Reality Bites Hard as a String Of Dot-Coms See Funding Dry Up
By DAVID P. HAMILTON and MYLENE MANGALINDAN Staff Reporters of THE WALL STREET JOURNAL
Get ready for a pileup of corpses in the land of dot-coms.
Just months ago, when the Internet seemed to promise untold stock-market wealth, Web companies could count on their backers to keep pouring in more money whenever the coffers ran dry. Now that party is suddenly over, and Web investors are in brutal triage mode, on the lookout for losers and cutting off their cash.
Violet.com, an online retailer in San Francisco, learned the new rules the hard way. The company got $3 million in an initial round of fund-raising last October to help build a Web boutique stuffed with fancy beaded purses, orchid-oil lamps and other retail rarities. Founded two years ago by former Apple Computer Inc. engineer Amy Barnett and marketing specialist Bonnie Cohen, the site also featured a search engine that claimed it would let shoppers pick gifts based on their mood.
Shrinking Violet
That initial funding didn't last long, and by March, as the Internet-stock sell-off was under way, Violet was asking venture capitalists for more. No way, said its backers, who tried to arrange a sale of the company to another retailer. When a promising deal fell through, the company's lead investor stepped back and let Violet fold.
It closed its doors last month. Today, all that's left on its Web site is a short note thanking visitors and urging them to "continue to seek out unique and interesting items that bring inspiration to the things you do every day."
In just the past week, nearly a half-dozen dot-com ventures have imploded, many of them quite suddenly. High-end fashion retailer Boo.com collapsed last week after spending much of its $135 million in seed capital on lavish marketing and advertising campaigns promoting its plan to dominate global online sales of Donna Karan, Helly Hansen and the like. Its investors, which included French entrepreneur Bernard Arnault and Italy's Benetton family, failed to find a buyer for the company, and instead put it up for liquidation.
Toys and Crafts
Earlier this week, Walt Disney Co. shut down Toysmart Inc., an online toy start-up in which it owned a majority stake. CraftShop.com (www.craftshop.com), a Connecticut-based retailer of craft supplies, sought bankruptcy-court protection on Monday after its backers, led by Brand Equity Ventures of Greenwich, Conn., decided to withhold a promised second round of funding. Join the discussion: Have we seen the end of the great rush to the Web or will we see a second wave of new businesses online?
And one of the most closely watched experiments in online entertainment, Digital Entertainment Network, shut its doors last week after a long stream of bad publicity -- including the resignation of a co-founder amid allegations of a sex scandal -- soured investors on its prospects. That co-founder, Marc Collins-Rector, has denied the allegations.
Could some big-name Internet highfliers be next in line? Auditors at both CDnow.com Inc. and drkoop.com Inc. have expressed doubts about the companies' viability. CDnow says it expects to sign a merger or investment transaction by the end of the second quarter. Drkoop.com says it has slashed expenses and retained Bear Stearns Cos. to help it explore strategic financing options that could include the sale of the company.
In the meantime, even relatively successful Internet companies are postponing their initial offerings, following the stock-market slump. AltaVista Co., a unit of CMGI Inc. that operates a popular search engine, postponed its IPO until September or October, when the company expects to be closer to profitability. Others are doing some vigorous cost-cutting. Living.com(www.living.com), an Austin, Texas, furniture e-tailer, on Monday laid off 50 people, or 13% of its staff, to streamline its operations.
Natural Shakeout?
Some venture capitalists see the spreading turmoil as a natural shakeout of marginal Internet companies -- many of whom, they say, would never have been funded without an overheated IPO market that made cashing out early investments far too easy. The fallout could easily continue through the Christmas season and into next year.
"As those companies are locked out of money, they're faced with the challenge -- they either shut their doors, find a buyer, or take cash at any price," says Michael Linnert, a general partner at Technology Crossover Ventures, a Palo Alto, Calif., venture-capital firm.
