Who’s calling the shots?

Dot-com toppers want more funding, but worry they might lose corporate control

With the market for Internet initial public offerings even worse than conditions for IPOs generally, it won’t be long before the digital wheat is separated from the cyber shaft.

Some number of stronger companies will continue to position themselves to go public eventually, but many more weaker Netcos will be sold to deeper-pocketed parents and some will simply fade away.

“There is no IPO market for dot-coms right now,” says Frank Biondi, the former Hollywood exec whose Waterview Advisors has about 20% of its $250 million venture fund invested in Netcos. “When it will come back is anybody’s guess, but what dot-com management has to do in the meantime is raise money. Yet, that’s tough, because there’s no third-party financing going on right now.”

As a result, he adds, “some of those puppies are going to be hurting.”

David Menlow, president of IPO-research firm IPOFinancial.com, is even blunter.

“There’s no compelling reason people should be buying (into dot-coms),” Menlow says, “so the market can’t get behind what’s now considered a played-out theme.”

Most Netizens insist there will be an eventual return of Wall Street interest in dot-coms. But there’s an interesting trend afoot that could decide whether individual Internet businesses will even be around by then or will have been sold off to the highest private bidder by boards tired of waiting for IPOs to gel.

To wit: In the absence of significant new sources of venture capital to tap, many dot-coms will need to seek additional funds from existing investors — and lose control of their companies as a result. That’s because each time outside investors make equity investments, company managers dilute their own holdings and the process has advanced to a critical juncture.

A pair of Hollywood-oriented companies in the Waterview portfolio are among Netcos in just such jeopardy.

Creative Planet, whose business involves the online migration of software-based systems used by Hollywood production pros, soon should close on upward of $25 million in new venture capital, adding to $63 million obtained in two previous rounds of private funding. But the new money will push above 50% shares controlled by nonmanagement directors, effectively taking final decisionmaking authority away from the company’s founders, a source says.

That development could be especially meaningful at Creative Planet, where execs continue to preach the IPO gospel but others holding the company purse strings are more amenable to a sale or merger as an alternate exit strategy.

“We’re not going public right now, because we need to have more product in the marketplace and to get more traction with our business model,” says Creative Planet chief exec Allen DeBevoise.

But he stresses the company still expects to go public, possibly near the end of 2001. DeBevoise declines to detail ownership stakes by various directors, but says a board should be neither too lax nor too controlling.

“You have to let the management team execute or else you might as well get rid of them,” he says. “The ideal board can bring knowledge and connectivity. What you don’t want is a board of yes people or a board who are overly controlling.”

At Creative Planet, board meetings are held quarterly, he says, with additional telephone conferencing on at least a monthly basis. Those meetings could get interesting once the balance of power tilts toward investors.

Over at AtomFilms, another Waterview-funded Netco, CEO Mika Salmi’s challenge in going public is convincing Wall Street his short-film- Web site presents a compelling enough business to support an IPO. But he may never get to make that pitch — his board is close to controlling the company’s decisionmaking process and further equity financing could tip the balance for good, an insider confides.

“I didn’t start this company to go public and get rich,” avers Salmi. “From the beginning, the game has been for us to be a successful company. So, we’ve always been focused on things like profits and revenue.”

But he won’t project when the company might hit break-even. As for growth strategies, Salmi acknowledges AtomFilms might agree to some sort of merger in lieu of mounting an IPO — though he stresses certain mergers might not be ideal.

“If a big media company were to control us, that might limit our options,” he says.

For the present, AtomFilms is seeking $20 million or more in third-round private funding from unspecified strategic investors, he says. The company previously won a relatively modest $27 million in private funding, which Salmi acknowledges has nibbled away at his ownership stake.

Meanwhile, the situation at Creative Planet and AtomFilms is mirrored many times over in the Netco community. Most dot-com execs continue to hope for a speedy return of a robust IPO market, but many others are in a race against time before their steady diet on private funding eats away at their equity.

On the other hand, a certain minority of dot-com entrepreneurs are perfectly happy to sell or merge their companies rather than take them public, says Peter Levin, managing director at Lynx Technologies.

Lynx, a venture capital and consulting firm founded by Michael Ovitz, has stakes in Netcos including youth-services platform Campus Pipeline and language-based search engine Oingo.

“Most of the companies in our investment portfolio aren’t necessarily the most high profile of companies but have more of a focus on infrastructure and distribution platforms,” Levin notes. “So, their exit strategy is often more skewed toward strategically aligning with players in their respective spaces by way of a merger or acquisition.”

But Waterview’s Biondi says it’s the rare dot-com exec he’s seen who strives for a private sale rather than public offering.

“It just doesn’t seem to be part of the psyche,” he says. “Usually the decision to sell comes out of duress, and that’s when your stake holders say it’s unlikely you’re going to get enough money to keep going or that your business model just isn’t strong enough.”

Some companies, including the high-profile MTVi Group, were already well down the road toward public offerings only to pull their IPOs when the market went south. Even among that group, only the strongest can expect to go public eventually, suggests analyst Lee Isgur of the Corporate Counsels venture capital and consulting firm.

