FIGHTING FOR FUNDING

JON SPRINGER

Chalk up the recent deaths of Internet grocery companies ShopLink and Streamline in part to a Catch-22 of the New Economy: You cannot find funding without profitability, and you can't find profitability without funding.

In the end, Westwood, Mass.-based ShopLink and Streamline found neither -- and that's a problem for other Internet food retailers, including Webvan, Foster City, Calif.; PDQuick, Camarillo, Calif.; Kozmo.com, New York; the corporate parents of Peapod and GroceryWorks, and scores of smaller firms serving independents.

Virtually all of these companies were brought to life by investors who as little as a year ago were willing to pump capital into ambitious startups aiming for a growing segment of the grocery business.

Growth projections of Internet grocery sales haven't changed. Some industry-watchers still estimate that on-line groceries will be a $14 billion-a-year business by 2004.

However, the backers of the companies chasing those sales certainly seemed to have changed their minds, observers say. They're losing patience with companies showing little promise of immediate profits, and in many cases, letting their investments die rather than risk more on the chance Internet grocers can survive.

Investors and entrepreneurs are also acknowledging they in many cases underestimated the costs of building competitive e-commerce operations, experts told SN.

April's Nasdaq crash has meanwhile made it prohibitively expensive for public companies to raise money through the stock market. The resulting swing in the availability of capital has pressured companies to survive without additional investment.

"The market has gone from irrationally liberal to irrationally conservative," Matt Stamski, senior analyst for Internet research company Gomez, Lincoln, Mass., told SN. "It's driven some dot-coms out of business and it will continue to do so."

Rough Times in the Capital Markets

ShopLink and Streamline recently joined dozens of e-tail flops which, regardless of their promise, ran out of money before they could turn a profit. Both Streamline and ShopLink maintained they were on the right path, but that they needed more funding before they could become profitable.

Their inability to find additional funding did not come as a surprise to some experts, who said that capital has been directed elsewhere.

Venture capital firms such as Hummer Winblad, San Francisco; Kleiner Perkins Caulfield & Byers, Menlo Park, Calif.; The Sprout Group, New York; and Benchmark Capital, Menlo Park -- all of which invested heavily in various on-line grocers -- have since turned their attention to other technology concerns, experts say.

This was because their intention was to support emerging technologies -- but not necessarily retail businesses, John Taylor, director of research for the National Venture Capital Association, an Arlington, Va.-based trade group, told SN.

"The Internet was a brand-new space and the venture capital industry recognized it. It kind of loaned itself to retail," Taylor said. "A lot of their investing had to do with carving out a space in the on-line world, whether it was in pet food, supermarkets or books."

Most of the money invested by venture capital firms went toward attracting top talent to develop e-commerce technologies, Taylor said, citing the team that created Amazon's on-line ordering system and eBay's auction software. Webvan's sophisticated warehouse and delivery systems are another example.

But as e-tailers grew up, their efforts were less dependent on technology and more on the real costs of marketing and promotion, observers said. That is an area venture capital tends to stay away from.

"Venture capitalists like to invest in technology and what they realized was that they were really investing in consumer retail companies," Jesse Reyes, vice president of Venture Economics, a Newark, N.J.-based research firm, told SN. "That's not their area. Procter & Gamble may spend $40 million a year to find out why a housewife picks something in aisle four, shelf five. That's not what venture capital does."

Reyes said he feels the newness of the Internet and its potential as a commerce tool "seduced" investors of all stripes.

"It reminds me very much of the computer industry in 1983. Back then there were 43 hard-disk manufacturers and by 1987 there were only four. There wasn't room for 40 PC clone companies. A lot of venture capitalists lost money on that."

According to recent figures from Venture Economics and the National Venture Capital Association, the industry is still funding companies at record levels but its efforts are moving away from the Internet, and specifically, Internet companies dealing with commerce and content.

Venture investment in all Internet companies fell 17.6% from the second to third quarter of this year, according to the research. Of that figure, investment in companies specializing in either content or commerce fell 25.6%, from $10.3 billion to $7.7 billion.

Overall, the venture capital industry has invested $25.9 billion in 1,774 companies during the quarter, with industries such as medical/health (up 69.8%) and biotechnology (up 141%) receiving the greatest gains in attention.

Venture capitalists are also seeing smaller gains from their investments in Internet companies than they had hoped, with average returns at 3.9% during the second quarter, compared with 23.1% in the first quarter and 59.4% during the fourth quarter of 1999, when Internet companies were still red hot.

Even if capital were available, experts have come to realize that start-up e-commerce companies and their backers underestimated the costs of building a competitive business.

"I don't think I've ever met an entrepreneur who had any idea what it would take to support their company financially -- but there's plenty of blame to go around. The VCs were also naive," said Reyes.

John Icke, chief executive officer of ShopLink.com, told SN he never misled investors as to the cost of building the business. He admitted, however, that finding backers committed to such costly goals was almost impossible.

"I don't think we misled anyone. It was going to be a very expensive business to build," Icke told SN. "I don't think institutional investors fully realized what needed to be put into this space. They didn't have their mind's eye focused on the longevity of this business."

Icke argued to the end that his company had a solid business plan and was off to a strong start but that there was not enough time or money to support it. Cash-pressured e-commerce players essentially were forced to try to build in months what other industries assembled over years, he said.

"Imagine for a moment if you had to build Safeway's infrastructure all over again. The bill would run in the hundreds of millions or billions," Icke said.

The Future: Death or Glory

Lower returns from venture capital investments this year have mirrored the performance of the Nasdaq market, which crashed in April and took dozens of publicly traded dot-com stocks along with it. E-grocers including Webvan and HomeGrocer (now merged), Streamline and Peapod have for months traded at or near record lows. Streamline, trading at less than $1 since September, was headed toward a potential de-listing when it closed shop earlier this month.

Share price weakness not only makes it hard for companies to raise money by selling stocks, it has also scared off potential lenders and employees, said Ernie Goss, a professor of economics at Crieghton University, Omaha, Neb., who teaches courses in e-commerce. Goss added that rising interest rates contributed to the stock struggles and impacts fast-growing companies the most.

Goss said struggling e-commerce companies will have to find well-known partners to defray costs and find capital. Failing that, they had better have good earnings news soon.

"A company like Webvan is going to have come out with some positive earnings news," Goss said. "And not only will have it be positive, they'll have to manage it so that the next one is even better."

Webvan, which owes much of its growth to an infusion of millions from venture capitalists and a spectacular initial public offering, is at a critical stage, observers say. Still a huge money-loser and with its stock near record lows, Webvan could change its momentum if it is able to report that its huge distribution centers can actually break even.

So far, the company has far missed its first target on that front. Its facility in Oakland still hadn't gained enough in order size or volume business to break even during the third quarter.

And the clock is ticking: Webvan said it would need more money by mid-year 2001.

"Webvan is going to have to demonstrate they can give a return to their investors," George Dahlman, equity analyst at U.S. Bancorp Piper Jaffray, told SN. "It's as simple as that."

In some ways, the fact that Webvan was able to raise as much cash as it did before the downturn has helped it weather the storm that eliminated some potential competitors, Goss said. "They'll get to be known as a survivor." But to avoid what could only be a more spectacular failure than Streamline or ShopLink, Webvan will have to prove it can make money and fast.

"This sector," Stamski said, "could really use a success story."