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INNOVATION ECONOMY

$100m start-ups aim to stay in club

Successful so far, many struggle to remain on high ground

By Scott Kirsner
November 30, 2008
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Being a member of the Triple-Digit Club is a bit unnerving right now.

Start-ups join the TDC when they've raised more than $100 million. Right now, club members in the Boston area include companies like battery developer A123Systems Inc., "digital paper" maker E Ink Corp., coal-to-natural gas converter GreatPoint Energy, and LED manufacturer Luminus Devices - each of which has raised between $100 million and $150 million.

The current club president is Kayak.com, the travel search site, having raised $223 million. Investors in these companies obviously have high hopes for a lofty payday.

But what happens as these companies face a sharp economic downturn? Customers can go bankrupt (A123 has been developing batteries for a forthcoming car from General Motors, for instance) or throttle back their spending.

Prospective acquirers keep their wallets in their pockets - unless they're doing some bargain-hunting. An initial public offering is just a dream, and raising more money from private investors can be difficult or impossible.

"It's a really great ego trip when the venture capitalists are pouring the money in and telling you how much they think your company is worth," says one Boston entrepreneur whose last company raised about $30 million. "And then you realize how much pressure comes along with that, and how sometimes those expectations can be totally ungrounded in reality." (This entrepreneur, currently laying the foundation for his next start-up - and potentially raising money - didn't want to be named.)

The TDC has two subcommittees. In one subcommittee are the companies that aren't yet profitable and are running low on cash. In the other are companies that have reached profitability. "If a company needs more money in this climate, the investors really have to believe and see the light at the end of the tunnel in order to be willing to put more money in," says Sim Simeonov, a technology partner at Waltham-based Polaris Venture Partners. "But if you're cash-flow positive, investors can be very patient."

Some of the members of the Not-Yet-Profitable subcommittee will need to make cuts in headcount, or hone their ambitions.

"It's always a balance," says Lee Barbieri, managing partner of Stata Venture Partners in Needham. "Do you try to get to cash-flow-positive sooner by cutting back, and maybe you leave some opportunities on the table, or are you willing to have prolonged losses and invest in something you believe will really happen?"

Barbieri's firm is an investor in Luminus Devices, which raised $72 million in March to build a manufacturing facility in Billerica. He describes Stata Venture Partners as having "a very long-term perspective."

Members of the TDC, even if unprofitable, can get some protection from the "too big to fail" dynamic. It is embarrassing to investors to let so much money go down the drain in such a high-profile way, so they can keep pouring the greenbacks in even when it no longer makes sense.

But TDC members like the Internet consulting firm Zefer Corp. did vanish in the last downturn, and only last year the Los Angeles wireless provider Amp'd Mobile filed for bankruptcy after spending $360 million - some of it supplied by Highland Capital Partners of Lexington.

As for Kayak, with offices in Concord and Norwalk, Conn., it is lucky enough to be part of the profitable subcommittee, and cofounder Paul English says the company still has about $30 million left over from its most recent funding round.

Kayak helps travelers compare prices on airfares, hotels, cruises, and rental cars, pocketing a referral fee when a purchase is made. (The site also sells advertising.) English says the company, with 70 employees, is still hiring engineers and salespeople, adding, "we would never consider a layoff."

The company is planning to move from a 10,000-square-foot cubicle farm in Concord to 14,000 feet of custom-designed space, and Kayak employs a chauffeur to ferry employees between Concord and Norwalk so they can get work done during the drive. But even the top executives fly economy.

"Steve and I are very cheap with the company's money," says English, referring to CEO Steve Hafner. "It's some blue-collar hunger I have." (English's father worked as a pipefitter and the family frequented yard sales on weekends.) But one of Kayak's competitors, San Francisco-based Mobissimo, has built a similar travel site with just $1.1 million in funding. It is also profitable. Chief executive Beatrice Tarka asserts that Kayak has spent much of its money on marketing and to purchase SideStep, another West Coast competitor.

"I don't think the money that they've raised was to improve the product," she says. The entire start-up world, from the TDC on down, took notice last month when several partners of Sequoia Capital, the venture firm that funded companies like Google, PayPal, and Electronic Arts, called a meeting to warn its companies about the coming recession. The text on the opening slide? "R.I.P. Good Times." Spending cuts, the firm advised, are a must, and acquirers will gravitate to profitable companies.

Sequoia, as it happens, is an investor in Kayak (A123Systems, too). According to English, people who were at Sequoia's cautionary meeting say that partner Michael Moritz mentioned Kayak several times.

"They were talking about us as a company with a lean profile," he says. "In their portfolio, we are the skinniest as far as costs." That frugal posture will be an asset if even gloomier times are ahead.

But members of the TDC are expected not just to endure, but to eventually provide a rich return to their investors. That's an intimidating prospect.

Scott Kirsner can be reached at kirsner@pobox.com.

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