NEW YORK (Red Herring) - Investor losses from failed Internet startups could total more than $150 billion, putting the massive demise of Net companies targeting consumers and businesses on par with the savings and loan scandal, asserts a respected venture capitalist.
"It's so outrageous, someone has to say, 'Wake up!'" exclaims Ollie Curme, a general partner at Battery who has studied funding trends for business-to-consumer (B2C) and business-to-business (B2B) companies. Such a colossal failure would wreak havoc on limited partners such as pension and mutual funds, said the VC of 15 years, adding that the specter of taxpayer bailouts, public recriminations of the VC industry, and congressional hearings looms large.
Not everyone agrees with Mr. Curme that the sky is falling. Veteran VC market researcher Jesse Reyes downplays the impact of Internet company failures on the overall venture community. There will be a "train wreck" of a couple of hundred Internet VCs who started out two to three years ago, but those funds account for only 10 percent of the total venture capital under management, said Mr. Reyes, managing director of Venture. The failure of B2Cs and B2Bs ultimately means that VCs will have to go back to basics, spending more time on deals and being satisfied with historical rates of return, he said.
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 PROBLEMS SEEN IN STRATEGY
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For Ed Scott, a general partner at communications-focused VC firm Baker Capital, the problem with the last three years' worth of investments is that the VC community has funded "products" rather than stand-alone companies.
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Massive Internet failures spell bad news for VC firms, but their impact may be more harsh for entrepreneurs in search of funding. As growing numbers of VCs spend more time tending to troubled portfolio companies, their investments in new startups will grind to a near halt.
Mr. Curme's findings jibe with those of market researcher Forrester (FORR: Research, Estimates). Although Forrester hasn't put a dollar amount on potential losses from Net investments, it predicts that 75 percent of online-only retailers will fail and that only a handful of B2B exchanges will survive.
If the public markets are any indication, the odds of bringing any B2C or B2B companies public are next to nil. Online stock site VTO tracked 215 Internet companies and found that every single company's stock is lower than its 52-week high as of November 30 - by an average of 93 percent. The typical stock fell from $78.93 per share to $5.53. The median share price is $3.38, with 49 companies trading at less than $2 per share and another 15 trading under a buck.
The walking dead include E-stamp (ESTM: Research, Estimates), 23 cents; PlanetRX (PLRX: Research, Estimates), 28 cents; Popmail.com (POPM: Research, Estimates), 31 cents; Talk (TCTY: Research, Estimates), 34 cents; and Fastnet (FSST: Research, Estimates), 63 cents.
After the Internet bubble popped in April, Mr. Curme began to run some numbers. Worldwide property and business losses due to natural disasters cost $50 billion every year. The S&L scandal of the late 1980s cost taxpayers $153 billion.
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TRENDLINE LOWER...AND LOWER
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If the public markets are any indication, the odds of bringing any B2C or B2B companies public are next to nil. Online stock site VTO tracked 215 Internet companies and found that every single company's stock is lower than its 52-week high as of November 30 - by an average of 93 percent.
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But the amount of money invested by VCs in B2Cs and B2Bs is larger than even the S&L losses, Mr. Curme contends. He figures that 80 percent of the $183 billion invested by U.S. private equity firms between 1998 and 2000 will be written off and that the vast majority of those write-offs will be for failed B2C and B2B companies.
"It's really grim," said Seema Williams, a senior analyst at Forrester. If heavily financed e-tailers such as Living.com and Furniture.com continue to fail, the trend may very well equate to the tremendous losses that Mr. Curme predicts, she said.
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CROSSPOINT EXPECTS DOWNTURN
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Even Crosspoint, which has virtually no consumer Internet exposure, is bracing for a downturn. It recently turned away $1 billion for a new fund, citing a market that has "reached the point where it's not just bent -- it's out of kilter."
