Analysis: Boom and bust and boom again

The latest quarterly European Venture Capital Report, by Dow Jones VentureOne and Ernst & Young, reveals that web 2.0 is driving venture capital (VC) investment in the IT sector, which has seen the most significant upturn of any industry in the first quarter of 2007.

In total, £376.8 million was invested in 133 technology deals, representing £20.6m more in capital and 11 more deals compared with the first quarter of 2006.

This growth has occurred within a climate of flattened VC investment in European companies, with the £760m invested in the first quarter of 2007 reflecting investment in the same period last year.

"The emerging interest in web 2.0 technology, which is mostly focused in the information services segment, appears to be fuelling this growth in European technology investments," says Jessica Canning, director of global research for VentureOne.

This follows Ernst & Young's research from the end of 2006, which predicted that VC investment for the year would top £16 billion, bringing it to its highest level since 2002, when the global figure was around £25.8bn. Ernst &Young's VC advisory group global director picked out web 2.0 along with clean, biotechnologies as key areas of interest for the new wave of investment.

That today's major VC investment area is web 2.0 is hardly surprising, because VC necessarily mirrors what is happening in the market.

May alone saw teen community Piczo announce a global expansion plan, and the return of as a travel network, although the latter received little VC involvement.

BMW (for its new 1 series) and iVillage are among brands that have recently enhanced their interactive, UGC features (see Revolution, May 2007), while review site Trusted Places received funding from Howzat Media, the investment company set up by founders, in February.

But, as VCs take a renewed interest in digital companies, concerns are rife that their role in the last crash - where over-evaluation of businesses prompted the collapse - could be repeated.

Past lessons

In the late 1990s, a huge amount of money was invested by VCs in internet ideas with little or no proven business model.

Investors believed the necessary technology would develop quickly, and consequently expected hefty returns.

"The numbers looked amazing - this was the big difference between internet and classic business models," Tom Teichman, chairman of dotcom incubator NewMedia Spark, recalls. Investors saw opportunities to invest in companies that would go public within a year or two. But the technology was not in place and the market was not ready.

By 2003, many firms were forced to write off companies they had funded just a few years earlier, and many funds were found 'underwater' (that is. with a market value lower than the invested value).

Thinking again?

Will the latest internet investment revival, fuelled by deals such as eBay's acquisition of Skype, News Corps' MySpace deal and the runaway success of Google, be built on the valuable lessons of the past?

Julie Meyer the chief executive of Ariadne Capital, Skype's strategic adviser in 2004, and more recently focused on comms applications such as Spin Vox and Monitise, new-media applications and gaming firms.

She says: "In 1999, I saw a lot of investors funding companies to expand them internationally, taking on fixed costs without any recurring revenue streams.

"What Skype demonstrated is that there is a new way of segmenting your customer base - the 'go-to-market' strategies are sounder and less cost-rich than before."

Meyer describes a difference between 'me too' VCs and those that are truly differentiated from the herd. She identifies further segmentation within the early stage, namely the "early early" and "late early" investors.

Late early investors look for companies that have already derisked somewhat.

The early early investors, according to Meyer, are not taking risks with entrepreneurs.

In fact, they have probably already worked with them. The risk in this instance is market-based, but Meyer prefers this type of investment, for its creative opportunities.

She describes how progression in technology is strengthening marketing opportunities: "What technology is doing - and Google's whole essence is this, - is making marketing more precise, so marketing is coming to the fore, and technology is enabling it to become measurable.

"The past 20 years of the tech industry have been the triumph of great marketing companies over tech firms, but now it is more profound as marketing pounds and sterling can be targeted and held accountable."

Different investors

Importantly, she adds, many of the key VC players are different. Few of the investors active in the dotcom boom and crash are still here.

Another fundamental difference is that it takes less money to get a new-media start-up off the ground. "With broadband and open-source tools, and generally more infrastructure built into the web, entrepreneurial spend on technology has come way down," says Meyer.

Teichman,refers to the 1998 launch of "They had to build a huge amount of new software, the costs on servers, databases and so on were unpredictable. And then they didn't work as we wished, and service was slow," he says.

Teichman points to success stories such as MySpace, YouTube and Amazon. Why are they doing so well?

"It's down to huge economies of scale," he explains. "They can crank up the traffic with few overheads."

In the early days, lack of broadband technology was a major issue. At this point, with increased broadband penetration rates in many countries, especially the UK and US, the market is there, willing and able.

Richard Eyre, chairman of the Internet Advertising Bureau, said that all it takes to start up online these days are "the negligible assets - just an idea, software and viral appeal".

But VCs are generally being shrewder now.

Simon Murdoch is chief executive of the recently launched, language-sharing destination,, and also the entrepreneur behind Book Pages, which was eventually sold to Amazon.

The early days weren't easy: "We failed to raise VC money. I hadn't built much of a team by 1997 and competitors were already raising funds," he says.

Murdoch eventually raised £1m from investor angels, and sold to Amazon within three months.

Murdoch adds that VC boom or not, it's still not as easy to raise money as in the peak of 2000. "Entrepreneurs used to get money after one-minute pitches. VCs now look for experienced entrepreneurs who also have great ideas."

A great idea alone doesn't, however, guarantee success. Teichman identifies a new kind of financial risk.

"Ideas today have to grab virally and quickly. Lots of people have internet access today, and while you can set up a fantastic, creative site, it doesn't mean they will look.

"The challenge now is to create a simple, elegant site, with no irrelevant content, to ensure people come back. Today's consumer is aware of being sold to, and doesn't like it."

NewMedia Spark's recent investments include digital advertising business, Unanimis, and, the latter run by former Publicis and Conde Nast figures. Teichman says new ventures need seasoned business people, not just visionaries, who have the flexibility to change direction. He describes investment now as: "Less about chucking huge amounts of capital in, more about thinking sharp.

"When, from 2001-2006, the industry was starved of capital, we realised we had to be smarter about software, marketing, staff and be willing to take ownership rather than huge salaries. Ease up on salary and take an upstart risk," he advises.

Downturn 2.0

So will there be another crash? "If there is a real setback today, more professional than private investors will be damaged," says Teichman.

"VCs are not handling direct public money so the public is cushioned. The Nasdaq is half what is was in 2000, so while there may be an adjustment, I can't imagine anything like the initial bust happening again."

The Skype founder Niklas Zennstrom has said that, while the current boom is built on more solid foundations - with widespread internet use and soaring online sales - he cannot rule out the possibility of a downturn at some point.

This view is echoed by Meyer.

She says: "More people are using PCs, the internet, and have broadband, so whether there will be a crash is one point, but whether the pace of living more of our lives online decreases is another.

"We will continue to live more of our lives online, managing our relationships, communications, finances and so on, even non-techie people do that these days, but most certainly there will be another downturn again. It's probably a year away," she says. "However, some sort of terrorist attack, God forbid, could precipitate that coming sooner."

The dotcom climate is currently buzzing with new investment opportunities.

In contrast with the first boom days, when US firms were the big winners, the European market is looking healthy, with exits achieving high evaluations.

Today's web 2.0 early-adopter investors follow typical investment models.

How much of the early money will be lost, and what percentage of VCs will see incredible returns, is yet to be seen.


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