Eye on the Prize

Jim Long swore he’d never do another enterprise software deal again. Like many venture investors, he believed the enterprise was a dead-end for startups.

Why? Because big companies had spent the previous decade gorging on software. Badly burned by long, costly implementations, they weren’t in the mood for any more software products, especially from unknown companies. What’s more, industry consolidation led by the likes of Oracle Corp. meant that exit opportunities were extremely scarce—even for a successful software startup. “There used to be 20 companies you could sell the business to, and suddenly there were just three,” says Long, a venture partner at Gabriel Venture Partners.

But then he started to hear about something called Enterprise 2.0 that caused him to seriously rethink his beliefs. Enterprise 2.0 is a catchall term for taking consumer-based Web 2.0 technologies like social networking, RSS, blogs, wikis, mashups, podcasts, and widgets, and bringing them into the corporation. The idea is that these consumer services, pioneered by companies like Facebook and Flickr, actually represent a new way for businesses to connect with customers and harness the collaborative power of employees.

Opening doors

The more Long investigated the space, the more he realized that something significant was happening. “Corporate doors are starting to open to these technologies because they truly have the potential to solve an age-old problem,” he explains. “They can make workers more productive and help them get their jobs done faster and better.”

Putting aside his former distaste for enterprise software, Long led a $3.5 million investment in ConnectBeam, a startup that’s integrating Web 2.0 concepts like social bookmarking and social networking into the daily workflow of corporate employees.

The term Enterprise 2.0 was coined in 2006, drafting off of the excitement over Web 2.0. VCJ identified a handful of companies that fit under the Enterprise 2.0 umbrella that were funded prior to that time, such as KnowNow, which received its first backing in 2000. But for the most part, companies with Enterprise 2.0 characteristics didn’t really start to get funded until 2006, according to data from Thomson Reuters (publisher of VCJ).

Overall, VCJ identified 22 Enterprise 2.0 companies that have raised a combined $355 million to date (see table). While those are pretty small numbers compared to overall software investments, they continue to inch upward. Just eight Enterprise 2.0 companies raised a combined $44 million in 2006, but the following year 10 such companies collectively raised $88 million. And as of July 1 of this year, eight more startups pulled in a combined $138 million.

One of the main reasons why companies are engaging with Enterprise 2.0 is because young, Gen-Y employees who grew up on the Internet see it as a vital tool for collaborating and accessing information.”

Rona Segev-Gal

Draper’s enthusiasm notwithstanding, not every VC is convinced that Enterprise 2.0 has legs. Fred Wilson, a partner at Union Square Ventures, says the term “social enterprise software” is inherently contradictory. “I still wonder if enterprise software can really be social,” he argues. “Most enterprises don’t want their employees to be active members of a community that they can’t control, monitor and moderate.”

This thought is amplified by David Siminoff, a general partner at Venrock. “I think the only way the enterprise gets more social is by putting better coffee in the coffee machine,” he half jokes.

In fact, there’s nothing about Enterprise 2.0 that Siminoff finds interesting or exciting. “Maybe I’m a boring guy, but when I go into the office, I just want to work, and no amount of software is going to make me more social,” he says. “I can’t think of any good reason why I would want Facebook-like features within the organization. I barely want or need those things even when I’m on Facebook.”

Interestingly enough, Siminoff has made an investment in one company, SlideShare, that falls under the Enterprise 2.0 umbrella. SlideShare provides a service that is best described as YouTube for PowerPoint presentations. Seemingly sleep-inducing corporate slides that are the hallmark of every bad business meeting can now be uploaded to SlideShare for free, allowing organizations to publicly or privately share their ideas, connect with others and generate leads for their businesses.

Siminoff admits that he thought the service sounded pretty boring—until he tried it for himself. “I got utterly engrossed in it,” he says. “I spent hours going through these fascinating slide presentations on topics that really interested me. The thing I love about SlideShare is that it allows the average consumer to get valuable information from PowerPoint slides that happened to be created by businesspeople.”

Purchase decision

But SlideShare is different from other Enterprise 2.0 startups in that it makes money from advertising. Perhaps the greatest challenge facing other companies is whether chief information officers and IT departments will actually pay to purchase their software. After all, most corporations don’t have a budget line item that says “Enterprise 2.0.” Moreover, it’s still unclear whether social tools like wikis, tags, RSS and blogs will ever truly penetrate the enterprise. And if they do, companies may decide to just build them themselves.

Perhaps the greatest thing Enterprise 2.0 startups have in their favor is that, for the most part, workers have already shown a strong desire to embrace these technologies. That’s a far cry from the enterprise software systems of a decade ago, which were universally despised by users and had to be shoved down their throats. Today, it’s actually the end user, i.e. consumer, who is leading the charge, and it’s the IT department that is being pressured to respond.

The most troubling thing we saw was the large number of companies serving this market. We felt a consultative approach was the right thesis given the current state of affairs.”

