This Tech Market Has VCs Wary

Not too many of these guys have gotten caught up in utility computing so far. For one thing, lots of them aren't sure what it is exactly

Calling a venture capitalist a lemming is about as original as saying a lawyer is tricky. But the dig has truth. Who can forget all those online pet-food stores or the companies that were trying to bring a sense of smell to the Web?

The latest high-tech rage is utility computing. But this time venture capitalists are reluctant to dive in because they believe big companies like IBM (IBM ) and Hewlett-Packard (HPQ ) are already dominating the market. While a few venture firms like Highland Capital Partner have invested in utility computing companies, most have steered clear. VCs fear that startups hoping to get a piece of this nascent market are like mice running amid elephants.

The good news is the elephants are buying. Storage-equipment giant EMC (EMC ) paid $625 million cash in January for VMware, a Palo Alto (Calif.) company that makes software that can pool a company's computing resources into one big group. For investors always looking for an "exit" strategy, acquisitions seem the best bet in utility computing. "Big companies are in control of the distribution channels," says Ollie Curme, general partner at Battery Ventures. "It's harder and harder to find a startup that's a breakout company and can go public, as opposed to a nice little product that gets acquired."


  Of course, selling to the big guys isn't exactly getting VCs to open the purse strings. "The best shot [for utility computing investments] is an acquisition, and for VCs that's a bit like kissing your sister," says Nick Sturiale, a general partner at Sevin Rosen Funds. As a result, he has turned down about a dozen utility computing investments.

Getting acquired for $100 million or so is certainly better than nothing. But many startups can take $15 million to $50 million to build. For venture firms used to big hits, doubling their investment, if they're lucky, isn't going to cut it.

The confusion as to what exactly utility computing is has also put off the venture capital community. Some think of it in terms of just routing computing power where it's needed in big networks of servers. Others include pay-as-you-go software applications like (CRM ), which sells customer-management software like a service over the Internet.


  Truth is, utility computing has no rock-solid definition. About a year ago, Neeraj Agrawal of Battery Ventures saw about 50 companies with the word "grid" or "utility" in their one-line explanation of what they did. "They saw it as hot and wanted to ride the wave," he says. "Investors have figured out that this term is very nebulous, and we're not seeing as many new companies because the market is trying to figure out what it is."

Nonetheless, some utility computing companies are being funded, though it's impossible to say exactly how many. Analysts figure at least a dozen such startups have received funding in each of the last three or four years.

One poster child is BladeLogic, a Waltham (Mass.) company that has received $22 million from Battery, Bessemer Venture Partners, and Globespan Capital Partners. BladeLogic's software can manage thousands of server computers as though they were one giant machine. It's akin to putting a giant mainframe through a cheese grater, jokes one investor. More important, companies like Wal-Mart Stores (WMT ) and General Electric Co. (GE ) are buying it, says Agrawal. In all, BladeLogic has more than 100 customers.


  The on-demand software model, if you want to call that a utility, is also catching on. Exigen Group in San Francisco sells software as a monthly service that handles high-volume, recurring financial transactions. It made headlines on Nov. 1 with a deal to create a new company to manage royalty disbursements for two major record labels, Universal Music Group and Warner Music Group. Exigen is profitable and will have more than $60 million in sales this year, before this deal, says George Bischof, a general partner at Focus Ventures who invested in it.

Propero, a startup based in London that has raised about $17 million so far, takes the on-demand software model a step further. Funded by 3i, a British venture and private-equity firm, and Britain's Catalyst Venture Partners, it can take traditional software and deliver it as a pay-by-the-drink service over the Web.

That said, venture capitalists remain wary of utility computing, however you want to define it. While that skepticism sure makes life harder for entrepreneurs trying to land investment money, they should keep the faith. Tech trends have a pattern, says Bischof. There's the unavoidable hype, followed by overinvestment, followed by the shakeout. Then the real survivors emerge. That's what happened to Google (GOOG ), a relative latecomer to the Internet search market.

Now that early utility computing hype has given way to reality and skepticism, sorting the winners from the losers can't be too far off.

By Sarah Lacy in Silicon Valley 

Edited by Jim Kerstetter

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