News | 06.03.09

Internet Retailer: Cold Cash

It may not be quite as bad as the nuclear winter of 2001, but raising money is very tough again for online retailers and e-commerce technology providers. A market shakeout could be in the offing.

Growth was at the heart of the strategy at Working Person Enterprises. Use the Internet to become the category killer in work clothes and boots, then sell the company or go public.

But that plan required continually raising capital to add inventory in new categories and to improve the web operations of the retailer, which generates at least 90% of its sales online. When the economy spiraled downward in the fall, suddenly capital became hard to come by. And the company’s board and investors changed its tune, says Stephen Antisdel, a director and investor in the company.

“While the early strategy was focused on top-line growth, that shifted as the world changed,” Antisdel says. “Now the strategy is: Don’t focus on growth for growth’s sake, focus on operations and profitability.”

That’s a common theme among online retailers and e-commerce technology providers that have relied on investor capital to grow. Investors—be they venture capitalists or Uncle Robert—were happy to put money in as long as the economy was healthy and online retailing was growing steadily, suggesting the possibility of a big payday down the road. Now those investors, their portfolios hammered by a 40% drop in stock prices, have less money to invest and are increasingly telling e-commerce companies to make do with the capital they have.

This capital shortage will affect online retailers in two ways. Those e-retailers like Working Person relying on investor capital to grow quickly will, at best, be forced to scale back their plans. Some are going under or being forced to seek a buyer in order to survive.

And all online retailers will be impacted by how this cash crunch limits the capacity of e-commerce technology providers to invest in new products and services. Retailers will want to pay close attention to the financial stability of vendors, as some of them inevitably will not survive the sudden sucking of oxygen out of the system.

“There are all these solution providers out there, and there’s not that much room in the market,” says Mike Miller of e-commerce consulting firm FitForCommerce. “There’s got to be some consolidation.”

While the sudden shock of last fall’s Wall Street meltdown invites comparisons with the collapse of technology stock prices in 2000-2001, the evolution of e-commerce makes the two periods very different. It also explains why relatively young e-commerce technology providers are better positioned to raise money than online retailers just getting started.

2009 vs. 2001

Online shopping is much more pervasive than it was early in the decade, more U.S. homes have broadband Internet access and it’s clearer how online merchants can attract consumers through tactics like search engine and e-mail marketing, says Amish Jani, director of venture capital firm FirstMark Capital.

“All have come together to create a fertile and robust environment for e-commerce and technologies that support e-commerce,” says Jani. That helped convince Jani and FirstMark to participate in April in a $10 million second round of funding for Conductor Inc., whose technology helps retailers and other web site operators measure and optimize natural search results.

But the growth of online shopping has attracted to the web such retail giants as Wal-Mart Stores Inc., and fueled the growth of such successful online retailers as Inc. Jani would not be interested in investing in a retailer that proposed to sell everyday goods in direct competition with these huge retailers. “You have to have a novel approach, because e-commerce has matured,” he says.

Retailers that offer customized products, like CafePress or Zazzle, and the member-only site Gilt Group that sells designer clothing at deep discounts, are examples of online retailers he considers innovative, says Jani, who does not have investments in those companies.

Jani is not the only investor showing caution when it comes to e-retailers. Online retailers have attracted relatively modest interest in the last five years from venture capitalists, says Mark Jensen, leader of the U.S. venture capital services group at accounting and consulting firm Deloitte and Touche LLP. Since early 2004, there have been 148 deals that infused $1.7 billion into 79 U.S. e-retailers, he says. That’s barely more than 1% of the more than $135 billion invested in U.S. venture capital deals during that period.

Although it’s hard to come up with comparable figures for technology companies focused on e-commerce, it appears those companies are having more success than e-retailers in attracting capital during the current economic downturn.

While not a single online retailer had publicly disclosed raising capital this year, through early May there were 11 deals in which providers of e-commerce technology or services raised money. And six of those deals were for at least $10 million, including a $70 million investment by three venture capital firms in e-mail service provider ExactTarget.

It’s easier for a start-up to make the case its innovative technology can help retailers sell online than for a new retailer to persuade investors it has a truly unique approach to selling on the web, Jensen says. “There are major opportunities for companies that enable e-retailing,” he says. “They would have an easier time raising money than an e-retailer, for sure.”

A tough sell

Jensen wouldn’t have a hard time convincing executives at e-retailers Working Person, eImprovement LLC or LLC that it’s a tough time to raise cash. All have tried without success to raise money in recent months, and are adjusting their strategies accordingly.

