All new companies need financing of some sort to launch operations. In some cases, entrepreneurs are able to simply dip into their existing personal savings accounts. For example, Jerry Greenberg and Stuart Moore, who co-founded Sapient Corp. in 1991, used $40,000 of their own savings and charged nearly $70,000 on their credit cards rather than seek outside funding for their new information technology (IT) consultancy. In other cases, entrepreneurs will ask a friend or relative for funding, as Gateway, Inc. founder Ted Waitt did in 1985, when he secured a $10,000 loan from his grandmother to establish his mail order computer business. Most often, though, new businesses will turn to outside sources such as banks and venture capital firms for startup funding. Because venture capital firms actually purchase a portion of the company they are funding, quite often they help to steer the firm's strategic development.
Funding for firms which have not yet launched operations is known as seed money or seed investing, while funding for fledgling upstarts that have already opened for business is called early stage investing. Banks and venture capitalists also loan money to established businesses seeking additional growth; this process is known as expansion stage financing. Wealthy individuals who fund startups are sometimes called angel investors. To gain access to outside funding, entrepreneurs typically submit some sort of a business plan, which details exactly how a new or existing company will accomplish goals like launching operations, finding customers, making money, and expanding into new markets. Typically, the most successful business plans, at least in terms of securing funding, are those with a clearly defined target market. In many cases, once officials at a bank or other funding institution determine that a business plan warrants further consideration, they expect the individuals requesting the funding to pitch their ideas in person as well. Many investors also favor startups with experienced management, a diverse and qualified board of directors, and an exit strategy, such as a planned initial public offering (IPO), which allows investors to cash out in three to five years, if desired.
In the U.S., securing financing proved an easier task than ever before for Internet-related startups in the mid-1990s as predictions of astronomical growth in e-commerce fueled what became commonly known as dot.com mania. In fact, many venture capital firms began to focus solely on Internet markets. For example, Internet Capital Group, founded in 1996, invested specifically in business-to-business (B2B) ventures, such as Internet Commerce Systems and VerticalNet. Dot.com incubators—firms that allowed startups to grow in-house before venturing out on their own—also began to emerge. One such operation, idealab!, eventually launched both eToys and eve.com. According to Coopers & Lybrand, venture capital firms invested roughly $6 billion in technology firms, including PointCast, Yahoo!, and Amazon.com, in 1996. This proved to be only the tip of the iceberg, however. According to BusinessWeek Online writer Peter Elstrom in an April 2001 article, "For years, venture capitalists declared their mission was to build rock-solid, sustainable businesses. They would seed startups with millions of dollars, betting that two out of ten would hit it big, and they would be richly rewarded. When Net mania hit, they abandoned that approach and began rushing companies onto the public market with the ink barely dry on the business plans." Through the late 1990s and early 2000s, three of the most active dot.com financiers proved to be Tokyo-based Softbank Corp.; Menlo Park, California-based Benchmark Capital; and Andover, Massachusetts-based CMGI, Inc., which created @Ventures to handle its venture capital operations.
One of the first Internet-only based venture capital firms, @Ventures was founded by holding company CMGI in 1995. CMGI had made its first investment in an Internet-based firm the previous year with its $900,000 round of funding for Book Link Technologies, one of the first commercial World Wide Web browsers, which also allowed users to search for and purchase textbooks. Book Link was later sold to America Online (AOL) for $30 million in stock, and it was with the proceeds from the Book Link sale that CMGI formed @Ventures. Initially, @Ventures provided funding to companies building Web communities, those providing Web tools for online advertisers and direct marketers, and those offering e-commerce, infrastructure, and content-related services.
In 1995, @Ventures invested in Lycos, Inc., a fledgling Internet hub founded that year. Less than a year later, Lycos conducted its IPO; in October 2000, it merged with Spain's Terra Networks to form Terra Lycos. @Ventures also provided financing to Web-based community developer GeoCities Inc. in January of 1996. GeoCities went on to complete its IPO in 1998 and was acquired by Yahoo! Inc. the following year. Early stage financing was also provided to Silk-net Software, Inc., a customer relationship management (CRM) system developer that merged with Kana Communications in February 2000 and Half.com, a fixed-price online marketplace operator acquired by eBay, in July of that year. CMGI secured its own investments from Intel Corp. and Microsoft, which allowed the holding company to continue pumping funds into @Ventures. Other Internet startups financed by @Ventures included CarParts Technologies, Critical Path, ONElist (later named eGroups), Ikonic, KOZ.com, MotherNature.com, PlanetAll, Reel.com, Softway Systems, Speech Machines, Chemdex (later named Ventro Corp.), and Vicinity.
The aggressive growth strategy of @Ventures ground to a halt in the second half of 2000 when holding company CMGI began to flounder. In an effort to improve its performance, CMGI restructured its 17 operating companies into six different business units: search and portals, infrastructure and enabling technologies, Internet professional services, e-business and fulfillment, interactive marketing, and venture capital. CMGI also announced that @Ventures would limit new investments in 2001.
Standard initial investments by @Ventures range from $2 million to $10 million, and the firm most often acts as the lead investor when it participates in a round of financing. Typically, @Ventures takes a seat on the board of each firm to which it provides financing, and it also offers incubation services to businesses seeking such an arrangement.
