NEW YORK - Ever wonder why some businesses attract venture capital and others never get the nod? |
Venture capitalists are very clear about what they want out of a deal: They want to make a lot of money funding high-growth companies; they demand a strong management team; and they must have a clear exit strategy.
Despite the fact that the founder of Gotajob.com had filed for bankruptcy, Santa Monica-based Digital Coast Partners placed a $9-million bet on the company, as long as the founder agreed to get out of the way.
"The idea was so good that we decided to work around the other issues," said Jamie Montgomery, a managing partner at Digital Coast. Gotajob.com is an online recruitment service for seasonal, part-time and temporary jobs.
"It was a unique business model that turned the whole model that most employment services use on its head," said Montgomery.
Gotajob.com caters to the low-level, part-time jobs that most recruitment and placement services avoid. Intrigued by the concept, Digital Coast raised about $750,000 in seed money, brought in a new management team, revamped the business model, and is about to invest another $8 million. In exchange for the cash, the founder stepped down, but remains a stockholder and board member.
Every year, Digital Coast reviews about 100 business plans. This year, Gotajob.com was one of the lucky four to five businesses the venture firm decided to fund.
Being a 'dot-com' is no guarantee
Despite the media hype surrounding Internet companies, having a "dot-com" after your name is no guarantee that your company will attract venture funding. Professional investors want to see that by serving a large market, you can turn a small business into a very large one.
"If you only serve a $20-million market, even if you have 100 percent of that, you can't get that big," said Geoffrey Smith, managing director of Alterity Partners LLC, a New York City venture capital bank that specializes in the information-technology industry.
He said venture capitalists look for companies with target markets of $1 billion or more and whose market is fragmented among many vendors. They want companies in industries not already dominated by an Amazon.com-type monopoly, and companies with the potential to become market leaders.
"Gotajob.com found a good niche," said Edward Milstein, who was brought in by Digital Coast to serve as CEO of Gotajob.com. "Nobody is in the high-turnover job space. Typically, people in that space don't have a cost-effective vehicle for finding job applicants. It's not worth it for them to place an ad or hire a recruiter to fill those jobs."
Experienced managers only
Milstein said no matter how great your product is, investors demand an experienced management team.
"You want to bet on the management team," said Alterity's Smith, adding that Internet experience is less important than experience in the industry or the market that your Internet company targets.
"Someone who knows the Internet but doesn't have industry knowledge is going to have trouble," Smith said.
For example, he recounted the plight of a software company that created an application for the medical industry that was supposed to revolutionize how hospitals did business. Unfortunately, the founders didn't have in-depth knowledge of how the hospital industry functioned, and the industry rejected their software.
Think big, move fast
Investors also look for companies that can grow quickly to meet the demands of large markets. This means your ability to ramp up quickly is critical.
"We see a lot of business plans, and the biggest challenge is that people are not thinking big enough," said Montgomery. "We saw a plan last night that would have taken just too much effort to grow."
Another buzzword related to Web businesses is "viral marketing," which means that the more business the site does, the more business it generates. At Gotajob.com, for instance, the more jobs are posted, the more applicants will visit; and the more applicants visit, the more employers will want to post jobs. The growth of this mass market boosts advertising revenues.
More machines, fewer folk
Alterity's Smith also said he looks more favorably on businesses whose growth would require additional equipment, not staff.
"It is much easier to add hardware than to have to add people," he said.
When staffing and manpower is an issue, investors are more cautious. The biggest secret about the Internet economy is that business-to-business commerce dwarfs the consumer market, where a company like Amazon is selling a lot of books but not making a profit.
"The folks making the most money online are Cisco and Dell, which sell millions of dollars worth of equipment through their Web sites every day," said Smith.
Consumer commerce on the Internet, he said, is becoming more and more brand driven. But creating a brand is extremely expensive and difficult for most Internet entrepreneurs. Companies providing business-to-business services online will continue to be the top moneymakers on the Net, he said.
At Alterity Partners, Smith said a strong distinction is drawn between e-commerce/transactional sites and "new media" sites that provide services or content and rely on advertising for revenues.
E-commerce and transactional sites have a more sustainable revenue stream and can grow more quickly because they also fit the model of requiring more hardware than staffing to grow.
His firm looks less favorably on sites based on advertising revenues.
"It is very difficult to build an advertising sales force," he said, adding that those ad revenues are highest when the site is hot. If traffic dies down and advertisers pull out, your business is history.