Inside Venture Capital's Red-Hot Wireless Play
In late June, mobile check-in service Foursquare announced it had landed $50 million in venture capital financing. Less than a week later, mobile payment company Square snagged $100 million in venture capital money, pushing Square's valuation toward the $1 billion mark.
Hardly a week goes by without an announcement that some startup company in the tech space has landed millions of dollars in new financing. Venture capital firms have decided the time is right to invest in technology, and wireless is smack in the middle of it.
Brent Iadarola, the director of Frost & Sullivan's wireless group, says interest in the wireless industry is being fueled by the maturation of the technology. Technologies like location-based services that couldn't get past the concept stage a decade ago are now coming to fruition thanks to advances in networks, devices and operating systems.
"A lot of players in the venture capital community are seeing advances in networks and devices. Certain concepts here now aren't that new, but have been on the sidelines because networks and form factors weren't mature enough to support applications," Iadarola says. "We're at an inflection point where networks, devices and applications have come together."
Jay Jamison with BlueRun Ventures, which recently participated in an $18 million funding round for cell phone component maker Silicon Blue, says the firm is spurred to invest in mobile by the breadth of the technology's impact.
"For us, the big opportunity in mobile is its disruption capability. Many markets that exist today are impacted by the features and functions that a smartphone can provide," Jamison says. BlueRun Venture's past investments include PayPal and Motally, and the venture capital firm currently provides funding to several companies in the wireless industry spanning apps, software and hardware.
Having tens of millions at stake without a clear path to recoup the investment is business as usual in the high-stakes world of venture capital.
Venture capital firms sometimes invest in promising companies whose business models are unproven, a practice that has continued in the wireless industry. Foursquare, for instance, has secured more than $70 million in venture financing despite the fact that it is still trying to figure out how to make money off its mobile check-in service.
Investors bank on the promise that with enough users, a company will eventually figure out some way to monetize its service, or be acquired by a larger firm like Google.
"It's appropriate to invest in the promise that if we create something that everyone is using, monetization is going to occur," Jamison says. "As a venture investor, what you're looking for is to create an outstanding company that's going to stand the test of time. It makes sense to me that many of these companies are taking their time to see what kinds of monetization experiments deliver the best value to users and investors."
Matt Howard, general partner at Norwest Venture Partners, agrees with Jamison. "It can work and has worked over time," he says, citing companies like LinkedIn, ngmoco and Pandora. "It's a very typical thing with anything consumer oriented. The number one thing is creating value. You don't want to create too much friction early on to stop people from enjoying the service, like a credit card payment."
The Bubble Question
With hype around the mobile Internet and social media reaching a fever pitch, some have begun asking whether venture capital investment in the tech space is merely a short-term bubble doomed to collapse.
Naysayers have a good deal of ammunition. The staggering billion dollar valuations of companies like Square, Twitter and Facebook are worryingly reminiscent of the 2000 tech bubble, when investors threw money at startup companies valued well beyond their actual worth.
"I think the consumer Internet, especially where there's a mobile play or a local play - there's a tremendous amount of hype around that space. I'm not ready to call it a bubble, but it's pretty darn close," says Chris Sugden, managing partner at Edison Ventures. "When you see investment based on the possibility of what revenues might be, that spells worry to me."
Gartner analyst Ken Dulaney agrees. "I think it's getting a little out of bounds, frankly," he says. Dulaney points specifically to venture investment in mobile apps at a time when there are hundreds of thousands of competing applications already on the market. "There has to be a balance between being able to make yourself recognized to a large number of people. As soon as that becomes hard to do, it's probably over-capitalized," he says.
Sugden also warns that a company won't be successful just because it's landed venture capital financing, even if the funding is significant.
"In no uncertain terms, too much money is bad. Most problems aren't solvable with just capital," he says. Sugden argues that bloated funding can cloud a company's judgment, making it more difficult for them to determine whether there are flaws with their business model or they genuinely need more investment capital.
"The bad news about a lot of capital chasing specific areas is that you get confused about what's something you can solve with money, versus a fundamental business model problem," Sugden says. "For a few million you can find whether you have something with potential for success."
However, some say the level of investment in many tech startups is appropriate and simply reflects the growth of the industry, from social media to wireless.
