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Excerpted from the book Done Deals, edited by Udayan Gupta, Harvard Business School Press
The success of Internet companies such as Netscape, Amazon, Geocities, and Lycos have become the talk of investors everywhere. In the process, Wall Street and many investors have gotten excited about CMGI, a publicly traded database marketing company, that early on chose to make investments in Internet companies through a company-funded Internet-only venture capital pool, and chose to sell shares in that pool in the public market. Venture capital funds historically have been pools of capital whose value cannot be accurately pinpointed. That is because they mostly own shares in privately owned companies whose price has not been determined in the manner that shares of publicly owned companies are. Indeed, the combination of CMGI and @Ventures, the venture capital arm of CMGI, is a fascinating experiment in how to publicly value a portfolio of public and privately owned entrepreneurial companies. CMGI, which is publicly traded, had a market valuation as high as $16 billion in 1999. CMGI owes much of its success to its investment in Lycos, the search engine company, but it also has been an active investor in Internet start-ups such as Chemdex and Critical Path, and more established companies such as Alta Vista.
At a time when many venture capitalistsboth experienced and inexperiencedhave chosen to jump on the Internet bandwagon by creating Internet-only funds, @Ventures stands as the granddaddy of them allin cyber-time, of course. Jon Callaghan, a managing partner of @Ventures, talks about the industry's first Internet-only venture fund and the benefits of such a focused strategy.
CMGI |
The Early Bets | Lycos | The Rookie Syndrome | Our Own Keiretsu | Internet Only |
I got into venture capital in a unique way. I joined Summit Partners straight out of college. Prior to that I started a small business and ran it for about eight years. It was a chain of retail sporting goods stores in Jackson, Wyoming, called Mountain Bike Outfitters. I ran that during college and after, even while I was at Summit. I got into the venture business from the entrepreneurial side, although I joined pretty young in my career.
When I joined Summit it was about a $400 million fund. When I left, it was probably triple that. Early on, we were doing what for Summit were early-stage deals$2 to $5 million investments. For Summit today, an early-stage deal is a revenue growth company with profits. It's definitely later stage by the industry's definition. I spent four years there, and then went to business school at Harvard Business School. While I was at HBS, I worked for America Online's Greenhouse, which is now AOL Studios. At the time, the Greenhouse was a $10 million pool of capital that was put aside to find and seed content opportunities for the online service. With my bike shop background, I was much more interested in working with young companies.
I did a lot of other work in the Internet at business school, including a field study called Chemdex in which we wrote the business plan for an online market for specialty chemicals. I got exposed to the Internet, and actually hooked up with the guys at CMG way back when CMG was a Summit investment. I knew David Wetherell, and knew what he was doing in the Internet, and joined the company to do early-stage Internet venture capital.
Structurally, we're not CMGI but its venture arm. CMGI was the sole limited partner in our first two venture funds, @Ventures One and @Ventures Two. We're structurally like any other fund, in that we take and carry from our limited partner on the gains that we create. So, I joined as a general partner in @Ventures One and @Ventures Two. At the time there were me and four others in @VenturesPeter Mills and I on the West Coast, and David Wetherell, Guy Bradley, and Andy Hajducky on the East Coast.
CMGI initially was in the database marketing business. Then in 1994, Dave Wetherell put a small development effort together under a division he called Booklink Technologies, which had developed a browser designed to let people read books remotely over a network. It used HTML and HTTP. Booklink was sold to America Online for about $30 million in AOL stock, which traded up to $70 million very quickly. We took $50 million of that and put it into @Ventures One, which became the first Internet-only venture fund.
The thinking for us has always been that the Internet was going to be big. We didn't profess to know where it was going, nor did we profess to be experts on the Internet. It's far too big and it is going in too many different directions. From the very beginning, however, all of us knew that the Internet was going to revolutionize the way that people communicated, accessed data, and stayed in contact. So, a lot of our early bets were on three areas: content and community, electronic commerce, and enabling tools. That's been our mantra since day one.
We chose those three areas because we thought there was a need for content in communication, which is part of creating a community. We also thought that there needed to be people building the structure of the Internet, so enabling tools and technology were very important to us. Lastly, we had the vision early on that people would conduct business on the Internet, either business to business, or business to consumer.
Lycos fit everything. It's an enabling tool and a component of the Web infrastructure. We saw very early on that there was this tremendous growth occurring with Web sites and we figured there was a need to index all of them. We knew that the directory/search engine space was going to be a place where most people started their experience on the Webwhether they needed to find something or do something.
