Good money after bad? Venture capitalists and Internet start-ups

Following the recent failures of Toysmart.com and boo.com, many Internet start-ups have come under heavy - and often unjustified - criticism. Analysts point to flawed business models and over-inflated marketing spends, but does some of the blame lie with the people who often hold the purse strings - the venture capitalists.

Demanding too much too quickly is one criticism directed at the VCs recently accused of abandoning some firms with short-term problems but, arguably, long-term futures. So in recent times have venture capitalists been vultures swooping on a hot market only to exit as soon as the going gets tough?

Not according to Eric Copeland, Principal of Venrock Associates. He says it is unfair to tar all investors with the same brush. He claims that while the Silicon Valley VCs may be the most visible players in the sector they have just been following the lead of other investors rushing - sometimes blindly - into the market.

"Venture capitalists have just been chasing what they have seen in the retail equities markets, which has been a lot of enthusiasm by individual investors for Internet space," he said.

It's a view backed up by Greg Rayes, CEO and founder of SAN switch vendor Brocade, who also believes that some of the more high-profile venture capitalists are being used as scapegoats.

"The VCs are easy targets to pick on. The reality is that the market went frothy because individual investors got greedy," he said.

He added: "At the end of the day the sell off is healthy. It helps investors discriminate between companies that are a real substantial investment and those that are just concept companies."

According to John Browning, co-founder of investor network First Tuesday, the highs and lows of the market are a natural progression, mirroring the evolution of the PC entrepreneurs of the 80s and the chip start-ups of the 70s. In these businesses there was consolidation after three to four years, he said.

The investment process has become more discriminating. Even if there were poorly thought out decisions made in the beginning, it's easy to see why, he claims.

"The commercial opportunities are obvious. It doesn't take a rocket scientist to see a viable business model of selling books online. The barriers to entry were low. There was a big supply of plans out there. The rush was rational at that time," Browning added.

Percy Kavas, president and CEO of Netliant, claims the current market trend stems from some less than cautious investors who got caught up in the initial glamour and hype of the Internet.

"What's happening is that people with a lot of money who haven't really analysed businesses are listening to ideas, thinking they're cool, getting excited with entrepreneurs and giving them the obscene evaluation that triggered the feeding frenzy," he claimed.

"But I think the Valley VCs are very smart individuals. They understand trends, they know what is going on. They know when a company is good or bad and invest wisely," he added.

Janice Roberts, general partner with Mayfield Fund agrees that beneath the hype the VCs are doing something of substance.

She said: "It's not as if the VCs on their own generated the madness in the marketplace. There are other contributing factors like investors and companies buying other companies. I have a strong belief that the top tier firms are creating businesses to last."

But there are some complaints. While reluctant to dismiss venture capitalists as greedy, Bob Ogden, chairman and CEO of Mshow.com, readily admits they are difficult negotiators.

"We've raised over $50m and we haven't raised a single penny from VCs because we just couldn't resolve price. There have been many example where they have been the making of a company, so to say they're all too greedy is an overstatement, but I've never been able to get to their table."

According to Samir Arora, CEO of NetObjects, any dot-com start-up with a business-to-consumer concept will find it almost impossible to get funding in the US now. Venture capitalists are realizing retail concepts are not the get rich quick certainty they once were considered to be. The business-to-business model is the way forward, Arora claims.

Technology share prices will continue to fluctuate. But one thing is certain - investment in the online arena is here to stay, but it is a skill that's evolving almost as quickly as the technology and ideas it depends on.