August 21st, 2007
Investors to Web Start-Ups: Where's the Advertising?
By Rebecca Buckman
Wall Street Journal
Tech entrepreneur Glenn Kelman’s online real-estate brokerage, Redfin Corp., allows consumers to buy or sell homes online and takes a cut of each real-estate transaction it brokers.
To Mr. Kelman, it’s a sensible business model. But when he sought backing from venture capitalists this past spring, he found the process much tougher than he had expected.
During his meetings with Silicon Valley financiers, many kept urging the Seattle company to start selling advertisements on its Web site instead of making money from commissions, he says.
“Today, there’s nothing more fashionable than having an ads-driven model,” says Mr. Kelman, 36 years old. Content to be unfashionable, he stuck to his guns and ultimately raised $12 million.
Mr. Kelman’s experience is one of many like it as venture capitalists increasingly advise consumer-focused tech start-ups to follow the same business model: online advertising. Chief executives of Web start-ups such as EnjoyMyMedia Corp. and Cake Financial Corp. say they have also recently faced tough questions from venture firms over their business models that don’t rely on advertising income.
Photo-and-video service EnjoyMyMedia runs a few ads but mainly offers a paid service; Cake Financial plans to charge customers fees for investment services.
“If you have a model that is different from the 90% of consumer-Web companies folks are seeing today ... it’s difficult to break through that clutter,” says Cake CEO Steven A. Carpenter, whose San Francisco firm ultimately snagged money from Baseline Ventures and Alsop Louie Partners.
Entrepreneurs say the laser-focus on online advertising may be a sign of a declining risk appetite in Silicon Valley. By focusing simply on advertising, venture investors are concentrating on businesses that “aren’t as aggressive” as those that dominated the Internet in its early days, says Redfin’s Mr. Kelman. He notes that Web companies like his that are trying to disrupt brick-and-mortar industries would have a hard time surviving on advertising since ads tend to be linked to a Web site’s business—and “if you’re going to change the insurance industry, you’re not going to be running ads from the insurance industry.”
According to research firm VentureOne, U.S. investors in the first half of this year poured $317 million into “Web 2.0 companies”—generally ad-supported Web sites in fields like social networking or blogging—up nearly 21% in the year-earlier period. Venture capitalists typically take stakes in start-ups with the hope of cashing out later through a sale or initial public offering.
Some venture capitalists say they are backing innovative consumer-Web companies that don’t sell ads, such as game companies that peddle “virtual goods.” Others are funding business-focused companies that make money through more traditional means. But in the world of consumer Web services, “everybody’s under pressure to do ads,” says Brad Silverberg, a partner with Bellevue, Wash., venture outfit Ignition Partners. His firm declined to fund Redfin, but Mr. Silverberg says it was mainly because he was busy with other investments.
Venture capitalists tend to be fans of ad-driven sites since advertising revenue theoretically covers the cost of giving away a Web service free, and free sites attract users much faster than sites that charge money. Such sites are typically also cheap to run because there is often no need for customer-service agents or costs for physical goods. So such companies can have high profit margins if they succeed. Many of today’s hottest Web properties are based on the online-ad model, including Google Inc., which pairs ads with search results, and social-networking site Facebook Inc.
U.S. Internet-advertising revenue reached nearly $17 billion last year, up 35% from 2005. Revenue has been rising since 2002, and “we have every confidence that this growth trend will continue,” says Randall Rothenberg, CEO of the Interactive Advertising Bureau trade group in a May statement.
Still, most of that money remains concentrated on a few large sites, raising questions about whether thousands of start-ups can snag a significant piece of that pie and grow into large-enough companies that could actually make money for their investors.
Nonetheless, some entrepreneurs trying to profit from non-online-ad models say they are being penalized for being different. EnjoyMyMedia, which charges people a monthly subscription to post and share family videos, photos and other materials through special online software, has faced some “hard questions” from investors over its business model, says CEO Keith Loris.
EnjoyMyMedia runs some ads on its site, but Mr. Loris says the company is “very much counting” on people actually paying for the service. It’s still looking for funding.
New York Web company Meetup Inc., which spurns ads and uses its Web site to help people form local community groups, says it hasn’t had trouble raising money. But “there are [investors] who certainly say, ‘You’re not advertising? You’re missing out!’ “ says Scott Heiferman, the company’s co-founder and CEO.
When Mr. Kelman went looking for money earlier this year, he says he had some awkward encounters with investors, even though he says Redfin’s business was growing quickly. In presentations to venture capitalists, Redfin positioned itself as the E*Trade of real estate. The company offers Web tools to let home buyers research properties and then drafts offers online. Salaried Redfin agents, similar to call-center employees, then step in to help customers negotiate prices and close home purchases. Redfin rebates buyers two-thirds of the commission it gets for representing them, saving consumers an average of about $10,000, Mr. Kelman says.
“We would say, ‘We’re going to let people buy and sell homes online’ “ and save them money, Mr. Kelman recalls of his meetings with investors. “And half an hour through, someone would say, ‘Well, where are the ads?’ And we’d say, ‘We’ve been trying to tell you, no ads.’ They’re like, ‘No ads? When are you going to put them up?’ “
Mr. Kelman says Redfin talked to more than 10 venture firms, ultimately getting funding from firms such as Draper Fisher Jurvetson, though his executives originally “thought that if we met just a few that it would be sufficient.” Redfin, which started its current service last year, had previously raised $8 million from Seattle-area venture firms.
Some investors say they had concerns about Redfin’s business that had nothing to do with online advertising. For one, the National Association of Realtors, along with local home-listing services, have complex rules that make it difficult for online real-estate companies to get access to a nationwide directory of home listings, Redfin says. The association says it is “open to all business models and favors none.” Redfin says it has access to such directories now, but without them, the company would have no business because it would have no inventory of homes for sale, Mr. Kelman acknowledges.
In addition, Redfin is competing for venture dollars with online real-estate Web sites like Zillow.com, the brainchild of Expedia Inc. founder Richard N. Barton. Zillow, which sells ads, doesn’t act as a broker in transactions and focuses on offering people slick, easy-to-find real-estate information online.
One investor who says he heard Redfin’s pitch says Redfin’s online-search engine isn’t as easy to use as those offered by sites such as Zillow and Trulia Inc., another real-estate player. The investor, who declined to be named and who didn’t fund Redfin, adds that Redfin could incur high costs to snag customers since it has to pay salaries to real-estate agents and customer-service employees.
Mr. Kelman says he doesn’t view Zillow and Trulia as competitors and worries more about traditional real-estate brokers who are beefing up their online presence. He adds, “We’ve never denied that in some ways our business is more difficult to build than Zillow’s or Trulia’s” because Redfin is in the brokerage business.