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Sunday, Jun 4, 2023

OVERVIEW–The New Landscape

Jeff Graves recently got a $50 million haircut.

No, it wasn’t from Jose Eber or any of the other L.A. uber-stylists. It was from tech investors, or more specifically, from tech investors’ flight out of the Internet sector.

Graves’ El Segundo-based Internet startup, iBenefits Inc., valued itself at $150 million before the tech-market plunge.

“The market corrected, and we found ourselves (valued) at $100 million. A 30 percent haircut,” Graves says with a slight chuckle. “For about two weeks, it was a really black period in my life.”

Graves can afford to chuckle. Since the March meltdown, investors have once again warmed up to iBenefits, which is about to close on a $40 million-plus second round of venture funding.

Not everyone has been so lucky, and the casualties are just beginning.

For many professional investors, the collapse of eParties and its subsequent acquisition by eToys Inc. is a harbinger of things to come. Despite eParties’ substantial marketing scheme when it debuted only nine months ago, it couldn’t find additional funding, so portions of its carcass were swallowed by eToys for a mere $1.6 million in stock.

The acquirees will mainly consist of roadkill along the Information Superhighway failed e-commerce and Internet content companies. These firms are finding the financial well has dried up, and are desperate to survive in one form or another. Most will either fail outright, or be swallowed up in what is expected to be a far-reaching “roll-up.”

Roll-ups are consolidations of established industries comprised of many small, scattered businesses, like the plumbing industry. The term is now being used to describe deals in which defeated Internet startups are encouraged by their venture backers to be acquired, even at bargain-basement prices.

“Call it roll-up or whatever, what you’re referring to is clearly going to happen,” said Brad Jones, general partner at Redpoint Ventures, a prominent local venture capital firm. “Some are total bailouts, because without it the company would just collapse. The price paid for eParties was next to nothing.”

In some sense, eParties was lucky. Not all floundering e-tailers are going to find a helping hand at any price. Other companies are still hashing out their survival prospects, and may not yet realize the time is nigh.

It’s a new era of fear, greed and opportunity.

“It’s all of the above,” said Alan Barton, a partner in the venture and investment practice of the law firm Paul, Hastings, Janofsky & Walker LLP. “If you’re a buyer, this is a tremendous opportunity if you’re getting funded. If you’re a seller, it depends on how realistic you are.”

While the Nasdaq has revived substantially since its meltdown in March, the scene today is vastly different. No longer will venture capitalists fund bright ideas sketched out on a couple of pages in the expectation that they could be flipped to an initial public offering in 18 months.

Merger-and-acquisition activity is ramping up. Public and private companies with access to cash are on the prowl picking and choosing from the wreckage of failed ventures that were up-and-comers just a few short months ago. Companies on the skids are scrambling to find some way to salvage themselves before they burn through their remaining cash.

Looking for good deals

One e-commerce company that continues to find funding is Cooking.com, like eToys a hatchling of Pasadena incubator Idealab. It recently concluded a round of financing that added $35 million to its coffers and it’s looking around at what it can acquire. But the online gourmet food site is content to wait for valuations to come down further.

“We’re interested, and we’d like to pick up good assets on the cheap,” said David Hodess, Cooking.com’s CEO. “We’ve had lots of folks approach us wanting us to buy them, but we felt they haven’t adjusted their expectations yet.”

Cooking.com and its investors can afford to wait, because companies that don’t get funded may wither and die, making it easy to pick and choose which part of the failed company to purchase.

“A client of mine was going to acquire another (Internet) company in the same area that wasn’t performing,” said Jim Scnell, a partner in the law firm of Riordan & McKinzie specializing in mergers and acquisitions and debt financing of technology companies. “The trajectory of the company was such that it didn’t survive long enough to be acquired. If you’re going to do a meaningful acquisition, do it quickly.”

But one strategy, which is frustrating for companies looking to be acquired, is for the prospective buyer to purposely delay the purchase. After all, the longer it takes to do the deal, the more cash the prospective target burns through, bringing valuations down even more and thus making for a cheaper buy.

“It’s the execution risk,” said Brian McCarthy, a partner and M & A; specialist in the L.A. office of Skadden, Arps, Slate, Meagher & Flom LLP. “These companies want to know what to do if someone does due diligence on them for three months, while every day the burn rate goes on.”

Among those looking to take advantage of the situation is Graves of iBenefits, an application service provider that develops and markets health benefits and financial services online.

Flush with his $40 million-plus second round of venture funding, Graves was able to complete iBenefits’ acquisition of Costa Mesa-based UltraLink, an established off-line health plan management company, a few weeks ago. And now he’s looking for further opportunities.

“We have some people we’re interested in (acquiring), and some people have approached us,” Graves said. “Everybody’s going back and thinking longer and harder about what (the market correction) means for them. It makes our life a little easier.”

And Graves is far from the only one who’s flush with cash. Investment pros confirm that there is still a huge amount of venture capital available for nascent businesses, and attorneys and bankers alike continue to refer clients to their venture contacts. Even angel investors, who are retrenching as well, continue to pony up money for startups that are technology-based and have realistic expectations for revenue and profit. But it’s no longer easy money.

“Everything has changed, no question about it,” said John Morris, a founding member of the Tech Coast Angels. “Our screening meetings continue to attract 30 members. But we are doing a lot more due diligence.”

Raise the money or die

For e-companies dependent on easy access to capital to facilitate their growth, times are hard. Some are even seeking out professional buyout firms in hope of raising cash and making themselves more attractive for purchase.

“We’re getting calls left and right from companies and venture capitalists,” said Peter Nolan, partner in the leveraged buyout firm of Leonard Green & Partners. “I was just in a meeting with a CEO who said, ‘I’ve got 60 days and if I can’t raise the money, I’m dead.'”

While Leonard Green hasn’t yet taken any wounded Internet firms under its wing, the possibility exists.

“The opportunities for us are several-fold,” Nolan said. “Is it a business we can acquire or do something strategic with for our portfolio companies? If not, there are very, very talented people in some of these companies, can we pick some of them up? Or, can the assets be liquidated for cents on the dollar?”

Regardless, the odds that many foundering tech companies will be snapped up are likely to increase in the coming months if the IPO market remains severe. Mergers and acquisitions will increase, venture funding will go more and more to tech-infrastructure companies, and previously well-regarded companies will disappear.

“People have put a lot of equity into these companies,” Skadden Arps’ McCarthy said. “They’ve run through their cash, and they have a concept, but two of the three doors available to them (venture funding and IPOs) have closed. So you need to team up with someone who has deeper pockets and can preserve some of the value that’s been put into the company. The M & A; market for emerging companies that can’t make it is going to increase.”

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