Finding Riches in Entrepreneurs' Woes

NEW YORK (MarketWatch) -- Bankruptcy. Asset sale. Shutdown.

Those words make most entrepreneurs and venture capitalists cringe. But for Joseph Finn Jr., they spell big business. Finn, the founding partner of Finn, Warnke & Gayton, works with distressed companies and auctions off assets.

And these days, after a bit of a dry spell, he's licking his lips.

VentureWire's Tomio Geron reported on Thursday that N2N Commerce Inc., a start-up that attempted to revolutionize the online retail industry, is selling its assets in an upcoming auction. The company had raised at least $30 million from General Catalyst Partners and Limited Brands Inc., but it shut down and terminated all 70 of its employees in December after a dispute with investors.

Now Finn is handling the asset auction of N2N's intellectual property, allowing bidders to enter sealed bids until April 11. As VentureWire reported, Finn played a similar role for a number of companies during the dot-com bust, such as 3Plex Inc. in December 2001, Powercell Corp. in April 2002, and eSupportNow Inc. in November 2001.

Finn hasn't had many such cases since then, but recently this part of his business has picked up. In addition to N2N, he's handling the sale of the assets of biopharmaceutical company ActivBiotics Inc., which is up for auction after raising more than $68 million in venture backing.

Tidal Wave

This may be the beginning of a tidal wave of asset sales and bankruptcies, the likes of which we haven't seen since the technology bust. Finn told VentureWire that business should pick up in the near future due to the economic downturn.

"Attorneys in the field are saying to me, 'Joe, you're going to be really busy,'" Finn said. In the past few months, we've seen a load of companies go belly up. And these aren't tiny companies. Many of them, such as airplane maker Adam Aircraft Inc., which just filed for Chapter 7 bankruptcy, are well-financed venture-backed start-ups, raising questions about the health of start-up companies during the current economic downturn. Here's a table of some of the biggest start-up losers from the past few months:

ActivBiotics Inc. - The biopharmaceutical start-up raised about $68 million in venture capital, but in December decided to put its assets up for auction after a Phase III failure of its lead drug candidate.

Adam Aircraft Inc. - The well-financed airplane builder laid off some 300 workers in January and attempted to quickly raise up to $150 million in funding from Citibank with hopes of staying afloat, but instead succumbed to Chapter 11 protection last week.

Blue Frog Media Inc. - The interactive television company, which raised $16 million from two venture firms since its founding in 2004, filed for Chapter 7 bankruptcy earlier this month.

Go Fig. Inc. - Just four months after receiving a multimillion-dollar Series A investment from Bessemer Venture Partners, this company filed for Chapter 11 bankruptcy in January and shuttered most of its aesthetics clinics nationwide.

Judy's Book Inc. - The story is over for this online local directory, which shut down in the fall and put itself up for sale after raising some $10.5 million.

Linux Networx Inc. - After raising more than $90 million over the past seven years, this maker of high-performance cluster computing systems sold its core assets to rival Linux supercomputer maker Silicon Graphics Inc. in February

NeoScale Systems Inc. - Faced with competition from every angle, the provider of data-storage encryption appliances closed its doors in December and sold the majority of its assets to nCipher PLC for a paltry $1.95 million in cash.

Novalux Inc. - After surviving the telecom bust a few years ago, emerging from Chapter 11 bankruptcy in 2003 and raising more than $200 million in VC, the company sold in January for just $7 million in stock to electronics maker Arasor International Ltd.

Revver Inc. - The start-up was a pioneer in allowing producers of homemade digital videos to share and make money from their work. But competition was overwhelming, and it reportedly sold its assets this month for less than $1 million to LiveUniverse after raising $13 million from VCs.

Solidus Networks Inc. - The biometrics company, known as Pay By Touch, raised more than $300 million before filing for Chapter 11 protection in December. It's now selling three money-losing units as it seeks to reorganize.

Terawave Communications Inc. - Telecommunications equipment maker Occam Networks Inc. paid just $3.2 million in cash plus the forgiveness of $1.9 million in bridge loans for assets of this company, a one-time leading light in the field of passive optical networking that raised $170 million.

Xytrans Inc. - The maker of a concealed-weapons detection system found itself filing for Chapter 11 after weak demand and too many strategy shifts left it with more than $5 million in debt.

VCs seem to remain cautiously optimistic, at least the ones I've chatted with. They say this is just a temporary blip, a normal part of the investment cycle, and they'll be able to weather the storm. Some start-ups are raising significantly larger venture capital rounds, mindful of some possibly troubling times to come.

But something's got to give, and here's why. The amount of venture capital invested in start-ups has steadily climbed each year since 2003, reaching nearly $30 billion in 2007. There's now a lot of excess fat in the industry, yet it's taking a record median time of nearly seven years for a start-up to raise its first round and then generate a return for its investors through an initial public offering or acquisition.

Exit Strategy

That means VC portfolios are stocked with companies that need to exit (including more than 1,400 originally funded in 1999 and 2000). But the IPO market is practically dead right now. Toss in a tightening of consumer and information technology spending, and tolerance levels drop, especially when some VC firms are required to liquidate huge funds that were raised in 1998 and 1999 because they're on a 10-year investment cycle.

It's unsettling to see a company like N2N fall so quickly. It raised $30 million from General Catalyst and Limited Brands in early 2007 and planned to offer a cross-channel platform that integrated e-commerce, call center and order-management applications.

N2N was testing the product and was close to delivering it, but Limited pulled N2N's only client, Victoria's Secret, which resulted in the closure of N2N. While Limited's pulling out of N2N could have been related to the economy -- it has suffered from a slowdown in consumer spending, and its quarterly sales fell 20% -- there was also a dispute between investors General Catalyst and Limited, Larry Bohn, managing director at General Catalyst, told VentureWire in January.

It's one of a number of start-ups to fall apart since June when wireless carrier Amp'd Mobile Inc., which raised $360 million in financing, filed for Chapter 11 bankruptcy protection in spectacular fashion.

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