Stories of successful turnarounds abound in the business world, but not when it comes to L.A. dot-coms.
Several industry observers and participants, when asked to name a troubled Internet startup that has managed to right itself, merely scratched their heads and shrugged their shoulders. Part of the problem is that L.A. has a heavy concentration of business-to-consumer Internet companies. “You cannot really turn around a B-to-C startup nowadays,” said Jonathan Funk, general partner of Media Technology Ventures. “In most cases these companies are so far away from profitability, there isn’t really anything to turn around, and secondly, there’s just so little interest in investing in anything that’s related to consumers right now.” As a result, scores of Internet startups that have run out of cash and have fallen out of favor with the venture capitalists who originally backed them are now drifting into oblivion. At the same time, the VC firms, angel investors or other early-stage financial backers are loath to advertise the fact that they pumped money into a losing cause, which means that those that fall by the wayside are quickly forgotten. “VC firms like to bury their dead quietly,” said Aubie Goldenberg, partner in charge of the e-business group for the Pacific Southwest with Ernst & Young LLP. “That’s why you hear so little about individual dot-coms that are in serious trouble.”
Most of the failing dot-coms are still privately held and do not have to file financial statements with the Securities and Exchange Commission. Hence, only those closest to the companies themselves are aware of how close they are to the brink. As for alternatives, there are few for these cash-strapped startups. And most options result in the original venture disappearing, one way or another. Given that such companies don’t have much in they way of collateral, it is virtually impossible for them to get a commercial loan. VC firms and angel investors, upon learning that the original investors are not putting up any additional funding, become understandably reticent to invest. And besides, many VCs and angels are now focused on salvaging their own portfolio companies, rather than jumping into additional ones. Cut off from further funding, the dot-coms have undertaken severe belt-tightening laying-off staff, slashing marketing expenditures, etc. to make whatever cash they have left last as long as possible. For many, bankruptcy looms large. Other alternatives include merging with a competitor in the same online space or being acquired by a brick-and-mortar company looking to expand into e-commerce quickly rather than build its own from scratch. Don’t expect white knights to ride to the rescue in a hurry, though. Potential buyers are often waiting as long as possible, even until after the company has filed for bankruptcy, in order to acquire the operation at bargain basement prices.
If the situation is extremely bleak for struggling startups, it’s slightly better for more-established Internet companies, even though they’re still losing money. A number of cash-stripped dot-coms, which had already gone public, have in recent months returned to private investors to raise the money needed to stay in business.
L.A.-based eToys Inc., for one, raised $100 million in June from a group of private investors led by Promethean Asset Management of New York. More recently, Marina del Rey-based U.S. Search.com raised $27.5 million from Pequot Capital Management of Westport, Conn.; and Prime Ventures LLC of Santa Monica led the $20 million bailout of Drkoop.com of Austin, Texas. These companies were all at risk of running out of cash and having to shut down their operations, but because they are established entities and have at least shown that they can implement a business plan something that many smaller startups have not yet had an opportunity to do investors will be more inclined to take a gamble on these companies turning out to be survivors in the long run. In addition, these publicly traded companies have seen their share prices drop to record lows, which make them a comparatively good buy for an adventurous investor. “Brand-new startups won’t last once they run into cash problems,” said Steve Green, president with Kibel Green Issa Inc., a Santa Monica-based consulting firm. “If a company has a history of making revenues of, say, more than $3.5 million a year, then there’s going to be more ways to keep it going.”
