November 6, 2006 4:00 AM PST

Does Web 2.0 bubble have a silver lining?

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John Girard, founder and CEO of hosted content management company Clickability, is now considering another round of funding. The quest is vastly different from when he started the company in 1998.

"Today, like then, money is pretty easy to come by. We're thinking about the $7 (million) to $9 million dollar range for the next three to five years," Girard said. "In 1999 dollars, that would have been a $55 (million) to $65 million plan."

"Web 2.0 in the consumer world is frothy but it's not eating up capital like the old days."
--Gordon Ritter, co-founder, Emergence Capital Partners

In addition to cheap building materials for technology outfits, viral marketing techniques, such as providing a free version of software or relying on word-of-mouth adoption, keep costs down.

As a result, the financial models behind many Web start-ups have changed--and investors are being forced to change strategies.

"Most venture firms have built their DNA and fund sizes around funding product-based business models, which means that you have to put a great deal of money into the first version," said Gordon Ritter, who co-founded Emergence Capital Partners to focus on hosted software companies. "And only after 18 or 20 months do you get the product out the door and see if it sells."

Venture investors these days are either looking to invest relatively small amounts--say, less than $5 million--to incubate small companies. Or they can invest bigger sums later to expand a company with an existing customer base, said Silverberg.

Recent evidence of the "cheap company" trend came last week when Charles River Ventures, one of the oldest investment firms in the country, launched a program to give out $250,000 loans to get new company ideas off the ground.

Angel investors--typically cashed-out former entrepreneurs--are more influential these days as well because their seed capital can be enough to launch a company, noted Kraus.

Like a 'Long Tail' bubble?
Yet even with less money at stake--involving professionals, rather than retail investors buying public Internet companies--there are some warning signs.

Mike Koss, a former Microsoft executive and angel investor, earlier this year joined Seattle-area start-up BlueDot, a site that allows people to share Web bookmarks--a product area that already has many alternatives, including Delicious, which was bought by Yahoo.

Koss is optimistic that people's desire to share Web content--one of the ideas behind the Web 2.0 model--will create room for large companies with scalable technology.

But the company is not taking a "if you build it, they will come" attitude, he said. It introduced Web advertising earlier this year to test its business model, which hinges on gathering data on users' interest for advertisers.

"A lot of Web 2.0 companies are ignoring the revenue model completely now. The VCs (venture capitalists) are telling them to get the eyeballs and we'll figure out how to monetize later," Koss said. "We hope to pitch to VCs that we really understand the business model."

Another sure sign that business is getting overheated is the behavior of recruiters in Silicon Valley, said Clickability's Girard.

"It's the recruiter activity that scares me the most," he said. "If we don't call within half an hour of a Craigslist job posting, it's too late. The recruiter's already called and told them not to talk to any companies."

Ritter has decided to focus on business customers with so-called Office 2.0 services, rather than the more speculative consumer area. A subscription-based business model, rather than one based on volume advertising, provides a fairly clear picture of when they can be profitable--assuming existing customers continue to subscribe, he said.

Generally speaking, many entrepreneurs are wary of not spending too much money and repeating the excesses of the dot-com days. Clickability, for example, cut salaries for everyone to $60,000 for a while to survive the downturn.

Whether that hard-learned fiscal discipline will remain is still an open question, however. In the meantime, many think the rapid creation of consumer Web services will raise people's product expectations both at home and in the office.

"Web 2.0 in the consumer world is frothy but it's not eating up capital like the old days. It's almost like a 'Long Tail' bubble," said Ritter, referring to the Long Tail idea of targeting goods to niche markets. "It won't take the economy down like the bubble did before."

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