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The unsung wonder of the Web: It can be a haven for venture capital

On the internet, no one has to know where your company is located. So Russ Fletcher and his partners figured they would have no problem basing their Net startup, HealthDirectory.com, in scenic but isolated Missoula, Mont. "We wanted to live in a place we loved," says Fletcher, chief executive at the online publisher of physician directories.

But out on the Bitterroot Range, it's easier to find bighorn sheep than investors--let alone venture capitalists. So to raise the $5 million he needs to take his service worldwide, Fletcher went back on the Web--and located Venture Capital Online (Vcapital. com), a Chicago-based online network. HealthDirectory's business plan, tuned up under Vcapital.com's tutelage, snared the attention of six firms, whom Fletcher is interviewing to find the best fit for his enterprise. "For companies in a remote area like ours, the Internet offers an excellent way to at least get in front of investors," he says.

The World Wide Web is turning into a Capital Web for entrepreneurs. New companies are springing up that use the Internet's connective power to link idea-rich entrepreneurs with cash-rich investors. The result can be a streamlined funding process that leapfrogs over the geography-bound personal networks of traditional venture finance to form virtual networks that span the nation--or the globe.

Moving the hunt for capital online doesn't take the work--or the risks--out of the search. The Net's anonymity means companies must keep up their guard against funding scams or middlemen who will publish corporate confidences far and wide. "The Internet doesn't change the basic rule: know who you're dealing with," says William L. Walton, CEO of Allied Capital Corp., a Washington-based small-business lender.

The promise of Web capital is that it will expose an entrepreneur's bright ideas to many more potential investors. The details vary, but most online financiers work like this: A company seeking capital can submit an electronic form via the financier's Web site. If the prospect's business seems likely to match investors' interests, the banker will work with the firm, via phone or in person as well as by E-mail, to refine its business plan and put it in a format investors like to see. The banker then distributes the plan, without identifying the company, to investors. If they're interested, they tell the banker, who introduces them to the company. The banker might put together a deal, or let the investors and prospect negotiate directly. The banker takes a cut from the deal's proceeds and, in some cases, also takes a stake in the prospect's stock.

Like other venture capitalists, the best Web financiers demand a lot of work from their investment prospects. A finely honed business plan and energetic, focused management still are crucial to success. And many entrepreneurs have learned that the online hit rate isn't necessarily any higher than that of old-style finance.

Caren J. Martineau, for one, feels the winnowing process of online finance took the romance out of her business--literally. Martineau approached Vcapital.com for a $4 million investment in her firm, Romance Boutique, an online gift catalog and shopping service for lovers. The service put her through weeks of eye-opening preparation before it posted her Web presentation on its site. The pitch drew requests for a full business plan from more than a dozen venture capitalists--but none followed up. Martineau blames the "dry" format of an online pitch: "The process doesn't let you sell the sizzle of your business," she says. "For a venture like ours that's based on romance and emotion, that's deadly." The Glen Ridge (N.J.) CEO is now negotiating financing with Orbital Capital, a New York venture firm.

The best new-wave Web financiers try to match a carefully screened portfolio of companies with a similarly vetted network of high-net-worth individuals and private and corporate venture funders. Take garage.com, based in Palo Alto, Calif. Founded by computer marketing expert and former Apple Computer Corp. executive Guy Kawasaki, garage.com has signed up more than 1,000 "accredited" investors--a Securities & Exchange Commission category that, for individuals, requires net worth exceeding $1 million or three years of family income topping $300,000. These angels congregate in Heaven, a password-protected Web page where they can view pitches from companies selected and groomed by garage.com's partners.

And how does a venture get to Heaven? Tripwire Security Systems Inc., a maker of software to detect tampering with corporate and government databases, was introduced to garage.com by an investor who had helped CEO W. Wyatt Starnes with seed capital. Garage.com's investment bankers helped Starnes refine his business plan, which they then posted in Heaven. When intrigued angels responded, they got an E-mail introduction to Tripwire. For Starnes, the final deal included two pleasant surprises: Tripwire was able to raise $2.4 million, up from an initial target of $1.5 million, and its investors include a major venture capitalist. Six months later, the investor and Tripwire are discussing a follow-up round.

New players are crowding into Web finance. After managing his own company's $2.5 million private stock placement in November, 1998, CEO Greg Halpern of Circle Group Internet decided to expand his Web-site development business into investment banking. The Mundelein (Ill.) firm has bought a broker-dealer and built a list of accredited investors out of a database of 324,000 online investors. Circle Group now has nine private placements in the works--all for clients of its main Web-authoring business.

Not all Internet financiers are newly hatched. The Capital Network, an Austin-based nonprofit, has raised more than $50 million in seed funding for 2,500 companies since 1989, through a computerized match-up of business plans with investors' interests. TCN still pitches its 20-plus prospects each month to investors via snail mail--but most business plans are now submitted to the network's Web site, and TCN is moving toward Internet and Webcast presentations for investors.

High-tech firms have been quickest to tap the Internet for capital, but old-economy businesses are getting a chance, too. OffRoad Capital Corp., with a network of investors spanning 48 states, plans to do private offerings for operating businesses in any industry. "Revenues and profits still matter more than having a `dot.com,"' says OffRoad CEO Stephen Pelletier. Entrepreneurs also can tap the Internet even if they would rather work with traditional bankers. Since 1995, Direct Stock Market has provided a marketplace for 115 direct public offerings, either self-registered by issuers or managed by small broker-dealers. The Santa Monica (Calif.)-based company's advantage, says CEO Clay H. Womack, is the low cost of E-mailing prospectuses and putting road shows online.

With so many investment services pitching themselves on the Web, how can an entrepreneur guard against scams? One clear giveaway is a for-profit banker who demands hefty fees up front from a client. "Legitimate bankers take their compensation out of the back end, from the proceeds of the deal," says Philip A. Feigin, executive director of the North American Securities Administrators Assn. That should go double for venture funders, since their lifeblood is a steady flow of business plans to present to investors.

Another danger sign: services that demand confidential technical or financial details without signing nondisclosure agreements or stating who will see the information. Even traditional venture capitalists can leak business plans to other firms they are involved with--and with a Web-based investor network, you can't tell who will end up reading your company's plans. Besides, investors don't need such detail for preliminary screens: "If you can't explain what you're doing without getting into bits and bytes, you need to revisit your business plan," says TCN Assistant Director Paul L. Myers.

Investigate any potential investor or banker just as thoroughly as you would an investment you're making. When Auren Hoffman was seeking funds for Bridgepath.com, a San Francisco-based firm that helps headhunters use the Internet to manage their businesses, he demanded that would-be financiers provide the names of clients they had funded. "Most of them just never called me back," says Hoffman, Bridgepath.com's president.

Hoffman gave up on online financiers after checking references on six firms in 1998. Instead, he tapped a traditional angel network to raise $1 million plus. But now that he needs a second round of capital, he figures he can turn the financiers' tools back on them, using the Internet to research which venture firms--and even which partners--will be most receptive to his pitch. Even without an Internet banker, the Web can speed the flow of capital to entrepreneurs who need it.

Frontier has a free searchable database of several thousand capital sources. Click Online Extras at frontier.businessweek.com.

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