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With the IPO window virtually closed, Mr. Curme reckons that a slow-motion train wreck is in progress. Limited partners are tightening their belts by refusing to put money into smaller VC funds and scaling back investment in general, he said. Consequently, VCs have to be more judicious with their present funds.
Even Crosspoint, which has virtually no consumer Internet exposure, is bracing for a downturn. It recently turned away $1 billion for a new fund, citing a market that has "reached the point where it's not just bent -- it's out of kilter."
The slowdown is apparent to anyone seeking funding for startups. "It's not that VCs are doing zero new investments, it's that they're doing far fewer and with heavy due diligence," said Rob Ryan, former CEO of Ascend Communications (bought by Lucent) and the founder of some 17 startups.
Back when Ascend was seeking funding in 1989, the company took three to four months to develop its business plan and rehearse it, then another three months to get a check from VCs, he said. That kind of time is an eternity for Net entrepreneurs, who have grown used to hearing stories of VCs writing checks for new deals in less than a day.
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TIMES CHANGE
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Back when Ascend was seeking funding in 1989, the company took three to four months to develop its business plan and rehearse it, then another three months to get a check from VCs.
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You may reject Mr. Curme's doom-laden scenario, but he has touched on points with which most VCs and industry observers agree: investment in new startups is grinding almost to a halt, and early-stage firms are finding it more difficult to raise money.
Closer to home, VCs must embrace the fact that internal rates of return (IRR) will fall from the obscenely high 500 to 1000 percent to the historical norm of 20 to 40 percent, said Mr. Reyes of Venture Economics. He predicts that the third quarter of 2000 will bring the first negative IRRs the VC industry has seen in more than ten years.
"The dirty little secret of the VC industry is that, until the Internet phenomenon, they weren't investing in startups," Mr. Reyes said. From 1987 to 1995, a mere 10 percent of all VC funds went to early-stage deals, he said. That percentage rose between 1997 and 2000 to the 20-percent range. Now VCs are reverting to later-stage deals, which carry less risk and require less time and energy, Mr. Reyes said.
"Being a startup expert is a risky place to be," he continues. "The Department of Commerce predicts that 80 percent of all startups will fail in five years, and VCs don't do much better."
Some 289 VCs raised funds in 1999, and another 250 funds sprouted up this year. But 2001 will see the number fall into the double digits, predicts Mr. Reyes.
For Ed Scott, a general partner at communications-focused VC firm Baker Capital, the problem with the last three years' worth of investments is that the VC community has funded "products" rather than stand-alone companies.
Many sickly upstarts were doomed from the start because their technology was weak and the management team was poor, Mr. Scott said. Such startups would have served better as part of an existing company rather than as a stand-alone firm, he adds.
The fundamental premise for Baker's continued investment, Mr. Scott said, is that the communications sector remains a strong source of good new deals.
He adds that Baker Capital doesn't forsee many failures of its portfolio companies due to lack of funding. The firm, with more than $1 billion under management, sets aside two to three years' worth of cash for each of its deals, so they have time to break even without going to the public markets.
Angel investor Ron Conway is also skeptical that losses from Internet failures will cause the sky to fall on the VC industry. A general partner at Net-heavy boutique firm Angel, Mr. Conway said that failures have caused a slowdown in new deals getting done but that saying it's a crisis on the order of the S&L disaster is downright "crazy."
Even Angel Investors, which is far more vulnerable than most because of its Internet focus, has enough diversity to return a "decent" two to five times its investors' money, he said. That remains to be seen, considering that Mr. Conway admits his fund will write off at least 20 percent of its portfolio.
As for why Angel Investors isn't raising a new fund, Mr. Conway said it's due to "lifestyle" reasons, not to the rash of Internet company failures. Still, he admits, the prospects of raising new funds from limited partners would be tough, since seed-stage Internet deals require a lot of time and effort.
The $50 million left over from Angel Investors's current fund will be reserved for the "winners" already in its portfolio. There will be very few new investments, Mr. Conway said.
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