Venture capitalists may be waist-deep in some irrational exuberance when it comes to their investments in online advertising companies. But some are avoiding that potential pitfall by focusing their Internet investments on safer bets in e-commerce software and services.

Some of the biggest financing rounds in the first quarter have targeted online advertising companies: Digital marketing company Datran Media Corp. raised a $60 million first round from VantagePoint Venture Partners and AzoogleAds.com Inc. received at least $30 million in a first round of institutional financing led by TA Associates. With such hefty investments, the online advertising space might be running the risk of being over-funded.

"Success often brings copycats," said Tom Alberg, managing director with The Madrona Venture Group and board member of Amazon.com Inc. He compared the state of online advertising to online retail during the Internet boom: "There wasn't one toy store," he said. "There were five or eight of them. It's the same now with online advertising. There are some good strong companies, but it hasn't seemed to stop other people [from entering the space.]"

There have also been recent signs that the space may be losing its luster among stock market investors. For instance, the ballyhoo surrounding the IPO of online advertising company Fastclick Inc. soon fizzled after public investors greeted the company with little fanfare - the stock began trading in early April at $12, the low end of original price estimates, and now sits below $11. Google Inc.'s stellar post-IPO raise has also come to a halt over the last few months as concerns grow that rapidly rising search term prices could deter companies from purchasing keywords and that click fraud could be dampening marketers' return on investment.

But while venture capital investment in online advertising companies could be slowing down in the second quarter, VCs are likely to continue investing in companies that enable retailers to do business online in a more efficient way.

"The whole ecosystem around e-commerce is maturing," said Joel Cutler, managing director at General Catalyst Partners. "We now look at companies that support that ecosystem."

For instance, The Madrona Venture Group has invested an undisclosed amount of financing at the beginning of January in Mercent Corp., which has developed software that helps retailers sell items on shopping-related Web sites. Alberg said that with Mercent's software, brick-and-mortar stores, which often have their own Web site, have been placing individual products on sites operated by Amazon.com, Yahoo Inc., and America Online Inc.'s AOL inStore to reach new customers, bring additional traffic to their sites and ultimately increase sales.

"This trend has gathered steam," Alberg said. "This is a very important supplement for merchants to sell."

Online retailers are also trying to retain consumers through loyalty programs and recommendation tools. InStorecard Inc., which has received a $4 million Series B round and which is backed by Canaan Partners, Outlook Ventures and Mobius Venture Capital, sells loyalty program software to retailers, whether they are solely based online or they have both a presence online and offline.

"We believe the customer wants a consistent, high-quality experience with their retailer regardless of whether the point of contact is a Web site, an e-mail, a mail order catalog or an in-store visit, or as is increasingly the case a combination of all of the above," said Heidi Roizen, managing director with Mobius Venture Capital. "We think the retailers want this too, in a lightweight, easy to install and manage system."

Mobius is also an investor in AuctionDrop Inc., which provides services helping customers to sell items on eBay Inc. "We think there are still many companies to be built that help transform retailing to meet customer needs," Roizen said. "We continue to seek investment opportunities in that space."

And so does General Catalyst. In the fall of 2004, the firm invested in DemandWare which provides on-demand e-commerce software to smaller companies that can't afford elaborate e-commerce platforms. In the first quarter, it was also the sole investor in a $7 million Series A round raised by ChoiceStream Inc., a developer of software for personalization and recommendation of online consumer services, including e-commerce.

Alberg considers such software as a form of outsourcing for online retailers looking to improve their offering and their sales. They address the "challenge of how to operate efficiently online," he said.

Companies in the space expected to close additional financing include Truition Inc., a Toronto-based provider of hosted e-commerce software focused on eBay, which is planning to cap its Series B round with over C$9 million (about $7.5 million). One of its competitors, ChannelAdvisor Corp., also said it plans to raise $15 million to $20 million in a new round later this year.

"I think there is still a whole lot to do in the space that is yet not done," Roizen of Mobius said.

http://www.mercent.com