Chris Pacitti

“One of the main reasons why companies are engaging with Enterprise 2.0 is because young, Gen-Y employees who grew up on the Internet see it as a vital tool for collaborating and accessing information,” says Rona Segev-Gal, a general partner at Pitango Venture Capital.

She recently invested in WorkLight, a company that “consumerizes” the corporate computing experience by making popular services like iGoogle, Netvibes and Facebook enterprise-ready. For instance, WorkLight has a new tool that lets companies provide employees with access to Facebook, while still ensuring that the popular social network is run behind corporate firewalls to restrict access to confidential content.

Kevin Talbot of RBC Ventures agrees that the usefulness of consumer software has greatly surpassed that of enterprise software and says that corporations are scrambling to catch up. “People leave the office and realize they have all these great productivity tools at home that they don’t have at work—tools to keep in touch with friends and share their videos and photos,” he says. “So where does that leave the enterprise? It can either continue to stick its head in the ground and block everything out, or it can find a way to embrace this new technology.”

Control freaks

But here’s the rub: Users want open tools and IT departments want control. With that in mind, the successful Enterprise 2.0 company will be a vendor that enables users to access and share information easily and also allows IT departments to monitor and enforce security and compliance policies.

Talbot believes he has found such a company in Igloo, a social networking platform architected exclusively for corporations. RBC led a $4 million investment in the startup, which blends an integrated platform of Web 2.0 tools with the security and administration controls required by corporate IT departments. The system includes tracking features that allow an IT administrator to see exactly what was posted, edited and deleted and by whom.

“The key to success for companies selling into the corporate market is understanding how the enterprise works,” Talbot notes. “There are plenty of applications that are successful on the consumer side but that do not translate to the enterprise space. You really have to know what you’re doing here.”

There are plenty of other pitfalls when investing in an Enterprise 2.0 startup. “There’s a lot of noise around this market, some of it is real but a lot is just irrelevant hype,” concedes Rona Segev-Gal at Pitango. “There are many small startups who have developed some kind of technology that is not enterprise grade and are positioning themselves as Enterprise 2.0 companies.”

I still wonder if enterprise software can really be social. Most enterprises don’t want their employees to be active members of a community that they can’t control, monitor and moderate.”

Fred Wilson

One of the biggest challenges for investors in the space is separating the steak from the sizzle, and knowing the difference between a cool, nice-to-have application that probably won’t sell, and a truly valuable must-have application that can generate real ROI for corporate customers.

“We’re seeing tons of cool things being done out there, but mostly they’re just tuck-ins and add-ons, and you can’t really build great companies out of any of them,” says Talbot.

Chris Pacitti at Austin Ventures is seeing the same thing. That’s one reason he’s backing an as-yet unnamed company founded by Jeff Dachis, former CEO of Razorfish, that is creating a strategic consulting practice around enterprise-grade social software. The new company is banking on the fact that corporations will need help sifting through the many Enterprise 2.0 offerings on the market and integrating the best ones into their existing business systems.

Essentially, this new consulting firm will pick and choose from all these emerging point solutions. As the middleman, the new company can become a huge player in the market, even if the vendors and technologies it supports do not.

Integration approach

“The most troubling thing we saw was the large number of companies serving this market,” explains Pacitti. “We felt a consultative approach was the right thesis given the current state of affairs. There are lots of little widgets for this or that, but they don’t really form a business in and of themselves. We felt it would be much more interesting to bring them together.”

Since announcing its intentions, Austin Ventures has been contacted by dozens of garage startups that hope to form a relationship with the new consulting firm, Pacitti says.

At the end of the day, an Enterprise 2.0 investment will be successful if and only if it can deliver real ROI to customers, say venture investors. Joe Zell, a general partner at Grotech Ventures, says he led a $5.6 million investment in HiveLive because the company’s corporate social networking platform was helping clients improve employee productivity and morale.

For instance, one HiveLive customer reported that within 45 days of launching the application, more than 1,500 people were using it to trade photos and recipes and to set up a classified marketplace. But just as importantly, the application created a sense of community among remote and home-based employees, allowing them to share knowledge and best practices with each other, thereby strengthening the company.

“Some customers are reporting that they can pay for the system six times over just from their ability to keep employees happy and cut their turnover rate,” says Zell. He adds that Enterprise 2.0 applications have the potential to pervade all parts of the organization, just as ERP systems did in the past, starting in the manufacturing division, but then gradually spreading to finance, human resources, product management and sales and marketing.

“From a deal flow perspective, were already starting to see entrepreneurs focus on a lot of different business applications for social networking,” says Zell. “Right now, I’d say somewhere between 20% and 40% of all enterprise software deals have some sort of social networking component.”

But is social software for the enterprise another passing corporate fad, just like reengineering and knowledge management before it? Not likely, say most VCs. “Some potential customers are still living in the past and think this is just more enterprise software,” says Draper. “They will either recognize that it is mission critical to them or they will suffer the tragedy of the dinosaur.”