For Silicon Valley venture capitalists it comes down to this question: Which of our progeny do we just let die? In an April memo e-mailed to his investors, Ron Conway of Angel Investors LP warned that because the IPO window has closed for many Internet companies, his primary focus would be to steer the fund's resources to its "top-tier" companies. The remainder, he wrote, were being encouraged to obtain additional funding from corporate partners.
"There are several of our portfolio companies that we have chosen not to fund in these market conditions," Mr. Conway wrote. "While we have not had one of our investments fail yet, we predict that five to 10 may fail in the next 60 to 90 days."
Mr. Conway was traveling and unavailable for comment, but Angel partner Bob Bozeman confirmed the authenticity of the memo. "You have to hit people on the head with a two-by-four to get their attention," Mr. Bozeman says of the memo. "Even now, we have companies that don't have enough cash, and they're doomed unless they get an infusion."
That doom befell Violet, which was one of Angel's portfolio companies. Many investors in Violet thought highly of Ms. Barnett and Ms. Cohen, and believed it was meeting the financial benchmarks used to judge a company's performance, says Angel's Mr. Bozeman. "They were a victim of circumstances and timing more than you should be," he says. "In a capitalist world, you shouldn't be subject to that hysteria."
Gamely, Violet's founders agreed to consider a buyer, and started soliciting interest among prospective "white knights." The company quickly narrowed down its choices to several prospective partners, one of whom was eStyle Inc. (www.estyle.com), a Los Angeles-based online women's retailer. But none of the deals worked out. One investor in Violet, who declined to be identified, argues that the deals ultimately failed because one of Violet's chief assets was its brand, which would inevitably be submerged after a merger. "At the end of the day, the value wasn't worth the transaction cost of relocation," the investor says.
EStyle's founder and CEO, Laurie McCartney, says that "multiple factors" nixed her company's potential acquisition of Violet. She adds that eStyle ultimately "didn't see enough of an opportunity to make it worthwhile."
Violet's lead venture capitalist, Neil Weintraut of 21st Century Internet Venture Partners, looked for new investors. But other venture capitalists were reluctant to sink more money into online retailing. When that failed, Mr. Weintraut pulled the plug, Mr. Bozeman says. Mr. Weintraut couldn't be reached for comment. Ms. Barnett, Violet's CEO, declined to comment.
Law Firms Staff Up
Like venture capitalists, Silicon Valley lawyers expect many more such failures. Bankruptcy-law firms are staffing up to handle an expected rise in business failures, although some of that reflects a rise in interest rates and fears of an economic slowdown, says Ken Klee, a bankruptcy attorney in Los Angeles. While many startups have few assets beyond their domain name, some will possess technology licenses or real estate that other firms will want to acquire, "and the best way to do that would be through bankruptcy court," Mr. Klee says.
And woes for one Web start-up create opportunity, naturally, for another. Traffic is heavy at Startupfailures.com (www.startupfailures.com), a fledgling, self-described "philanthropic for-profit" Web site founded earlier this month by Nicholas Hall, himself a three-time failed entrepreneur. The site, which features an active chat board in which failed and failing entrepreneurs vent their frustration and share tips, has been overwhelmed with requests for "coaching" from an online adviser Mr. Hall brought on to pep up visitors.
Mr. Hall has been forced not only to seek out more coaches, but also to hire five part-time assistants who help maintain the site. He is in the process of arranging sponsorship for the site, and also plans an online marketplace where failed entrepreneurs can market their equipment and intellectual property to others.
Fallout from the Internet-stock turmoil has extended even to some would-be dot-com landlords in Silicon Valley. Real-estate agents who not long ago demanded start-up equity for office space are now instead asking Internet companies for six months of advance rent, a three-month security deposit and a one-year letter of credit. Many even want to see extensive documentation, including executive biographies, profit-and-loss statements and recent bank statements, says Roark O'Neill, a sales associate for Emerald Real Estate Brokerage & Investments Inc. in San Francisco.
