Web 2.0: thank goodness for cash-rich VCs

Web 2.0 guru Tim O’Reilly

Consider this: a UK-headquartered start-up with a Prague-based development team receives an undisclosed amount of funds from Skype backers Index Ventures and Mangrove Capital. The company has no revenues, no patented technology, and no current plans to finance itself via advertising or to charge for its product – designed to let users more easily share large files with one other over the Internet.

If the company has a firm business model, it is not telling. “We may eventually charge for certain features,” says Cedric Maloux, of Oxford, UK-based AllPeers. “Right now we are focusing on how to make our product most useful for users.” Already, the fledgling company has 45,000 people registered for the beta version, due to be released over the next few weeks. Users can also read what’s on Maloux’s mind on his blog.

Is this a flashback to 2000? Enthusiasm is back for Internet companies, and, some critics are saying, so is an element of insanity. A few years back no one wanted to touch an Internet company. Now cash-rich VCs are once again competing to fund fledgling companies with uncertain business plans.

Watch the millions

In November, the US-based video-sharing site youtube.com, for example, received $3.5 million from Sequoia Capital, a renowned Silicon Valley VC that is also making its bets in Europe. Earlier this month Sequoia reportedly put more than €2 million into Austria’s JaJah, a voice-over-Internet Protocol (VoIP) company akin to Skype. It also took part in a recent €21.7 million funding, along with Skype, Google, and Index Ventures, of Madrid-based Fon, a company that enables broadband users to share wireless access points.

Last week Index, along with prominent entrepreneurs Marc Andreessen, Pierre Chappaz and Martin Varsavsky invested an undisclosed amount in Netvibes. Founded several months ago, the Paris-based company makes free personalized home pages that let users integrate blogs, rss feeds, web sites, eBay auctions and search engines onto one page. The company says that more than a million such pages have already been created by users.  

‘Not companies, but tools’

Sceptics say that many of this new crop of web companies offer little more than a feature created by a software developer. “These are not companies, these are tools,” says Marc Goldberg, of Occam Capital, a venture fund based in Paris. “Giving away free stuff isn’t a business model,” he adds.

Others snipe that the business model is “build and flip” – after a rapid build-up of the user base, investors bet on the company being quickly acquired for a handsome sum – much as photo-sharing site Flickr was bought last year by Yahoo, or Skype by eBay – by a company that wants to integrate the application into its offerings.

Yet clearly those willing to invest in selected “Web 2.0” companies, as they have been dubbed, see some kind of new model emerging and are willing to invest in it.

“These companies are developing new disruptive ways to create value,” believes Eric Archambeau, general partner with Wellington Partners in Munich, which has an investment in Hamburg-based social networking company OpenBC and says it is close to closing two other “Web 2.0” investments.

What is Web 2.0?

Pundits continue to quibble over the definition of Web 2.0 – and some deny that it even exists. The phrase, coined by US marketing firm O’Reilly Media in October 2004, has come to mean a “second phase of architecture and application development for the World Wide Web,” according to Wikipedia (an open source encyclopaedia that is also considered part of the Web 2.0 phenomenon). Wikipedia then points out that the phrase has also become a “buzzword incorporating whatever is newly popular on the Web”, whether that be podcasts, tags or RSS feeds. One can argue over whether these developments are actually new and revolutionary, or a gradual evolution of long-established software development techniques.

In any case, VCs contacted by this reporter appeared to have reached their own consensus on what they see as companies producing Web 2.0 applications:  

• They make use of commonly-used web-based standards (Java, XML, RSS, Ajax,) as well as open-source software programs to develop new applications.
• Using the Internet and often the Internet browser as a platform, they encourage and simplify collaboration and utilise user-generated content.
• They make use of the convergence of media, such as Internet, audio, video and mobile applications.  

AllPeers is a good example of this new breed of company. Its application uses open source software such as the filesharing protocol Bittorrent and the open source browser from Mozilla, Firefox. It also promises to simplify user interaction over the Web. Instead of having to upload and store photographs on a remote server, as users do today, AllPeers says its product, an extension to the Firefox browser, will allow users to merely drag-and-drop photographs onto a buddy list.  

Similarly, Netvibes seeks to simplify user access to these new web-based applications by creating a kind of personal portal to integrate them. “This allows you to make sense of all these new services by controlling and displaying them,” say Neil Rimer, general partner with Index in Geneva.

Where’s the profit?

But while applications like these are undoubtedly changing users’ online behaviour, will they turn into profitable businesses? One problem is that as quick as they spring up, another competitor emerges doing the same thing. “There is a low barrier to entry,” says Maximilian Bleyleben, director with Kennet Venture Partners in London. “I see few business models that work and are defensible.”

Indeed, patents appear to be irrelevant for the business model. “This space moves so fast. You can’t afford to spend the time on patents,” Rimer says. But he denies that Index is interested only in a quick sale. “We only invest in companies where we have a road map to lead us to services we can charge for,” he says, adding: “We back entrepreneurs that have a compelling vision and know how to create an emotional link with users that will hold as they grow the business.”  

Clearly, VCs like Index and Sequoia are taking a more aggressive approach than some other VCs to funding consumer-oriented Web companies in their earliest stages. But others prefer to wait and only fund those companies that actually prove they can bring in revenues.

Kennet, for example, which only invests in companies with between €4 million and €50 million in revenue last year made a €5.1 million investment in Danish company Kapow Technologies (which has since moved its headquarters to the US). The company makes a web integration platform utilising robots that trawl the Internet and cull data from other web sites. Kapow’s product is being used, for example, by Deutsche Post, to help it aggregate the data from inventory tracking systems it uses in different countries, simplifying efforts by customers of the German post office to locate their packages online. Knight-Ridder/Tribune Information Services is also using the company’s product to streamline its enterprise data collection.

Even though Kennet takes a more cautious approach, Bleyleben says he welcomes the new wave of companies. “Sure there’s a lot of dross out there. But we like having this model around. You can launch a product and test it with the public for very little capital.”  

Like Kapow, some of these companies are able to “bootstrap” their business and raise around €5 million in revenue, which is where Kennet gets interested. And even if there are excesses, enthusiasm for building companies is at least on the rise again. “Anything that encourages entrepreneurship in Europe is a good thing,” Bleyleben says.