"I don't believe there's an unwarranted level of investment. I believe the level of investing is appropriate to where we are," says Mark Jensen, national managing partner for venture capital services at Deloitte & Touche. Jensen concedes that some recent investments in social media are "frothy," but insists that the state of mobile technology justifies venture capital's enthusiasm for the space.
"I think the venture capital community sees that the changes taking place now made possible by the fact that we have all these technologies available. This has finally matured and is letting companies get started," Jensen says, citing growing adoption of smartphones, the proliferation of mobile applications and the rise of next-generation mobile broadband networks. "That's why they're looking to invest early."
While there's disagreement within the industry about the existence of a new tech bubble, the numbers suggest no such bubble exists in the wireless market.
Statistics provided by the National Venture Capital Association (NVCA) show that investment in the wireless industry will hold steady this year and is far away from the level it was at during the dot-com bubble.
During the peak of the Internet boom in 2000, venture capital investment in wireless spiked to $3.75 billion. By 2002, that number dropped to $634 million as firms pulled back on their tech investments. Venture capital investment in wireless companies rebounded to about $1 billion a year between 2004 and 2008, only to drop off to $251 million in 2009 on the downturn in the economy.
Last year, venture capital firms invested $498 million in the wireless industry. Just $101.4 million of venture capital was invested in wireless companies in the first quarter of 2011, putting investment on track to come in slightly below last year's level.
No Safety Net
Venture capital is critical to getting companies off the ground, but it's no guarantee of success.
Emily Mendell, spokeswoman for the National Venture Capital Association, says that one-third of all venture-backed companies fail completely and go out of business. Still others end up getting sold at well below what was invested, leaving their backers unable to recoup their investment.
For instance, video ringtone company Vringo raised $28.5 million since its inception in 2006. The proceeds from that investment: $387,000 in cumulative sales over the past five years and $31.1 million in losses.
Vringo managed to pull off a $9.2 million IPO last summer, but the company is having trouble saying afloat and warned investors in its most recent quarterly report that it only had enough cash to run its business through the third quarter. Vringo's poor financial performance drew the ire of the New York Stock Exchange, which threatened in May to kick the company's stock off the exchange unless it was able to improve its financial standing.
Another venture-backed company with a shaky IPO is Motricity. The company raised more than $400 million in venture capital since its inception in 2001, but the company was forced to drop the price of its initial public offering and eventually raised just $50 million when it went public last year.
The company has managed to improve sales, which rose 10 percent to $32 million in the first quarter of this year, but has struggled to become profitable. Motricity's losses ballooned to $6.1 million in the first quarter, from a loss of just $1.5 million last year, on costs from its buyout of mobile marketing company Adenyo. Motricity CEO Ryan Wuerch remains optimistic about the company's future and said in June he expects to announce a number of new customers over the coming months.
Companies backed by venture capital can also be wildly successful. Google raised just $25 million in venture capital before it went public in 2004 at $85 per share, raking in $1.67 billion.
Venture capital is crucial to startup companies otherwise unable to raise enough funds to get to market, since banks are often unwilling to provide loans to startup companies that might not be able to make payments for several years.
"The thing about debt capital, there's some covenants you have to follow through and repayments you have to do, and when you're expanding, payments are the last thing you want to worry about," says VPIsystems President and CEO Tito Sharma. VPIsystems used $4 million in venture capital last year during its acquisition of Elanti Systems to fund its expansion into analytics for wireless networks. Sharma says the company is currently self-funded.
Without investors willing to take a big chance on a largely unproven business, many companies would miss their market opportunity.
"If we did not have this funding, we would not be able to execute our business plan," says Steven LeBoeuf, co-founder and CEO of Valencell, which recently received $5.5 million to help spur the development and marketing of its wireless body monitors. "Our current revenues weren't going to allow us to ramp as fast, and we were going to miss the boat, so to speak, if we weren't able to ramp up fast enough."
Venture capital is a high-risk, high-rewards business. When a venture-backed company fails, there's no way for investors to get their money back. But when an investment succeeds, it may reap several times the amount of money initially put into the company.
While the existence of a tech bubble is still a matter of debate, investor enthusiasm for wireless is a boon to many startup companies trying to make inroads into a promising marketplace.