Ants

My neighborhood tennis joint is blessed with clay/dirt courts and, during this time of year, ant hills are a common site along the service lines. Marching over to verify the mark for a line call, I was struck by the way these little guys scamper around in a seemingly irrational way; wondering how they get anything done in a world of such micro disorder. Yet the length of the court has at least 15 ant hills, perfectly aligned; order amid seeming chaos. It set me to thinking about what we are now seeing in the Internet Commerce space.

Today brought news of an investment in fast growing Modcloth by Accel and First Round. Yesterday's news brought the acquisition of Woot by Amazon. Earlier in June, Ebay bought bar code scanning infrastructure from Red Laser. Of course, funding stories abound from places such as Gilt, Ideeli, and elsewhere.

On the surface it seems as if there is a mad ant scramble in the commerce side of the internet. Hmmm, I suppose there is a mad ant scramble in the commerce side of the internet. I think it's justified. Let me explain.

In an area I've recently been looking at (and a microcosm of the vast commerce arena), teen commerce, enjoys less than 6% of all apparel sales online. It's a number that is probably appropriate given that most of the leading commerce sites were built and implemented prior to the social revolution, massive broadband acceptance, mobile search (which is fundamentally changing as people increasingly tend to search from within applications, as opposed to via the browser), real-time alerts/buying, and the prevalent use of video for presentation of items. In other words, the legacy sites were implemented more than two years ago. The change in the infrastructure and supporting technologies, individually, may seem like ants running about, but stepping back, there's a method to the building.

We are at the beginning of a fundamental platform shift in commerce. It has the appearance of a random ant walk, but I am convinced there's a method to this capitalistic ritual. The leading economic indicator I can point to is the rut that same day store sales are in, coupled with the double digit growth of internet sales by the same brands. I don't think we are in an economy induced retailing rut, and think the move away from physical stores will accelerate as the innovative factors mentioned above are adopted by mainstream sites, optimized by independent vendors, and embraced by savvy consumers. Now, I don't think remote sales will totally replace physical shopping, nor do I think the 95/5% ratio is justified.

Consumers are benefiting from better prices passed along to vendors who are far more inventory efficient, but the benefits extend beyond 'permacheap', into enhanced selection, real-time curation by your peers/experts, emotive real-time offers, far more efficient promotion and many other attributes which passionate entrepreneuers will uncover.

NY entrepreneur happenings

Over the past couple of weeks I had the opportunity to attend and speak at a couple of NY sessions that were remarkable for their similarities and differences.

NY Video Meetup (450 attendees) led by Yaron Samid has become the focal point of the NY internet video community. The 90 minute session consisted of 10 minute presentations by 5 companies to the general audience:

Volomedia-Ad insertion and campaign management
SesameVault- Video management platform
Clearspring- widget advertising/mgmt
http://www.aniboom.com/-Animation marketplace
Mag.ma- Video aggregation, but with a real-time twist

After the presentations and high quality audience Q&A, 3 VC's (me, Howard Morgan from First Round, and Sita Vasan from Intel Capital) gave feedback, from a funding perspective, on the companies.

Though named 'NY Video Meet-up' it's clear, and apt that video is a loosely defined cornerstone of these sessions. As much time is spent getting exposure to the business around internet video, as is being spent on producing, distributing and viewing experiences.

The Funding Post. was attended by 100+ entrepreneurs. This sold-out event was one of a series of entrepreneurial 'boot camps' held throughout the US by the Funding Post founders, Joe Benjamin and Joe Rubin. Attendees came from across the US and were all in young start-ups ranging from medical devices, to consumer goods, to hardware and software.

Attendees get a full day of intensive 'real-world' counsel on business plans and pitching for dollars. They use this background for exposure to funding sources. A win/win for all concerned. VC's get deal flow and entrepreneurs get access.

Venture backed exit statistics

One of the major publications that follow the venture market, PEhub, recently published their recap of '08. As expected, the numbers were not pretty with:

M&A deal value was down 54% to $23B, representing 325 venture-backed transactions (down 29%).

The median consideration amount was down nearly 50% to $45mm; something to think about when these acquired firms raised a median $22.6mm

Seven IPO's generated a scant $551mm in liquidity.

Significantly, it took a median 6.5 years for a Company to reach liquidity via M&A and 8.3 years for an IPO.

No doubt these numbers were skewed by the financial downturn but I also sense something more significant that portends short-term bad news, and longer-term good news is happening, at least in the software and internet sector.

First the bad news.

Many of the investments in consumer facing applications that are dependent upon advertising dollars to support their businesses will be in for far tougher times than anticipated. The combination of a steep downturn in CPC and PPC rates, coupled with rising inventories will leave their backers with an unenviable choice of putting more capital to work in troubled companies (hoping for a short-term market rebound), or withdrawing support and allocating funds towards new investments or supporting the firms with positive momentum. While this Darwinian process is expected, and encouraged, in the venture business, it's happening earlier in the company life cycle than anticipated.

Investments in companies selling to the SMB's and Enterprise arenas are also seeing slower revenue momentum than anticipated, but all indications are that business spending is not as impacted as much as advertising budgets. The issue in this arena is crafting a value proposition that is so compelling that it overcomes the steepening conservatism seen in the early days of a recession.

The bigger market issue, in my mind, is that the dearth of IPO's has left the software and internet arenas with a large imbalance between the number of sellers (large increase) and the count of willing and able buyers (steady decrease). As a consequence, unless there is a rapid pruning of investments, I expect the 'time to liquidity' metrics to worsen over the next few years as many companies, lacking the growth story for a positive IPO, and having raised too much capital to show a positive liquidity event (but respectable businesses who have reached a critical mass to be self-sustaining), continue on their private path.

The good news is that these numbers do not reflect the intense move towards capital efficiency that many entrepreneurs, and their venture backers, have been preaching over the past 3 years. Harnessing instant information from the internet to optimize sales and marketing, and running their businesses based on 'just in time' infrastructure creates situations where less capital translates into better businesses that are equipped to pass these efficiencies onto their customers. Thereby, creating greater opportunities for all stakeholders.

Venture firms, which were formed in the past 5 years, seem to have the DNA to focus on these trends. In the NY area, we see firms such as First Round Capital and Union Square Ventures to be two examples of firms that vigorously practice the capital efficiency mantra; while focusing on high growth market opportunities. It is still premature to label these firms as institutions with the foresight of Kleiner or Accel; but their investing and portfolio maintenance styles bear watching.

Goldman Sachs analysts feel growth is oversold in the market

Goldman Sachs technology analysts hosted a call today where they made the case that technology growth companies are trading at a relative discount, approaching 30% to 'defensive' companies with many EPS growth levers. outside of incremental margins garnered from revenue growth. Here is the link Goldman Presentation 111808

Get your own at Scribd or explore others:

Public company valuation is an underpinning of private company liquidity events, and a benchmark for investments too. This market reality seems to correlate pretty well with the advice many VC's are giving their portfolio companies to contain expenses, even at the risk of giving up market share.

The advice works well in the public markets, where it's easier to rotate in and out of your ownership position. In Venture, we tend to see a move of investment stage to the 'right' as a way to ameliorate risk profiles (where early investors seek to be adequately compensated via a risk premium) for their efforts. Other VC's remain true to form and concentrate on funding innovators (Union Square, Spark, First Round)