type of venture seeking funding: whether or not they can generate sales.

“Eighteen months ago, a business plan presentation [for an e-business] might have had half of its revenues coming from its non-core sales functions, and VCs won’t accept that anymore,” Walden said. “Your revenues can’t come from anywhere other than selling the products you’re designed to sell.”

Across the Board

Although the vast majority of Internet companies funded were in the later stages of startup, the types of e-ventures getting the cash spanned a wide range of niches.

From consumer sites, such as GiftCertificates.com ($4.4 million) and Napster ($26 million), to business-to-business (B2B) ventures like ReturnsOnline ($4 million), nearly $460 million was invested in Internet businesses in Q4 2001.

“There’s no specific pattern [in terms of what types of dot-com industries are being funded],” Lancaster said. “It’s more based on the company’s business model itself.”

Software Stands Out

However, much of the capital once reserved for the Internet now is going to software providers instead. The software sector made up 22.5 percent of total VC investment in Q4 2001, up from 16.9 percent in Q3 2001.

“VCs are embracing the creation of technology rather than the application of existing technology to other businesses, and as a result e-tailers are not getting as much money,” Walden said.

“[VCs] are much more interested in those who will create some new code and software — it’s much more of a back-to-the basics approach, of getting back to the roots of innovation,” he added.