Hot or not?

It took awhile for investors to recover from the IPO hangover of the dot-com party, but they are now once again toasting successful exits such as VMware, a business software vendor whose shares quadrupled from its August IPO price of $29 per share to a record $125.25 at the end of October. Success stories like that have pumped fresh enthusiasm into the venture community and given VCs a glimpse at a roadmap for 2008.

“Excitement does tend to get driven by exits,” says Keith Benjamin, managing partner at Levensohn Venture Partners. “For instance, enterprise software a year or two ago wasn’t in the front of people’s minds as a hot area. But we’ll end up 2007 as a solid IPO year for some software deals doing well, and I think that is going to continue.”

What other areas will be hot in 2008? And what areas will not? We polled a cross section of venture capitalists and asked them what they anticipate in the year ahead.

HOT

Still SaaSy

Customer resource management (CRM) software led the on-demand charge but now every department from HR to marketing to procurement is looking for on-demand solutions. “We’re starting to see an on-demand trend that goes far beyond CRM,” says Gordon Ritter, general partner at Emergence Capital Partners. “On-demand software will increasingly be applied to every critical but non-core part of the business.”

Even younger generations are actively pursuing aesthetic procedures.”

Nick Simon

Ritter believes the market is still in the “first or second inning” of the software-as-a-service (SaaS) revolution and that 2008 will see adoption of the technology by corporate customers across all lines of the business. “Any software application that can be turned into an on-demand application will be turned into one.”

Beauty regimen

Baby boomers have reached that age where they feel a lot better about themselves if they can access cosmetic surgery. “Even younger generations are actively pursuing aesthetic procedures,” says Nick Simon, a managing director at Clarus Ventures.

He believes new medical devices that target the aesthetics market will be sitting pretty. Why? Because the aesthetics business is generally a cash market, with patients gladly paying for such procedures out of pocket. As a result, they are not subject to the pricing pressures that other medical devices face from insurance companies and HMOs.

Open up

We’re starting to see an on-demand trend that goes far beyond CRM,”

Gordon Ritter

Facebook cracked open the flood gates when it provided APIs and gave access to its platform to outside developers. “Really, 2008 could become the year of open APIs,” says Naval Ravikant, founder of seed-stage fund The Hit Forge.

“Suddenly it’s not so hard to imagine many of the top sites like eBay and Amazon opening up as well,” he says. “Imagine building a better recommendation engine and being able to plug it directly into Amazon.”

School is in

The education vertical will again be recognized for the massive opportunity it is, predicts Mike Kwatinetz, founding general partner of Azure Capital Partners. “Improved technology is the only way to bridge the gap between shrinking educational budgets and increased needs,” he says.

This was a very hot market in the 1980s and ‘90s, with some billion-dollar exits, such as Broderbund Software. But, due to a number of different factors, the market got sent to the corner. Kwatinetz believes online learning is gearing up for a major comeback. There was at least one sign at the end of 2007 to bolster that belief: American Public Education Inc., a VC-backed operator of several online colleges, priced at $20 on Nov. 9 then quickly shot past $40 in the aftermarket.

Improved technology is the only way to bridge the gap between shrinking educational budgets and increased needs.”

Mike Kwatinetz

Special delivery

There is a wide-open opportunity for companies to bring information from the far flung edges of the Web to mainstream consumers. “It’s not enough anymore simply to have your website and wait for people to come there,” says Gus Tai, general partner at Trinity Ventures. “You need to find a way to get your presence in front of your potential customers.”

The solution? Widgets. For example, YouTube has pushed its video widgets everywhere and now gets billions of eyeballs on and off its homepage. Tai expects to see even more widget companies emerge.

Jennifer Fonstad, managing director at Draper Fisher Jurvetson, agrees that is strong demand for “taking information at the edge of the Web and delivering it in a context people can use.” For example, a hedge fund manager has a team of analysts to cull every piece of public data out there, but consumers who trade stocks have to do their own leg work. “There’s a need for the retail trader to be able to access financial services information at the edge in a reasonable amount of time,” notes Fonstad. “It’s an algorithm worthy of Google, but that’s an opportunity. People might pay $9.99 a month to access that information.”

More green

Really, 2008 could become the year of open APIs. Suddenly it’s not so hard to imagine many of the top sites like eBay and Amazon opening up as well.”

Naval Ravikant

Most VCs expect cleantech to continue to be red hot in 2008. The National Venture Capital Association asked its members in December which sectors would experience the biggest growth and cleantech ranked No. 1. More than 80% of respondents said cleantech would see increased investment, according to a preliminary version of the survey. Not that VCs are thrilled with the heightened interest in all things green. Asked which industry would be overvalued in ’08, the vast majority (over 60%) said cleantech. (Internet deals came in a distant second with less than 20% of the vote.)

Back in business

The software industry will return to basics, which means more emphasis on enterprise apps for corporations, predicts Benjamin. “Since the bubble, enterprise tax spending has gone down and it looks like in 2007 we bottomed out and we’re starting to up tick. If I had to pick one thing for 2008, people are going to be talking again about how technology does improve productivity and create ROI for customers.” That may be, but most VCs expect investments in software companies to be flat in 2008, according to the NVCA survey.

NOT

Cold shoulder

Some VCs expect to see a cooling in the consumer Internet space. “For everything interesting on the Internet there are 85 competitors, so it’s much more difficult to the pick the winners,” says Ritter.

If I had to pick one thing for 2008, people are going to be talking again about how technology does improve productivity and create ROI for customers.”

Keith Benjamin

Benjamin agrees. “It feels like we’ll have to see some natural weeding out,” he says. “A lot of money has been placed and if you’ve already made two or three social media plays, it’s hard to make a fourth.”

And yet most VCs expect dollars to continue to flow into the sector. Half of those who took the NVCA survey predicted that the Internet sector would have the third-highest investment growth rate in ‘08, behind cleantech and media.

Big is bad

With startups requiring less and less money, big funds may go the way of the sock puppet. “The loudest refrain I’m hearing from entrepreneurs is, ‘Thank you very much, but we don’t need all that cash,’” notes Ravikant. With less money going into startups and less money coming out because of lower exits, we could see a proliferation of sub-$100 million funds. “The folks at Y Combinator proved you can develop technology companies for $20,000 apiece and still be successful,” Ravikant says.

Open warfare

It feels to me that [gaming] is getting institutionalized. I still believe in the category, but there are people looking at it who don’t have domain expertise.”

Gus Tai

The open source community will split between those who remain idealists—namely, those who reject commercialization—and those who increasingly believe that building a company requires monetization and even some protection of intellectual property.

“The successful open-source companies will be the ones that invest in R&D and initiatives that can be better protected,” Kwatinetz says. “This will make the zealots increasingly unhappy. They’ll continue to attack the open-source companies that prefer to operate according to capitalism rather than communism.” The resulting strife could sour VCs on the sector.

Game over

The gaming field is getting saturated, says Trinity’s Tai. “It feels to me that it’s getting institutionalized. I still believe in the category, but there are people looking at it who don’t have domain expertise.” That means too many VCs chasing not enough quality deals, which drives up valuations.