Web 2.0 exits smaller, more frequent

When investors began funding Web 2.0 startups a few years ago, the expectation was that the hot, young companies would swiftly find their way to a deep-pocketed acquirer or a welcoming public market.

Instead, amid continuing weakness on the IPO and M&A fronts, many Web 2.0 companies and their backers are opting for a more realistic survival strategy—linking up with other startups. While many investors remain optimistic that large M&A deals—particularly by large media buyers—are poised to pick up, recent transactions have primarily been small-scale. In addition, acquisition targets have tended to be bootstrapped, angel, or Series A stage startups.

“These are companies that have more to show on less capital. And companies like that are in a better position to make an acquisition or be acquired,” says Craig Jacoby, a partner at Cooley Godward Kronish and an advisor on several venture-backed acquisitions, including April’s purchase by social media ad network BuzzLogic of Activeweave, which makes a browser plug-in to track blog content.

Since the spring, a broad cross-section of venture- and angel-backed Web companies have been acquired by other Internet startups. Jacoby says he expects the pace to pick up some over the next few months as fast-growing startups become more adept at using their stock to fund purchases of smaller rivals.

It’s happening already. In the last couple of weeks, privately held digital media companies have announced a spate of both cash and stock acquisitions aimed at bolstering market penetration.

Last week, Seattle-based mobile game publishers Reaxion and Mobliss announced that they are merging to form a new company, which will operate as PressOK Entertainment. Investors attributed the move to industry pressure to scale up.

“As the mobile entertainment market matures and consolidates, only the largest and most innovative companies will thrive,” says Brad Farkas, general partner of i-Hatch Ventures, which funded a $2 million early stage round for Reaxion. (Mobliss is known for branded games such as Deal or No Deal, Family Feud and The Price is Right. Reaxion titles include Gin Rummy and Mahjong Deluxe.)

Also this month, iSkoot, a provider of mobile VoIP services, acquired Social.im, a social network IM client, for an undisclosed sum. San Francisco-based iSkoot has raised about $15 million in VC funding from Charles River Ventures, Khosla Ventures and ZG Ventures. Social.im had raised an undisclosed amount of funding from Felicis Ventures and individual investors.

In late August, Aptana, a producer of Web development software, acquired Pydev, a development environment for the Python software language. Aptana raised $4 million in October from Accel Partners.

Meanwhile, consolidation plays in the Web 2.0 space are also gaining traction. Jeffrey Dachis, the former CEO of digital ad agency Razorfish, raised $50 million from Austin Ventures this spring to lead a social networking software company for corporations.

In Los Angeles, LiveUniverse, a network of entertainment sites led by MySpace co-founder Brad Greenspan, has made multiple acquisitions in the past year. Purchases include Jangl, an application for exchanging phone calls and text messages without revealing phone numbers; Pageflakes, a site for building personal home pages; and Revver, a site for posting videos.

While deal sizes have in most cases not been disclosed, those familiar with the transactions say purchase prices for most Web deals done can go down to low six figures and rarely exceed the low eight figures. For the most part, neither the companies being acquired, nor those doing the buying, have had a high cash burn rate.

Sharon Wienbar, managing director at Scale Venture Partners, says she expects to see more M&A transactions involving Web 2.0 companies in the near future, especially those with social networking expertise or tools. She says buyers will probably mostly be mainstream media companies, such as Hearst Corp., that are looking to expand their online presence. Last month, Hearst agreed to buy Kaboodle for an undisclosed amount. Kaboodle, which operates an online community for users to share information about shopping and travel, raised about $9 million from Garage Technology Ventures and others. (Scale is not an investor in Kaboodle.)

USA!! Alastair Goldfisher contributed to this report.