We invested very early in a technology that we licensed out of Carnegie Mellon University. I think we put in $4.5 million. We brought in a CEO by the name of Bob Davis, and basically built Lycos. We still own 18 percent of Lycos, and at one point owned somewhere in the high 50 to 60 percent range. It was a very successful investment for us. The investment was obviously as early as it gets: we literally licensed code out of a university, negotiated that license, and built a company around it.
Did it take a lot of thinking to put $4.5 million10 percent of our total fundinto one deal? This gets back to your risk tolerance. We have an exceptionally high tolerance for risk. We acted very quickly to get the competitive advantage in this space. We saw Lycos as being fundamental to the building block of the Internet. It was a very complicated deal to doand it was super riskybecause we were negotiating with a university to pull a piece of technology out, relying on researchers who had never been in the private sector before for the code. It was a very risky venture deal.
Lycos was an East Coast deal. We are split geographically, because our mode is to be very operationally oriented, very hands-on. When we work with companies, we work with them day to day. We always give exposure to companies like Lycos on the West Coast, and others, but they need lots and lots of handholding, which we provide.
We also were the first professional investor in Geocities. David Bonet had approached twenty other venture capitalists, and got turned down by all of them before he met us. We invested something like $5 million in Geocities. At its acquisition by Yahoo!, our investment in Geocities was valued at somewhere between $1 billion and $1.5 billion in Yahoo! stock.
Geocities was something really fascinating. We fundamentally believed that the Web was a great place for people with common interests. Birds of a feather flocking together. We thought that David Bonet had something major in his paradigm of allowing people to build Web pages.
How can a new fund break into this ultra-competitive world? Every single venture fund is doing Internet investments, including Kleiner Perkins and Sequoia. All the big and very successful names in the business are in Internet investing. So how do we compete in such a market?
We compete by virtue of our focus. Our value is that we do only Internet investing. A few things result from that focus that are more valuable than capital in the competitive Internet marketsnot in the market for Internet deals, but in the competitive market that is the Web. One is familiarity with the problems of rapidly scaling Web companies. We've not only seen Lycos and Geocities, but we're also investors in Iconic, which was sold to US Web; Netcarta, which was sold to Microsoft; Planetall, which was sold to Amazon; Real.com, which was sold to Hollywood Video; Chemdex, which exploded growthwise and is doing great, but is still private; and Critical Path, which went public in February 1999. We've got forty investments that we've worked with from early-seed stage to maturity. We have experience with a lot of the specific challenges and pitfalls that these companies are facing for the first time.
A lot of the challenges and pitfalls are uniquely related to the Internet. They can be as simple as deciding whether to do a big portal deal with Yahoo! for $2 millionor with AOL for $5 millionor putting that money somewhere else. Or it can be as complicated as determining how we should think about customer acquisition costs or an OEM strategy. We've lived through all these things, specifically on the Web. That's one result of our focus.
Another is business development opportunity. We invested in Planetall early in its development, then helped forge strategic alliances between Lycos and Planetall, and between Geocities and Planetall. Both alliances drove their membership growth overnight and dramatically contributed to the success of the company. The same can be said for Critical Path. We have Planet Direct, Nabasite, Raging Bull, Ancestry.com, and a couple of others, all of which are customers of Critical Path. In a way we're the keiretsu of the Internet.
We've done probably five to ten strategic deals with Yahoo! on behalf of our companies. We've done that many with AOL. We've done that many with Inktomi and Excite. Across the portfolio, all of us partners have had direct interface with many different companies, so it's very easy to figure out who to talk to at Yahoo! for a deal with a new portfolio company. It's easy for us to pick up the phone and make that introduction. Externally we work very hard to provide strategic resources to our entire portfolio. For example, we work tightly with Compaq to make sure that every company in the portfolio gets close to cost pricing and rapid deployment of hardware. They did that with us because they see forty companies growing rapidly and think it is a great way for them to get an inside track. I don't want a CEO of a start-up wasting his or her time on these types of administrative issues. I can pick up the phone, get a team of Compaq or Inktomi people there, and basically allow the company to focus on the important stuff.
We're getting into a third area we call building-block technologies. Within the portfolio, CMGI owns a company called Nabasite, which provides hosting co-location and bandwidth. Raging Bull is a great example. By hooking them up with Nabasite, we took Raging Bull from one server in a dorm room to a fully redundant and scalable architecture within a hosting facility within a month. Ancestry.com is an even more dramatic example. We installed and went live with fifty servers redundant for the Web site within about four to six weeks. So, we can deploy building-block technology.
Another example is our advertising suite of companies, owned by CMGIInterpreter, Engage, Adsmart, Youcan, and Eyepro. If there is anything to do with advertising at any one of these start-ups, we can deploy a technology, whether its an ad network, a serving solution, or a traffic profiling engine. Again, it's a very easy way for a company to get up, out, and on its way to being a real business without spending a lot of time on some of the lower value-added decisions.