Working Person’s parent company, WPE Holdings Inc., was among the last e-retailers to report a venture capital deal, obtaining $1.1 million in funding in October from Agile Opportunity Fund LLC. Agile cited Working Person’s double-digit revenue growth even in a difficult economy as a reason for making the investment.

But raising that money was difficult last fall, and it’s even more difficult this year, Antisdel says. A big factor is that the roughly 40% decline in the stock market has prompted a comparable reduction in the value investors assign to privately held companies. Just as selling a house today means accepting less than it was worth a few years ago, Antisdel says a retailer exchanging equity for cash must give away a bigger share in the company to get the money it needs.

Online retailers face another hurdle, Antisdel says, because much of what they’ve invested in—libraries of product descriptions, images of products taken from several angles, acquiring and editing customer reviews—are hard to put a value on. “These are valuable assets in the world of e-commerce, they’re mission-critical, but they’re not on the balance sheet,” he says. That means banks won’t lend against those assets, and only Internet-savvy venture capitalists will put much value on them when considering investments.

With private capital hard to come by, and the idea of going public largely foreclosed by the depressed stock market, Working Person has laid off some personnel and scaled back inventory expansion. It’s also put on hold a plan to complement its web site with a print catalog that construction managers could pass around to workers so they could select the boots and apparel they want.

Working Person is also considering other options, including the possibility of merging with another company. “The company has had merger discussions to see if that’s a path that makes sense, to align what Working Person is really good at, e-commerce, with someone with a complementary business model,” says Antisdel, who did not elaborate on who the potential merger partners might be.

Safety first

For, the aim has been to raise capital to grow, primarily by acquisition, says Michael J. Fox, chief operating officer. But he’s finding investors are risk-averse and taking a hard look at the company’s performance.

“There’s a stronger focus on your financials,” Fox says. “It’s not just do you dominate your space, but prove to us how you’re going to be able to grow substantially. It’s got to be not just believable but achievable—we’re hearing that same comment from everyone we’ve sat down with.”

Many investors also tell him they don’t want to take on the risk of investing cash in inventory that may not sell. That, he says, is an advantage for eImprovement, which primarily takes orders via the web and has suppliers drop ship the items.

At the same time, however, investors increasingly are trying to reduce risk by proposing to invest in stages, requiring the retailer to hit goals to get the full funding. “They say, ‘We’ll give you X today, and if you get to this point in six months, we’ll give you this,’” Fox says.

At, the difficulty in raising money has P. Scott Vallely, managing director, considering for the first time selling all or a majority share of the company to bring in fresh capital. The company, which sells stationery and other supplies largely to offices of doctors, lawyers and accountants, has been hit hard by the recession, and sales are down, though Vallely won’t say by how much.

All the traditional sources of funds, not just venture capital, are drying up, he says. The friends and family who often invest in start-up firms have lost heavily in the stock market and have less to contribute, he says. Banks have raised their rates and are demanding collateral equal to 125% or 150% of the loan amount. What’s more, some banks seek personal guarantees that would put a borrower’s own wealth and even his home at risk, Vallely says.

Unable to raise capital at acceptable terms, Vallely in the past year has reduced his staff from 25 to nine, reviewed every vendor agreement seeking cost savings and cut his marketing budget. “We’re doing okay, but it’s not sustainable three or four years out, and it’s not fun if you’re not growing,” he says. “That’s why I’m willing to look at a partner who can infuse a bunch of capital and grow the business.”


Even retailers not dependent on investor capital will find the cash crunch prompting changes in e-commerce technology vendors, especially relatively young companies that have relied on steady infusions of outside investment to cover their losses as they ramp up.

Many of these tech vendors found, as Working Person did, that their marching orders from investors changed dramatically when the stock market plummeted last fall, says Peter Horan, CEO of e-mail security technology vendor Goodmail Systems.

“Without warning it was a quick shift from spend, spend, spend, show momentum, hire—then, bang! baseball bat across the forehead—cut your burn, show me how you’re going to raise revenue, how fast can you get to cash flow-positive, demonstrate that your business model holds even in a bad economy,” Horan says.

Horan compares raising money late last year to “trying to pass a kidney stone the size of a bowling ball.” But Goodmail Systems, which could point to a 30-fold year-over-year increase in volume for its CertifiedEmail service, was able to make its case, and raised a total of $25 million from venture capitalists, including Bessemer Venture Partners.

David Cowan, a partner at Bessemer, says Goodmail was attractive because its service improves the effectiveness of e-mail, a low-cost communication vehicle that is especially appealing to marketers in a recession. And he says Bessemer seeks out companies, like Goodmail, that use capital efficiently. “We’re looking for Hondas, not BMWs,” Cowan says.