The largest information service firm in Japan in the early 1990s, Softbank Corp. made its first major investment in the U.S. Internet market in 1995, when it invested in the upstart World Wide Web searching tool Yahoo! Inc. Over the next three years, Softbank paid a mere $374 million for a 31 percent stake in what became the world's largest Internet portal. Another major Internet investment by Softbank Corp. came in 1999 when BlueLight.com was established as part of Kmart Corp.'s efforts to develop an Internet presence. In May 1998, Kmart had launched Kmart.com, which neither improved the firm's faltering image nor increased revenues. Run by an inexperienced in-house staff, the site was a far cry from what Kmart executives envisioned. Consequently, Kmart sought out Softbank to secure the funding it needed to develop a new site, which essentially operated as a separate company. Although it was concerned about Kmart's battered brand image, Softbank was impressed with the retailer's customer reach. Roughly 85 percent of the U.S. population lived within 15 minutes of a Kmart store, four million people visited a Kmart store each day, and over 70 million Kmart advertising circulars were mailed out each week. Believing Kmart's existing customer base offered a significant advantage over rival Internet service providers (ISPs), Softbank agreed to fund the floundering retailer's Internet venture. Bluelight.com—which was majority owned by Kmart and funded by Softbank, Martha Stewart Living Omnimedia, and Yahoo!—originally operated solely as an ISP. In just two years, however, BlueLight had not only grown into a leading ISP with nearly seven million subscribers; it also evolved into an online discount shopping destination. In August 2000, BlueLight secured a second round of financing-roughly $80 million—from Kmart and Softbank for expansion efforts.
Along with providing financing to startups like Yahoo! and Bluelight.com, Softbank also funded more established firms. For example, the first the firm invested in three-year-old e-commerce site-rating service Gomez Inc. in October 2000, after Gomez announced that it was postponing its upcoming IPO. Blaming weak market conditions for the delay, Gomez instead secured private financing from Softbank and other investors to continue developing new marketing and product initiatives designed to cater to both consumers and businesses. By 2001, Softbank had invested in more than 600 Internet-related companies, including Buy.com, E*Trade, Key3Media, E-Loan, Inc., Viacore, Inc., ZDNet, ADIR Technologies, Critical Path, Inc., Net2Phone, Inc., Reelplay.com, Verisign, Inc., 1-800-FLOWERS.com, Toysrus.com, and WebMD.
Founded in 1995, Benchmark Capital is best known for its $5 million investment in online auctioneer eBay in 1997. eBay's founder, Pierre Omidyar, realized that he needed help managing what was becoming one of the most highly trafficked sites on the World Wide Web. As part of the financing deal, Benchmark obtained a 22 percent stake in eBay, which was eventually worth more than $3 billion. Also that year, Benchmark, along with Sequoia Capital and Stanford University, contributed $20.5 million in capital to Internet and e-commerce consultancy up-start Scient. In 1999, Benchmark, again working in tandem with Sequoia and other venture capitalists, provided $122 million to Louis Borders, the founder of the Borders bookstore chain, to create Webvan, an online grocery delivery service. Benchmark also invested in firms like online mortgage vendor E-loan Inc. and B2B technology upstart Ariba Inc., typically offering an initial round of financing worth $3 to $5 million. In some cases, the firm spent upwards of $15 million over the life of a company.
IMPACT OF THE DOT.COM FALLOUT ON VENTURE CAPITAL
When dot.com upstarts—many of them funded by venture capital firms like Benchmark, Softbank, and @Ventures—saw their stock prices tumble in 2000, funding sources began to run dry. This posed a major problem for the dot.com, most of which had been counting on additional capital for expansion. Many were forced to shutter operations, which drove the stock prices of the remaining Internet players down even further. Recessionary economic conditions compounded the problem, making venture capital firms increasingly leery of investing in new Internet ventures. As a result, venture capital funding by the middle of 2001 was less than half of what it had been during the first half of 2000. In the third quarter of 2001, only 540 companies had raised $6.7 billion in venture capital funds, compared to the 1,634 companies that raised $23.9 billion during the third period of 2000.
One group of e-commerce players who continued to secure funding after the dot.com meltdown were the online merchants peddling luxury items. According to a September 2001 article in E-Commerce Times, "venture capitalists are willing to bet that the upper class is still going to spend online for the things they want." For example, Blue Nile.com was able to secure a total of $7 million in funding from Bessemer Venture Partners, Kleiner Perkins Caulfield & Byers, and other venture capitalists in 2001. The jewelry etailer targeted professional men likely to purchase a diamond engagement ring or to make some other major jewelry purchase; working in the firm's favor was the low cost of shipping for objects as small as rings. Winetasting.com also secured financing in 2001, obtaining a $5 million round of funding from William Hambrecht in September. The site's narrow focus—specialty wines not easily found elsewhere—was credited for keeping the firm afloat while rivals like Wine.com went bankrupt.
Many analysts predict that even if the North American economy rebounds in the early and mid-2000s lenders will likely scrutinize the business plans of Internet-related ventures requesting financing far more closely than they did the dot.com business plans of the past. As stated in a November 2001 BusinessWeek Online article, "So here's how it works these days: The right company with the right technology and management in a potentially hot market is going to get a reasonable amount of money—but probably not much more than it needs to achieve lift-off. That's venture capital today—the way it was before the Internet bubble began to inflate."
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SEE ALSO: Angel Investors; Business Plan; CMGI Inc.; Dot-com; Due Diligence; Shakeout, Dot-com