Startups May Die, but not their Bright Ideas

Nicholas A. Grouf is taking a breather from his regular job of launching
high-tech companies. These days, the 34-year-old Harvard Business School
graduate sits on the sunny deck of his San Francisco home overlooking the
shabby-chic Haight-Ashbury district and pecks away at the novel he’s writing.
It’s a far cry from the frenetic pace he kept at the companies he co-founded
in the go-go 1990s, Firefly Network and PeoplePC. Both showed flashes of
brilliance but never made it big and were ultimately swallowed by larger fish.
EarthLink Inc, the No 3 Internet service provider, snapped up PeoplePC last year
for a measly $10 million.

Yet their innovations live on. As a subsidiary of EarthLink, PeoplePC
continues to break the mold by selling consumers PCs and Net access in a package
for an affordable $24.95-monthly fee. And Microsoft Corp made Firefly’s
technology the basis for its 200 million-member Passport system for storing
people’s crucial personal information on the Web. Grouf, who was CEO of both
companies, says he doesn’t regret that he no longer gets to play a role.
"When you sell a business, you still get the satisfaction of seeing them
survive and touch millions of people’s lives," he says.

Grouf’s journey is part of a huge transfer of innovation now under way that’s
reshaping the tech industry. While hundreds of Internet startups are dying or
selling out after nearly three years of being pummeled by the rotten economy,
many of the technologies they created are destined to live on and play important
roles in the future–either via acquisitions, in new startups, or through
copycatting by the industry’s giants. Think of it as a mammoth recycling
project. "The company is the most ephemeral institution in the information
technology world. The people are perennial, the technologies are repurposed, and
the products find new homes in surviving companies," says Geoffrey A Moore,
chairman of tech consulting firm Chasm Group in San Mateo, Calif.

Although the boom is remembered as a time of frivolity and excess, it was
also a bountiful gusher of business creativity. Nearly 6,000 tech companies were
financed by venture capitalists, and since there was little pressure to achieve
profits in the short term, entrepreneurs were given permission to dream–and in
some cases, hallucinate.

Sure, plenty of ideas were silly. But the era also produced an abundance of
ideas that were mind-bending, even if their inventors didn’t survive as
independent businesses. Take ICQ, the instant-messaging pioneer, which
flourished after its 1998 sale to America Online Inc. In many cases, the
challenge facing the new caretakers of these innovations is to take a
potentially world-changing idea and give it business legs.

Established firms are cherry-picking the best of the distressed properties.
One sizzling technology is Internet search. And anything to do with Wi-Fi, the
wireless networks that are spreading through dorms, offices, and coffee shops,
is sure to attract shoppers. In the past couple of months, Search site Overture
Services Inc has taken over Web search pioneer AltaVista Co, paying just $140
million for a property that had once been valued at more than $2 billion. Level
3 Communications Inc snapped up the original Net backbone operator, Genuity.
Even the stodgiest of Main Street outfits are getting into the act: Anderson
Merchandisers, a leading music CD distributor, in late January bought assets of
Net music-download specialist Liquid Audio Inc. "The task is sifting
through the wreckage and seeing where there’s an overlooked opportunity,"
says Paul Saffo, executive director of the thinktank Institute for the Future.
"A lot of these ideas were good, but were ahead of their time."

How smoothly this handoff goes will determine whether a generation of
innovation is put to good use or consigned to history. Plenty can go wrong, and
the tech industry is infamous for bungling acquisitions. Technologies clash.
Executives lose focus and screw up business basics. Or the best brains from the
acquired companies get frustrated with the new bureaucracy and run, screaming–the
way Netscape Communications Inc engineers fled en masse after the company’s
1998 acquisition by AOL.

Sometimes the handoff works like magic. Software maker BEA Systems Inc, for
instance, paid just $240 million in 1998 for WebLogic Inc, a leader in the
nascent market for Web application server software. By now, the software has
become a mainstay of Internet computing in corporations, and WebLogic-related
sales accounted for about 70% of BEA’s $934 million in revenues last year.

With examples like that to inspire them, savvy buyers are shopping for
companies that can boost their revenues or plug up holes in their offerings.
Documentum Inc, the leader in document-management software, is one example. In
the last year, it snapped up three companies for less than $10 million each,
before splurging, for $125 million, on eRoom Technology Inc and its
Internet-based employee-collaboration technologies. "We take pieces funded
by tens of millions of dollars of venture-capital money, pick them up much more
cheaply, and get their products into the mainstream much faster than they would
have gone otherwise," says Robert M Tarkoff, Documentum’s chief strategy
officer.

Plenty of entrepreneurs are grateful to be bought out, given the hostile
environment. Andrew Parkinson, co-founder and now CFO of online grocery delivery
pioneer Peapod, points out that despite the high-profile failure of online
grocer Webvan, Peapod is thriving under the wing of grocery giant Royal Ahold,
which bought it in mid-2001. And the parent company’s current accounting
difficulties don’t seem likely to change that. By plugging into Ahold’s Stop
& Shop and Giant chains, Peapod gains price advantages and plenty of
promotion. Peapod’s sales expanded 20% last year, to approximately $150
million, in an industry that grew just 3%. "We’re working with a retail
partner, and we’re making money," says Parkinson.

Selling out to the giants seems to be the way for startups to go–at least
until the initial-public-offering market picks up again. After a record 176
tech-industry IPOs in 1999 and 107 in 2000, there were only five last year. This
year isn’t shaping up to be any better. For now, the best hope for many
entrepreneurs is to position themselves as research and development labs for the
giants. They can cook up their technology in pre-IPO obscurity, prove that it
works, and then sell out to an acquirer who has the wherewithal to turn their
dreams into businesses.

By Steve Hamm (The author covers technology and is based out of New
York) in BusinessWeek. Copyright 2003 by The McGraw-Hill Companies, Inc