August Cover Story: Internet 2.0 –

Bob Kagle hasn’t been this busy since 1999. In the past three months the Benchmark Capital general partner has led investments in no less than four Internet companies, including an online service that connects attorneys with corporate clients and a Web-based marketplace where you can ship everything from a piano to a horse. And Kagle is just getting warmed up. “I’m looking at four more Internet deals that I just love,” he says giddily. “It’s getting hard to restrain myself, so I think I’ll just have to do them all.”

During the post-bubble years there were only about “four or five firms doing Internet investing consistently,” Kagle says. “Now there are many more. This means rising valuations, shorter periods of due diligence and greater competition for executives. No doubt, we are back at the beginning of those things.”

While Kagle and other VCs actively doing dot-com deals agree that that the sector is heating up, market researchers say they aren’t yet seeing a spike in their numbers. For example, Internet deal volume declined last year and was also down in the first quarter of this year. Still, it’s hard not to conclude that the Internet is hot once again when so many big name firms are jumping into the fray. Here’s a sample of the recent action: Sequoia Capital put $15 million into shoe e-tailer (following its $20 million investment eight months earlier);

Kleiner Perkins Caufield & Byers and Oak Investment Partners co-led a $26 million Series A in online ticket service RazorGator; Morgenthaler Ventures and Venrock Associates teamed on a $5.2 million Series A for online photo marketplace Digital Railroad; and 3i Group and BV Capital invested an undisclosed amount in a Series A for online DVD swapping service PeerFlix.

If that’s not enough, the founders of online payment service PayPal in July launched a $50 million fund focused entirely on-you guessed it-consumer Internet deals.

It may feel like 1999, but Internet investors say it really is different this time around. Back in the 1990s consumers were experiencing the Internet for the very first time. They had clunky dial-up connections, were terrified of giving their credit card numbers to Web merchants and they didn’t have good tools to find exactly what they wanted.

Now more than half of all U.S. Internet users have high-speed connections. The Web is tightly woven into the fabric of their lives. If stuck on a desert island, more Americans would prefer to have the Internet rather than their TV, according to one recent survey. “It’s not so much that VCs wasted $100 billion,” says Allen Morgan, a managing director at Mayfield. “It’s more that we inadvertently financed a mass education program for consumers. Most of these early Internet firms may have failed, but they got people used to the idea that you can do lots and lots of stuff on the Web.”

Today’s Internet startups aren’t the “build it and they will come” pipedreams of 21-year-old entrepreneurs. They have real business models with savvy managers at the helm. They also seem to have real exit opportunities thanks to the established Internet behemoths like Amazon, eBay, Google and Yahoo, all of whom have sizable market capitalizations and are not shy about snapping up innovative startups.

The mantra of the day is capital efficiency-the notion that you can build a great company from start to finish with only a few million dollars, not a few hundred million. VCs have traded in buzzwords like “eyeballs” and “stickiness” for new, serious-sounding ones like “organic growth” and “community.” More importantly, most second-generation Internet companies aren’t getting funded until they see revenue or even profit.

“The biggest difference this time is that we are out of the land-grab mentality,” says Heidi Roizen, a managing director at Mobius Venture Capital, a firm that had its share of dot-bombs. “These companies no longer require $20 million or $30 million right out of the gate. This is no longer about spending tons of money to attract customers, and then flipping the switch and hoping a million people show up.”

Roizen points to InstoreCard as an example of the kind of Internet company worth funding these days. It’s an online service that allows retailers to manage loyalty-marketing programs with consumers over the Web. It is focused on building its business one customer at a time and making sure users have a great experience before introducing new features and expanding the business.