@Ventures Two, which we closed in 1996, had roughly $50 million. It was very successful. We had investments like Planetall and Real.com. We still have 70 percent of Critical Path, and are in several others that are still live and active. We invested that very successfully, and then in December 1998 we closed @Ventures Three, which has $280 million in capital.
In @Ventures Three, CMGI is one of many investors. We also have investments from Microsoft and from LVMH, a European company. We also have Bank of Boston Capital and other financial investors. We want a deeper access to capital, because we think the market is accelerating and we want to do more large investments. More than that, CMGI has been a great keiretsu partner. Within their stable they have companies like Nabasite, which we've mentioned; Planet Direct, which is great for distribution; Engage, which is great for tracking; and Activerse, which is great for the chat-type thing. We thought by getting companies such as Microsoft, Sumitomo, and several large media companies to invest, we could have access into their networks.
It is part of the whole theme of providing more than just capital. If capital is a commodity in a competitive market, and we don't have the name and longstanding record of success that a Kleiner Perkins or a Sequoia has, we need to work harder and more strategically for our portfolio companies. So, we saw fund-raising as a way not only to bring in more capital for these companies, but also as a way to add additional strategic resources and contacts. It has worked quite well.
Do we worry that more money will change the way we invest? We had always thought, even in the early days, that we would trend up with the industry's growth. Initially, we were doing early-stage investments, and we still do a majority of those. But as more companies mature, there are opportunities for some larger investments, or perhaps some investments in companies that already have a Web site. We've been very active in doing those types of investments, and with good success.
There is a lot of competition and a lot of money. But for venture capital funds that are not focused on the Internetjust like for companies that are not in the Internetit becomes harder and harder to catch up. Our keiretsu is number two in total live hits all time, number two in total reach. When we go to any company that's interested in reach and distribution that's a meaningful statistic, especially if the entrepreneur's making the decision based on how to add the most resources to his company, and how to ensure success in the Internet world. Funds might be able to do one or two successful companies, but it's pretty hard even today to create a successful keiretsu on the order of forty companies. That's not to suggest that there isn't time and room for other venture capitalists to come into this space. We think there is. We have a tremendous amount of respect for some of the more traditional venture firms that have shifted their resources to the Web.
Our intent is to focus entirely on the Internet industry. We don't have the distraction of also having to monitor a health care portfolio, or a hardware portfolio. We're fully dedicated. I think that enables us to be much more nimble as a partnership.
I've talked to a lot of folks on Sand Hill Road, and they tell us that when they're having a problem with Internet investments, their health care partners just don't get it. Or some of the more traditional partners just don't get it. So, as a partnership they have trouble reaching a decision.
The nine of us at @Ventures get itat least the big picture. We all believe in this opportunity. It's not a question of figuring out whether this whole Internet thing is going to be real, but of evaluating the vision of the investment opportunity. It means we can act very quickly and decisively. We can bring in resources that others can't, and we can add value that others can't, because we've lived through several companies in the industryboth successes and disappointments.
The Internet is too powerful for businesses to ignore. It's too powerful for it not to proliferate into every single aspect of most companies. We have evidence that it costs certain companies upwards of $100 per purchase order. It costs us around $3. We're doing an investment in the health care sidean e-commerce company that sells specialty medical devices to hospitals. The cost in the industry per purchase is in the range of $300. We're doing it for dollars or pennies. The Internet is absolutely too powerful for any profit- or growth-motivated business to ignore. For that reason, and because the pace of business is accelerating and there's no faster way to communicate, I'm quite confident that the technology will expand into pretty much all aspects of business and our economy, which is what's so exciting about it from our perspective. We believe that in 1999, we're in the first inning of a long game.
Building an Internet company is also going to get more expensive. It costs somewhere between $25 and $50 million of private capital to get a standard e-commerce company up either to an IPO or to a larger strategic round. Our philosophy is that when we're behind a company, we like to not only protect but enhance our position. Clearly, we need financial resources to do that. We think we can very successfully and rapidly deploy this capital into good deals, since the opportunities are just tremendous. Again, that points to the opportunity being here now if we raise a larger fund, because there are good and prudent places for us as investors to put it.
Do I think the Internet will last forever? I think the Web will proliferate. I think it will become more of a mature business, and you'll see probably fewer of the home runs. By the same token, you're going to see much more consistent business models, much more consistent revenue models, and much more consistent profit models.
I don't think this type of explosive growth will last forever for investors or for the industry, because it will mature. The Internet is not just an industry, it's a layer on top of our economy and society. It's bigger than just one segment. So I don't think it will end or slow down soonor mature soon. But over time it will follow the path of other nascent industries, and grow up.
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