The wheels fall off Internet incubator bandwagon

Jim Christie

SAN FRANCISCO: CMGI Inc., on Friday, rushed to deny its once high-flying

venture arm, which helped launch dozens of start-ups, including Lycos Inc. and

Yahoo! Inc. was out of cash. CMGI's denial followed a Wednesday announcement by

privately held Idealab, the force behind bankrupt Web retailer eToys Inc. - that

it would close its office in California's Silicon Valley, the epicenter of the

Internet world.

Internet incubators, holding companies based on finding, funding and grooming

Web start-ups, were bound to turn in bad news, according to Thomas Hellmann, a

strategic management instructor at the Stanford Graduate School of Business.

Hellmann believes the incubator concept's days are numbered.

Web start-ups may have needed help only a few years ago, but now it makes no

sense for start-ups to seek expertise from within a limited business network -

especially if start-ups in the network are struggling. "These conglomerates

were permitting their companies to seek synergies with a set number of

players," he said. "You only want internal markets when external

markets fail," Hellmann said.

Meanwhile, investors flee



Of course, it has not helped Internet incubators that investors have been
running from tech stocks since the Nasdaq reached its all time closing high near

5,050 on March 10, 2000. On Friday - just a day shy of a year later - the Nasdaq

index closed at a 27-month low of 2,052.78, down more 59 per cent from its peak.

The once red-hot initial public offering market is dead, and start-ups are

finding private money has turned tightfisted - especially toward Web start-ups.

Internet incubators, along with a growing list of venture capital firms, are

paying a toll for betting all on a Web-driven New Economy, and for funding both

solid and flimsy business plans when Web start-ups were all the rage.

Harvard Business School faculty in the school’s most recent New Business

publication stressed lack of discretion. "Forming an incubator made perfect

sense," said a Harvard Business School professor, Donald Sull. "With

few barriers to entry, capital providers could play in the Internet space and

thus diversify their portfolios."

But, Sull stressed, "The problem is that people financed businesses that

should not have received funding." Nitin Nohria, also with Harvard Business

School, noted the Web's "gold rush phenomenon" boosted the number of

US-based incubators to 214 in June 2000 from 42 a year before, a sign of weak

players joining a bandwagon.

"Just as everybody thought that they needed to join the Internet

movement or be left behind, a large group of people with new venture experience

decided to start incubators," Nohria said. "And just like the

Internet, some people were credible players, and some were not."

Prospects at issue

Web incubators now face a credibility gap, making for big shows of strain in
past weeks. CMGI, for instance, on Friday swung into action to deny a report

that its once high-flying venture arm, which helped launch dozens of start-ups

was out of cash.

Andover, Mass.-based CMGI denied a report in the San Jose Mercury News that

said the company's @Ventures fund was tapped out. The fund fueled the run-up of

the company's stock in 1998 and 1999 as Wall Street snapped up shares from a

string of CMGI start-ups that went public.

But when the IPO market for Internet shares dried up, CMGI's stock plunged.

Its shares fell about 97 per cent over the past year to around $4-3/32 in Friday

trade on the Nasdaq. CMGI did however, acknowledge @Ventures will slow its

investment pace.

"In recent months, @Ventures has realigned its investment practice to

focus on fewer new investments, with activity concentrated on earlier stage

businesses emphasizing enabling technologies," CMGI Chairman David

Wetherell said in a statement.

CMGI’s misery has company



Other incubators likewise are pulling back. Pasadena, Calif.-based Idealab, for
instance, on Wednesday said it will close its Silicon Valley office due to what

Idealab executive Brian Steel told Reuters is a "tough funding

environment."

Idealab has reportedly lost $800 million from a $1 billion infusion early

last year, and some of its best known start-ups, such as eToys, free-Web access

provider NetZero Inc. and discount PC marketer eMachines Inc., have faltered

since going public. Also on Wednesday, Divine Inc., formerly divine

interVentures, said it would shut down its FiNetrics start-up, a provider of

Web-based financial applications for businesses.

The move comes a few weeks after Chicago-based Divine announced it would

reposition itself as a business software provider. Divine had styled itself as

an "Internet Zaibatsu," a concept borrowing from Japanese business

structure to form a network of companies with shared interests.

At least Divine is still operating - unlike New York-based Efinanceworks.

Late last month, the niche incubator said it would return nearly $150 million to

its founders, venture capital firms General Atlantic Partners and Capital Z.

Efinanceworks was launched to invest in start-ups working on Web-based

financial service technology. Its backers, however, concluded they could

directly manage Efinanceworks' 13 portfolio companies.

(C) Reuters Limited 2001.