To prove it’s an economical little Honda, Goodmail cut its staff by 25% in November, renegotiated its rent and pushed back the development schedules for some new products, Horan says. “There will be a point when we have to catch up,” Horan says. “But the priority is to get to cash flow breakeven and profitability this year, and we’ll have to do that with the products we have.”

By the numbers

If the pressure is great on a company like Goodmail, which could demonstrate enough growth to raise $25 million in the middle of a deep recession, it’s even greater on many companies struggling to hit the milestones they’ve promised venture capitalist investors, says Miller of FitForCommerce. He says a vendor may be required to reach a goal, such as 20 deals in a year, in order to get more funding. That can lead them to make deals that are barely profitable.

In addition, under the pressure to close deals, Miller says, some vendors promise enhancements to gain new customers—and then delay work on features they had previously promised other clients. “If venture capitalists say the tech vendors have to hit 20 deals a year, they’re making it work,” Miller says. “What suffers is that product roadmap.”

Retailers are increasingly questioning vendors closely on their success and financial status before making buying decisions, Miller says. “The financial viability of a vendor is certainly a top five decision factor,” he says.

And inevitably some companies, vendors as well as online retailers, fail to attract the capital they need and go under or put themselves up for sale. Several sources pointed to the example of Mercado, a provider of site search technology that raised more than $65 million in venture capital and then was sold last fall for $6.5 million and the assumption of debt to web analytics firm Omniture Inc. Venture-backed retailer Home Décor Products Inc., operator of nine e-commerce sites, ceased operations in March.

More are in jeopardy, as cash-strapped venture capital firms decide which of the firms they’ve invested in they can continue to fund. “If you have 10 companies, you might have a few you guarantee you’ll back and a few you don’t, and a bunch in the middle that are harder decisions,” says Larry Bohn, managing director of venture capital firm General Catalyst Partners, an investor in e-commerce platform provider Demandware.

Investors Jani and Bohn are advising their portfolio companies to budget their cash on hand so they can last at least 18 to 24 months without raising additional capital. That may well slow product development at technology companies, Bohn says. “You won’t hire the next five engineers to do a new product release, you’ll schedule it out a few months,” he says.

That conservative approach may not be sexy, but it’s likely to be the way many e-retailers and technology vendors manage their businesses in the next year or so. Only the strong will survive, and strength these days is measured in large part by how much money a company has in the bank.

Wall Street is showing e-commerce some love in 2009

One sign of how differently investors view Internet retailing today than they did when the tech stock price bubble burst in 2000-2001 is how quickly e-commerce stocks have rebounded this year from last fall’s steep decline. The Internet Retailer Online Retail Index of 25 e-commerce stocks was up 35% for 2009 as of early May, bouncing back much more quickly than the broader stock market.

“The Internet sector has rallied not only because 2009 is showing some stability, but also because a number of companies are showing some strength in market share and growth trends in an otherwise dismal economy,” says Colin Sebastian, senior vice president of equity research at Lazard Capital Markets, who covers e-commerce stocks.

Besides strong growth at Inc. and signs of improvement at eBay Inc., Sebastian points to e-commerce technology vendors like GSI Commerce Inc. and Digital River Inc. that “are benefiting from traditional offline companies investing more to build out the online channel.”

“Going forward,” he says, “the key will be for these companies to show ongoing stability, if not improving growth trends, particularly as we move closer to the next holiday period.”

As of May 8, the Online Retail Index had easily outperformed the Dow Jones Industrial Average, which was down 2.3% for the year, the Standard & Poor’s Industrial Average, up 2.9%, and the tech-heavy NASDAQ, which was ahead 10.3%. It’s true the 25 stocks in the Online Retail Index had fallen a bit faster than the broader market in 2008, losing 39% of their value. But that was not much more than the Dow, which was down 34%, or the S&P and NASDAQ, both down 37% for 2008.

Among the e-commerce stocks, three online retailers led the way in year-to-date stock price improvement through early May. Shares in VistaPrint Ltd. were up 96.8% for the year, Blue Nile Inc. up 92.3% and Shutterfly Inc. ahead 77.8%.

The 25 companies in the Internet Retailer Online Retail Index are: Inc., Akamai Technologies,, American Greetings Corp., Art Technology Group Inc., Inc., Blue Nile, CyberSource Corp., DemandTec Inc., Digital River, Inc., eBay, GSI Commerce, Keynote Systems Inc., LivePerson Inc., Netflix Inc., NutriSystem Inc., Omniture Inc., Inc., PetMed Express Inc., RealNetworks Inc., Shutterfly, Systemax Inc., United Online Inc. (owner of and VistaPrint.