Net giants in search of startups step on VC toes

SAN JOSE, Calif. — Yahoo! and Google, with loads of cash on hand and in constant competition for the latest Internet breakthroughs, are finding themselves brushing up against the interests of venture capitalists more and more.

The companies are eager to scoop up small, fast-moving companies that promise to boost their menu of Internet offerings.

But that can mean stepping on the toes of VCs who want to invest or already have invested in a private company.

For example, after Google introduced Gmail in May of last year, Yahoo! snapped up San Francisco e-mail startup Oddpost just two months later to spruce up its own Yahoo! Mail.

Oddpost helps people organize or delete messages by dragging them into folders instead of having to reload a Web page each time, which made it quicker to use than Yahoo!'s e-mail at the time.

But the acquisition came as a surprise to Oddpost — and to some of its investors.

Just three months before Oddpost was acquired by Yahoo!, venture capitalist Tony Conrad had made an investment in the company and planned to build up an independent company with Oddpost's management team.

"You're not thinking about selling," Conrad recalls his thinking at the time.

But after being approached by a big Internet company — not Yahoo! — Oddpost rethought its plan: seriously consider a sale and approach others who might be interested.

Oddpost approached Yahoo! for a counteroffer and accepted it.

Why go the acquisition route?

Big Internet companies like Yahoo!, Google and America Online offer small companies a huge distribution platform. A sale to a big company might mean less of a chance for a home-run return, compared to the jackpot IPO riches of the late 1990s, for instance. But a sale still makes a safe, solid return. In some ways, it parallels the aggressive acquisition spree by networking companies Cisco, Nortel and Lucent in 1999 and 2000 — except the amounts were much larger.

Now, a year after Oddpost's sale, Conrad is back in the game with San Francisco blog search engine Sphere.

He said a "bunch" of VCs are calling him, to see if Sphere will take a round of capital. But at the same time, a better option might be a sale to a big player that can offer immediate exposure.

And that is pitting big companies against the VCs.

"That's where the conflict is happening. It happens by the nature of the market," Conrad says.

The tension between big companies and VCs emerged again recently during a technology panel discussion in London. Simon Levene, managing director of corporate development at Yahoo!, told VCs: "Folks like Yahoo! will be competing with you for deals."

Later, Levene told search-engine expert John Battelle that Google had set up a fund to compete with VCs for early-stage company financing. Google denies it has created such a fund.

Others say Google and Yahoo! aren't specifically aiming to compete against VCs, merely that run-ins are normal because of how fast and cheaply Internet companies can launch these days.

The buzz circling Silicon Valley was that Google had swooped in to buy Redwood City startup Riya, which makes a facial-recognition technology for photos. The company has so far had only 25 testers of its product, which would make a sale to Google extremely quick.

However, both Google and Riya have not commented, while Riya said on its company blog two weeks ago that it was still entertaining options for raising more venture capital.

Matt Marshall is a columnist at the San Jose Mercury News.