The Start of a Dot-Comback?

By small and cautious degrees, VCs are once again opening their wallets to netrepreneurs. This time, however, reality rules

You'd have thought venture capitalists would have had enough of online grocers. Who can forget the spectacular bust of San Francisco's Web-Van in 2001? Yet New York's FreshDirect, launched in September, has had no trouble lining up backers. CEO Joe Fedele won them over by pushing low food prices rather than convenience. FreshDirect has already raised $100 million and is looking for more (see BW Online, 9/24/02, "Can FreshDirect Bring Home the Bacon?").

FreshDirect isn't the only fledgling dot-com attracting investors. Over the past six months, VC firms have started wading back into a sector many had given up as a lost cause. They're moving cautiously, though. According to industry tracker Venture Economics, VCs invested only $850 million in some 110 new and existing companies last year. During the boom's peak in 2000, VCs pumped $13.1 billion into 750 companies.


  "Maybe there weren't as many great dot-coms as people originally thought," says Jay C. Hoag, founder of Technology Crossover Ventures, a Palo Alto (Calif.) VC firm that last month invested $15.3 million in online movie-ticket service Fandango. "But that doesn't mean all of them are bad ideas."

What's drawing the VCs back into the fray? In large part, they're rewarding dot-coms' newfound focus on the bottom line. Most VCs say they are looking for strong transaction-based dot-coms that can persuade hordes of people to pay regularly for a service or product, such as tickets or online games. "Investors today are obviously concerned about reality vs. fantasy," says Fandango CEO Arthur Levitt III. "They want to see a proven track record and strong fundamentals."

That's what Hoag and his partners saw in Levitt's 3-year-old company. Although it had taken a while for Fandango's business to catch on, it began to mushroom in the past year. By the end of 2002, Fandango was attracting 2 million Web surfers a month, according to comScore Media Metrix, driving revenues up threefold from 2001.


  In part, it was the dearth of VC funds that forced dot-coms to get real. Take RedEnvelope, a company that specializes in last-minute gifts. In 1999, the year it was founded, RedEnvelope spent twice its revenues on marketing. This year, the company says marketing costs will amount to just 20% of revenues, or $72 million, up from $56 million last year. That's had two results: RedEnvelope expects to make money this year, and in October, it attracted $13.8 million in funding, much of it from the Boston VC firm Weston Presidio.

For the time being, caution will prevail on the dot-com front. VCs will focus on seasoned private players or startups with models that mimic eBay (EBAY ) or trade in information. Still, more aggressive VCs, including Sutter Hill Ventures and Brand Equity Ventures, say they will risk money in such new areas as digital-photography services. For dot-coms, the message is clear: It's time to grow up.

By Heather Green in New York and Arlene Weintraub in Los Angeles

    Before it's here, it's on the Bloomberg Terminal. LEARN MORE