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IPO Focus: VCs missing the boat?
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September 9, 2000: 8:38 a.m. ET
Venture funding bets on business services and other sectors no longer hot
By Staff Writer Luisa Beltran
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NEW YORK (CNNfn) - It used to be that if you wanted to find a hot IPO to invest in, all you had to do was follow the venture capital money. But of late, venture capitalists seem to be funding companies no longer in vogue in the new issues market, raising the question of whether the savvy technology investors who once were well ahead of the hot issues wave might now be trailing in its wake.
In 1999, start-ups received more venture capital funding, $37.3 billion, than any time in history, according to data from VentureOne Corp., a venture capital research firm that tracks investments. So far this year, VCs are on track to shatter that record, having invested $35.4 billion in companies for the first half of 2000 alone.
With the IPO market is still on hold following the Labor Day break and new issues not expected to begin coming to market until the week of September 18, IPO investors and venture capitalists alike are lining up their picks for the rest of the year. The question in analysts mind is are VCs still a reliable place to look for smart trends?
 Not surprisingly, nearly all VCs investments so far -- $30.1 billion -- have gone into Internet related deals such as infrastructure companies and software/database firms, VentureOne said.
Infrastructure and networking deals, thus far the surest best among 2000 IPOs, have received the most attention and money, $19.3 billion worth, from VCs. Yet, to the surprise of some analysts, VCs also are still investing in Internet-related companies, such as business services, that repeatedly are failing to perform well in the IPO market.
Business and consumer services -- which include companies that provide online advertising and marketing, banking and free-email to consumers -- received nearly $15 billion, the most out of all Internet-related sectors. Yet those companies are generating little buzz when they get to Wall Street.
"There seems to be a disconnect between the VC community and the IPO market," said Corey Ostman, co-chief executive of Alert-IPO.com.
For their part, venture capitalists said their investments have changed with the times.
For instance, the group recognized that business services isn't the hot sector it once was, and funding has fallen. Yet the sector is still ahead of last year's investment pace of $11.6 billion.
And e-commerce, one of the worst performing IPO sectors this year, has venture seen $1.2 billion in venture capitalist money, less than half of the $3.7 million invested in 1999, they note.
"VCs look at a variety of factors and what is going on in the IPO market is only one factor," said Staci Carney, a VentureOne spokeswoman. "Investing in companies is obviously a little more long term. VCs are making long-term predictions about what is going to be hot."
Looking for profits
Still, venture capitalists continue to pour money into companies with questionable business models, insiders said. For example, on August 22, Prime Ventures and other VCs invested $27.5 million in ailing drug retailer Drkoop.com (KOOP: Research, Estimates).
In April, a sell-off on the Nasdaq sent technology stocks plunging and forced the IPO market into a temporary freeze. When the new issues market bounced back in late Spring, dot.coms fell out of favor and Wall Street began looking to companies with earnings, profits and products.
Venture capitalists have yet to catch up with this trend, insiders said.
"When talking about changes in the capital markets, it take six to nine months before changes take effect in the venture capital industry," said Mathew Cowman, general partner of Bowman Capital, which helped fund the ill-fated Pets.com (IPET: Research, Estimates), also funded Noosh Inc., which pulled its IPO in May.
The continued focus on the Internet can be explained by the glut of new people joining the sector, said Andy Rappaport, a partner at August Capital, which funds primarily information technology companies.
"Lots of people in industry really only know the Internet and they only know companies that have short paths to an IPO," Rappaport said.
However, Bob Cross, president and chief operating officer of Chicago-based vcapital, which serves as an exchange for private capital, counters that VCs are not throwing money away on low-prospect companies. Instead, the dot.com failures are the result of choices made by investment bankers, who are picking up companies at an earlier stage than before.
Before the Internet boom, bankers would seek out companies with a five-year record of increasing sales and profitability and then push for an IPO. But the technology rush of the late 1990s pushed bankers to seek out flashier companies at an earlier stage.
"The banker's criteria for an IPO moved all the way into the venture capital area and they began doing VC-type deals and we began to see VC-type success rates," Cross said.
Venture capitalists, he said, will continue to fund risky companies and some will fail. Most venture capitalists seek out technology deals because that is where you have the most potential for explosive growth, he said.
What's next for the "smart money"
In 1999, nearly anything dot.com received funds but now communications and optical networking is generating the most buzz. For example, on September 6, communication service provider QoS Networks received $100 million in funding from a syndicate led by Warburg Pincus.
The framework for bringing a company public has also accelerated, although that is expected to change. In 1995, it took companies nearly five years from their initial round of funding to launch an IPO. But in 1999, that time frame fell to two-and-a-half years from the initial funding round, VentureOne said.
"With the Internet boom, the time to market shrunk to 12 to 18 months," said Ken Lawler, general partner of Battery Ventures. "But you will see that the time market will be more rational and it will be two to four years before a business is mature enough to go public. We think that's for the better."
Companies that want to succeed -- generally defined reaching the IPO stage -- also need to show strong management, a strong business plan and a convincing road map to profitability, he said.
"We are going back to the market rules of years ago," Cross said. "The IPO market is not as receptive to early stage companies as it was six months ago."
The most famous venture-back companies are Microsoft, Yahoo Inc. (YHOO: Research, Estimates), Cisco Systems and America Online (AOL: Research, Estimates). And venture capitalists still look to an IPO as the best way to get a return on their investment, said August's Rappaport said.
But for lesser companies that aren't a Cisco (CSCO: Research, Estimates) or a Microsoft Corp. (MSFT: Research, Estimates), VCs are now considering mergers as a way to get their money back.
"Companies that can go the distance, will go the distance," Rappaport said. "VCs that don't want to take a company public are seeing M&A as an option." 
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