A Sell Rating for Financial Startups

Justin Hibbard

Not much else to say about LiquidNet's monster financing last week except we told you so. Twice, in fact. First, we told you how late-stage VC firm Summit Partners has been unearthing gems like optionsXpress in the financial sector. No surprise that Summit co-led the $250 million investment last week in LiquidNet, an online block-trading service. Second, we told you how founders of late-stage startups are increasingly cashing out without an IPO or acquisition. That's apparently what happened last week at LiquidNet, according to several reports. Those founders must have made some serious bank--the New York Times says LiquidNet was valued at $1.8 billion. At a price like that, the company isn't likely to get acquired any time soon. Yet I have to think that after LiquidNet and optionsXpress have braved ups and downs on the Nasdaq, they'll eventually wind up merged with big financial-services outfits. That seems especially likely after a meeting I had last week with some E*Trade executives, who said consolidation is looming in their industry.

Discount brokerages like E*Trade can no longer rely on trading to carry their businesses. Trading volumes are fickle, and commission prices are dropping. In fact, brokerages are waging a price war over commissions. E*Trade was the lastest to cut prices this month after recent cuts from Schwab, Fidelity, and others. Several of these companies now derive most of their revenue from non-trading sources like banking, lending, and mutual-fund sales. Smaller brokerages that rely heavily on trading could be in for a tough slog--and some offers from suitors. Even a merger of big, diversified players could make sense. "A year and a month ago, we had some serious talks for a whole month with one of the players in the marketplace and came close," said Connie Dotson, chief communications officer at E*Trade. "I'm shocked there hasn't been more consolidation," added Mike Curcio, executive VP of retail at E*Trade.

Another private, VC-backed company to watch in the financial sector is ShareBuilder. Founded in 1996 and based in Bellevue, Wash., the company operates an online service that lets individual investors open accounts of any size and set up regular, automatic investments in stocks, index funds, and bond funds. ShareBuilder aggregates all of its customers' orders for, say, Microsoft stock and buys the shares in a discounted bulk trade. The company has over 1 million accounts, is profitable, and is on track to earn about $40 million in revenue this year, according to Tom Alberg, a VC at Madrona Venture Group. Along with co-investors such as Bowne & Co. and Wells Fargo, Madrona has invested $63.5 million in ShareBuilder in four rounds. Perhaps ShareBuilder can expect a call from E*Trade?