Start-up companies are in need of many things: usually office space, sometimes a CEO, and always financial backing to get the company off the ground. This funding often comes in the form of financing from a venture capital firm which is eager to invest in what promises to be the latest and greatest in the Internet community. But why do these VCs choose to stake their claim in VRML? Or, often, why not?

As we know, VRML is booming. From Silicon Valley to Europe to the deep south, companies offering 3-D content and tools are receiving attention and praise. And the venture capitalists are footing the bill. New companies needing VC money are sprouting up at an incredible rate, each promising to change the (inter)face of online communication.

According to Technologic Partners, as of the past year ending with June 30, 1996, 234 deals were completed which granted financing totaling $891 million to Internet-based companies, with $315 million going toward software. More than half of the overall sum went to seed and early stage deals to launch entries into the Internet arena. So why is VRML such a dangerous next step?

It would seem like investing in VRML would be the next logical investment choice in a series in Internet holdings, yet still many VCs are skeptical. The Internet, at one time considered overwhelming and outlandish, has been embraced by the VC community over the past couple of years. So why is VRML such a dangerous next step?

With the emergence of better, smarter, faster technologies each passing day, choosing to invest in one company or technology over another is becoming an increasingly difficult challenge. The competition is fierce in the overall Internet arena and even more intense within the tight 3-D community. Proving to the venture capital community that VRML technology will permanently change the Internet, a challenging task on its own, is only part of the process. There are factors which must be in place for a start-up company to be attractive to investors. A strong management team, a savvy business plan and a marketable technology are all crucial check-list items investors look for in a new venture. Individually, however, these items are immaterial. It is when they are added together that they form a potentially profitable business. And it always comes down to money.

In the minds of VRML developers and users, 3-D on the Internet had officially arrived with the ratification of VRML 2.0 at SIGGRAPH `96. But the rest of the world is still unconvinced, so anyone involved in the VRML effort must continue to be an evangelist. The energies of most members the VRML community are divided between promoting three concepts: 3-D, VRML and one's own projects. Therefore a success can take many different forms: A partnership with an industry leader, a positive run of press, a flagship product launch. Each of these day-to-day successes is also a benchmark for the investment firm (and its funding). Although the venture capitalists usually do not want to run, nor try to run the companies they fund, they do support and oversee the operation from a slight, but curious distance. In most cases, the connection between VRML companies and their venture capital funding is made through personal networking

In most cases, the connection between VRML companies and their venture capital funding is made through personal networking, allowing these executives to at least somewhat bypass the dreaded, traditional funding scramble companies do to get recognized and get money. Many high-tech executives are moving from traditional positions at large corporate mainstays to hot, new start-ups, taking with them their Rolodexes filled with years of business contacts - some in the financial community. An old associate in a new environment developing an exciting technology often provides the perfect (and simplest) investment formula to satisfy both the start-up's needs and the investor's portfolio.

When a venture capital firm invests in a company, they provide strategic counsel, advice, and business connections that a young company needs to succeed in this competitive market. Companies operating from within the same investment portfolio are given an inside means of introducing its management teams which can foster partnerships or collaboration. As the major investor for OnLive! Technologies, Softbank has opened doors for OnLive!'s executive team to trade ideas with its impressive list of investments. Betsy Pace, CEO of OnLive! Technologies reports that the company has developed a partnership to produce products with ZDTV, a division of Ziff-Davis, also funded by SoftBank.

Black Sun Interactive has followed down a similar path in its relationship with the popular homesteading Web site GeoCities. Both Black Sun and GeoCities are funded by CMG@Ventures based in Wilmington, Massachusetts. This past August, the companies announced their co-launch of GeoWorld, a 3-D multi-user environment created for the more than 100,000 GeoCitizens who post their home pages in GeoCities- themed neighborhoods. GeoWorld provides users with the opportunity to interact and exchange information with their neighbors, enhancing the site's overall sense of community.

In this industry where a month in a calendar year is equivalent to about six months in "Internet time," the ability of a company to adapt to the rapidly changing Internet landscape is crucial to investors considering its staying power. This is especially true in the case of VRML, which is still in the early development stages. According to Don Gooding, Research Director at Accel Partners, "The VRML market is still in its infancy, but the companies best positioned are those which focus on near term markets where current computing and communications limits don't apply, with a technology that can grow in use when the market grows."

To commit funds to VRML, venture capitalists need to believe in its mass market potential. One factor which could prohibit its widespread use is bandwidth. Investors need to be shown that VRML worlds can be built and accessed by consumers who probably aren't running ISDN lines into their suburban homes or rent-controlled apartments. Tiernan Ray, Staff Editor of Computer Letter and frequent contributor to Venture Finance says, "Investors will be looking to fund companies dedicated to putting an infrastructure in place. Up until now, firms have been investing in tools companies, but that soon will be giving way to protocol and applications as the audience, particularly in the corporate sector, for VRML grows."

Another emerging obstacle investors see to consumer adoption of 3-D spaces is that of modem delay. The latencies existing during communication over most users' systems can cause a major barrier to providing a rich interactive experience. Even the smallest time delay between the end of one person's sentence and the other personÆs response detracts from the level of immersion of the technology.

For Matt Burgess of Volpe Welty Asset Management in Alameda, California, researching this issue has been at the focus of his investigation of the investment potential of 3-D on the Internet. Burgess believes the most important element to any type of interaction is that it is synchronous. His studies show that households spend nearly the same amount of money per month for synchronous interaction (telephone communication) as they do for both information (books, magazines, TV, online services) and entertainment (games, movies, music) combined.

Says Burgess, "For individuals to create, maintain, and develop meaningful non-geographically constrained communities, there must be a synchronous element of interaction. At present, the leading method (by a long shot) of technology-enabled synchronous interaction is the telephone. When 3D multi-user environments offer the same level of synchronicity as the telephone, the market for this technology will be immense. In this context, I don’t see this investment arena as a "new industry." Instead, it is a new entrant in the synchronous interaction industry, which happens to be thoroughly dominated by the telephone."

Those venture capitalists who have financed VRML-based companies are quick to support 3-D as a breakthrough consumer technology. Mike Santer, General Partner of Platinum Venture Capital of Oakbrook Terrace, Illinois which funds the tools company VREAM, believes that, within the VC community, the many unknowns surrounding VRML and other VR technologies have in the past prevented conservative investment firms from getting involved. The inability to forecast the future of 3-D has definitely been a stumbling block for some investors, but with the recent surge of 3-D hardware, the investment community has begun to realize VRML and 3-D are not just passing fads.

"Until recently, 3-D was seen as a fringe technology because it was very difficult for people to understand where 3-D on the Internet is going to end up in a few years," says Santer. "Now, as the price performance of computers increases and 9 out of 10 computers now shipped will be 3-D enabled, the market for applications broadens and the future of 3-D becomes clearly positive."

Traditional firms seem to be catching on as well. Virtus, another VRML tools company is funded by TL Ventures out of Wayne, Pennsylvania which saw the potential of 3-D early on. TL Ventures is associated with Safeguard Scientifics, Inc., one of the country's oldest and largest venture firms which has launched several successful companies including Novell.

Obviously the VRML industry still has much ground to cover and many worlds to build and then populate, but the money is there to support the cause. And while those people working with VRML regularly have already embraced its potential to change the Internet and its use, it appears that the venture capitalists are beginning to realize that not so long from now, they too will find themselves at a portfolio company's board meeting, but as avatars.