Looking for 'Partners'
At the next level of triage are those companies forced to look for corporate buyers, often euphemistically dubbed "partners." Angel has even hired Tracey Ford, a former research analyst at Credit Suisse First Boston, as a dedicated mergers-and-acquisitions expert who advises portfolio companies on their options, helps them compile a list of potential suitors and acts as an intermediary.
Ellen Pack, senior vice president and general manager of Women.com Networks Inc., says the company now receives about twice as many calls from companies promoting themselves as potential acquisitions than before the stock-market slump began -- many from firms in the crowded online beauty-products sector. But Women.com, a San Mateo, Calif., operator of a Web portal for women, hasn't taken any up on their offers.
"The audience was a good fit, but the business models weren't," says Ms. Pack. One problem was that because Women.com doesn't sell products, merging with an online retailer would set up conflicts with its existing commerce partners.
Perhaps the toughest blow for a Web start-up is when the drying up of venture capital also prevents the company from finding a buyer.
Consider CraftShop.com, which until recently sold both craft products and projects, such as pottery tool kits or a wood-and-copper birdhouse. It also ran online communities on topics such as sewing and quilting, fine arts and framing, and kids' crafts. Angus Mackie, who for almost five years had run a Web-design firm that built Internet sites primarily for craft-related organizations, says the idea for the site struck him in early 1999 after a meeting with an investor who wanted to buy craftsearch.com, a domain name Mr. Mackie had registered but never used.
Mr. Mackie hammered out a quick business plan, and with a small amount of funding from that investor in hand, he successfully won a $15 million commitment from Brand Equity Ventures and CMGI's @Ventures. The venture-capital firms put up $4.5 million of that amount last August, and promised to release an additional $3 million in February if CraftShop.com could meet revenue targets and other benchmarks. The remainder would follow later.
"That August, we started doing everything at once," says Mr. Mackie, since the initial investor's funding wasn't enough to build up the site. His technical team labored to procure digital images for about 40,000 products, and then had to rewrite thousands of product descriptions in the company's suppliers' databases, which, for instance, originally listed "green thread" as "GRTHD."
Getting Vanna White
While the team had hoped to launch by Thanksgiving, "we all agreed that if it wasn't our best shot we shouldn't do it," Mr. Mackie says. So the team labored through the holidays, even as Mr. Mackie made plans to relocate his technical staff from San Francisco to a new headquarters in Norwalk, Conn. The site went live just in time for the Hobby Industry Association convention in late January, and won attention for Webcasting video clips, press releases and product reviews from the convention. CraftShop even snagged a video interview with famed crochet maven Vanna White.
As February rolled around, however, CraftShop fell short of its revenue goal, although Mr. Mackie says the site easily met other milestones. "If we had gone live in late October, we probably would have had two to three months of sales," he says. "As it was, we had three weeks. I had assumed there would be some leniency when it came to the milestones."
In the meantime, several other craft-related competitors, the biggest of which was Craftopia.com Inc., had also jumped onto the Internet, and enthusiasm was waning for such "business-to-consumer" Internet ventures anyway. Mr. Mackie forged ahead, proposing a partnership deal with a brick-and-mortar craft retailer. But that also fell through, in part because the retailer was worried about CraftShop's dwindling cash reserves. With the firm's backers withholding its second round of $3 million, Mr. Mackie laid off most of his 49 employees and filed a Chapter 11 bankruptcy petition on Monday.
The @Venture spokeswoman says the firm doesn't dispute Mr. Mackie's account, adding only that its partners felt CraftShop faced too much competition in a relatively small market and that no buyers could be found.
Mr. Mackie credits @Ventures with helping many of his former employees get jobs, and adds that he was able to introduce several workers to Priceline.com, whose offices are also in Norwalk. Still, he echoes an often-heard complaint these days: "If CraftShop had had a different funding source with more tolerance for the growth curve, we'd still be in business."