October 19, 2005

Web 2.0: Meet Venture Capital

New Web technologies let entrepreneurs do more with less, but they'll still need venture funding to grow.

By Jon Burke

Alarm:clock is a daily news site that evaluates privately-held technology startups in the areas of hardware, software, the Internet, and wireless communications. One industry overview and one company profile by alarm:clock's editors come to Technology Review every Wednesday by special arrangement.

Web 2.0: Meet Venture Capital
New Web technologies let entrepreneurs do more with less, but they'll still need venture funding to grow.

The emergence of Web 2.0 companies (see "'Web 2.0' Has Arrived,") is causing a good deal of excitement for entrepreneurs. Among the hallmarks of these next-generation companies are their low startup costs, limited infrastructure needs, and speedy time-to-market with products. Because of these modest requirements for launching a company, the reliance on venture capital, some argue, has been greatly reduced for Web 2.0 companies.

Indeed, many Web 2.0 entrepreneurs were present for "Web 1.0" and made enough money to support their own ventures. Others have learned through trial and error that it's possible to build and launch a Web-based product for a fraction of what it would have cost only a few years ago. Open-source software, virtual work environments (i.e., no rent or overhead), and cheap and plentiful server capacity have helped keep down costs.

As a result, many Web 2.0 entrepreneurs have been able to roll out compelling services without becoming involved in the culture of venture funding. The contemporary bias against VCs has been on display most recently in the blogging sector. A number of blogging networks, in typically transparent fashion, have written about the calls they're now getting from venture capitalists. And, for the most part, the nascent blog networks are uninterested in taking VC dollars. Sure, they're flattered by the attention (all right, the alarm:clock is no exception), but in the end they realize that Gawker Media, Weblogs Inc., and other content companies have flourished without outside investments and interference (see "The Business of Blogging").

Will this distaste for venture capital persist?  We don't think so -- and, even if it does, we don't believe the standoffishness of a relatively small group of Web 2.0 entrepreneurs will have much effect on the overall composition of the VC industry.

Keeping VCs at arm's length won't last because, as some of these companies start to exhibit sustainable business models and generate revenues, investment scenarios may emerge that are palatable to entrepreneurs -- i.e., companies may be able to get a lot while giving away very little.

Also, just as the Web 2.0 has created a new kind of entrepreneur, it has also created a new kind of early-stage venture capitalist. Firms like Union Square Ventures, which invested in the tagging and social-bookmarking company del.icio.us; the Omidyar Network, which has invested in the RSS company Feedster; and the blog publishing company Federated Media come to mind.

As for the overall VC industry, look outside the precincts of Web 2.0 and you'll be reminded that whopping investments are still handed down just about every day. VCs aren't waiting around for Web 2.0. Just consider a few of the larger financings that we've mentioned recently on alarm:clock. Pay By Touch Solutions, a biometrics authentication company that has created a fingerprint scanner that connects you directly to your bank account, recently announced a round of $130 million in new financing from both VCs and hedge funds. Meanwhile, Force 10 Networks, a developer of high-end networking equipment, raised $40.6 million, and MFORMA Group, a publisher of mobile games and entertainment, raised $30 million.