“Those companies that have a flawed business strategy have almost assuredly missed the opportunity to do an IPO, unless they can rectify their mistakes and fulfill the promise they had earlier,” Isgur says. “But if they tend to their knitting and maximize the opportunity the Internet has given them, they will eventually have an opportunity to do an IPO and see themselves valued at many billions of dollars.”

Digital video-recorder service ReplayTV pulled its high-profile IPO last August over market uncertainties. And with shares in its publicly traded rival TiVo languishing in the low to midteens after initially trading as high as $78, some analysts suggest there may never be enough interest in a ReplayTV IPO.

“TiVo has poisoned the water for ReplayTV,” says analyst Larry Haverty of State Street Research.

Haverty notes TiVo generated only $3 million in revenue in its latest quarter, hardly the kind of number to stoke Street appetites for another such public company.

“I would think that their technology is not exciting enough to cause a feeding frenzy, let’s put it that way,” quips IPOFinancial’s Menlow of the prospects for a ReplayTV IPO.

Jim Hollingsworth, ReplayTV’s senior VP for sales and marketing, says the company “absolutely plans to go forward with a public offering.”

In the meantime, the company is shoring up its capital base with another round of private funding — its eighth. Founder Anthony Wood has already relinquished ownership control and no longer has any operating title but holds a seat on the ReplayTV board.

SightSound.com a Mount Lebanon, Pa.-based Internet infrastructure company that helps deliver movies and music for Hollywood content creators like Miramax Films, Franchise Pictures and the Comedy Central network, withdrew its IPO registration in early October.

CEO Scott Sander says “the obvious reasons were the general conditions of the capital markets.” But he adds that a misconception of the company’s operations was also to blame.

Wall Street tended to lump SightSound with the content providers the company actually serves, he says. As dot-com “content plays” have been among the least in favor with investors, the perception was deadly to prospects for a successful IPO.

The confusion arises from the company’s Web site, which exists only to service clients that don’t have sites themselves. Sanders stresses that SightSound’s core business involves underlying technology that facilitates the delivery of content to that and other Web sites.

“But the markets just weren’t very discerning of the distinction,” he laments.

So where from here? Sanders won’t say, citing a mandated “quiet period” after the pulling of SightSound’s IPO registration. But he notes the company has burned through a lot of its private capital for research and development and suggests some further private investments might be necessary at some point.

“We’re in discussions with a lot of strategic investors, but we don’t need to raise money at exactly this time — which is a good thing, because it’s a terrible time to raise money,” he says.

Outside equity investors including Waterview already control 5-year-old SightSound, having exceeded 50% ownership during a concluded third round of private funding. But Sanders says he has no problem with that.

“A company’s executives have a fiduciary duty to act in the best interest of all of the shareholders, no matter what percentage they own,” he reasons.

Internet streaming company GlobalMedia.com took an unusual path to the public markets in August 1998 as management underwrote the entire first block of shares. The aggressive strategy was rewarded early on, with shares trading upward of $9 apiece, but the stock later tanked and currently trades at penny stock levels.

There have been suggestions in some quarters that companies with such depressed shares might do better taking themselves private again, but execs at the Vancouver, B.C.-based Netco say they aren’t considering a leveraged buyout. Indeed, one big problem with that tactic would be finding buyout partners willing to stage LBOs for beleaguered Netcos.

CEO Kevin Wendle still counts going public as a possibility for Hollywood business-to-business Web site iFilm.com. But he says iFilm is just as happy focusing on operations for the present and ultimately may decide on another strategy such as a merger.

“We’re just focusing on building the business,” Wendle says. “Bringing on partners makes more sense today than it did a year ago.”

He claims, too, that iFilm could continue on a solo private track indefinitely. The Netco is completing a sixth round of private funding, but Wendle says he will retain majority control of the company afterwards.

Waterview’s Biondi estimates that Netcos still looking to go public have no more than another 18 months to get to break-even, if not profitability, “and those that can’t do that better have a pretty compelling message about their company and why they can’t reach break-even.”

Companies who aren’t within 36 months of profitability won’t even get more private money, let alone muster IPO interest, he adds.

Netco execs, who love nothing more than a zippy business slogan, have turned this drive for profitability into a catch phrase, of course. Instead of the B-to-B (business to business) mantra of the past several months, the refrain has turned into “P-to-P” — path to profitability.

It seems that — despite their well-documented inability to turn profits so far — dot-com execs aren’t overly daunted by the tougher challenges of today’s marketplace and most remain hell-bent for IPO glory.

“Sometimes it seems hope just springs eternal,” Biondi smiles. “With some people it is like — they get two turndowns and they’ll knock on a couple more doors; they get 50 turndowns, and they’ll knock on another 50.

“But there can be a point when you say maybe it’s time we find a home for the company,” he continues. “And if the board doesn’t control the company, at some point it becomes a stare-down.”

At some dot-coms, the stare-down contest may be drawing to a close.

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