When it comes to venture capital for semantic web startups, there’s good news and bad news. Data in April from Dow Jones VentureSource reveals that investment was up nationally for the quarter from a year ago – but the $4.71 billion worth of investments was still one of the lowest totals in nearly a decade, and IT-influenced companies overall continue to represent less and less a share of the pie than in their heyday.

That said, VC-backed sem web startups can pay off big for their investors—witness Apple’s acquisition last week of Siri, rumored to be in the $50 million range. Admittedly, many semantic web startups can’t claim the same heritage Siri did, with its DARPA/ CALO/SRI International roots and its all-star talent team that includes CTO Tom Gruber.

Most companies that leverage semantic web technologies to deliver new solutions and services, and which also are in the process of raising capital, know it’s a difficult world out there. “The VC industry has been changed and is undergoing a lot of changes these days, and of course raising money for any entrepreneur is never an easy task,” says Yaser Bishr, co-founder, executive vp and CTO of smartRealm, an on-demand social business intelligence provider whose technology foundation is in the Semantic Web. VCs always look for strong management teams, customers, and a good product, but those requirements for reducing risk are even more stringent these days, he says. While it’s exploring funding options smartRealm says it’s got customers and revenue and R&D ongoing, and so its plans are not dependent on VCs coming through right now.

VCs acknowledge there are more hurdles to overcome and less money to go around, especially for those very early-on product development cycles. But the smart startups can capitalize on that.

“I’ve noticed on the early stage investment side a lot of smaller rounds,” says Don Butler, general partner at Thomvest Ventures. He notes, however, as a case in point the value of starting small, making strong progress with what you’ve got, and then working up to a bigger follow-on round the company TextDigger, a semantic profiling, text mining and search tools company. TextDigger was heading in this direction even before the downturn, when in 2005 the company initially received $1.5 million led by CNET; in late 2008 it then closed on $4.3 million in a series A-1 round led by True Ventures. “CEO Tim Musgrove’s a sharp guy – they got their initial capitalization, proved value and then went for more traditional funding in a bigger round,” Butler says.

It’s good to be a company seeking Series A funding thanks to the general optimism inspired by early initiatives that sound promising. ALTOS Ventures likes to be in on the ground floor of companies that have bootstrapped to some level of revenue or even profitability and are looking for their first venture partner, says general partner Anthony Lee. “We’re typically Series A investors,” he says. “Series B [investments] are challenging in the sense that Series A investors can invest on the hope and excitement of a great new idea. A late stage investor will invest on growth and tractions and financials. Somewhere in the middle the hope and vision has to translate into growth and financials, but oftentimes when you get to the Series B point you haven’t quite made that leap. It’s that awkward adolescence of still having a great idea but not having quite enough numbers to prove it and needing more money.” (Nova Spivack commented recently on how the difficulties for companies going beyond Series A funding played a role in Twine’s sale to Evri, noted here.)

In the new VC world, it’s about succeeding faster – or failing faster. “Some companies that should have lived might die but some companies that should be dead won’t live, so it works out fine either way,” says Lee. “Darwinism has a way of imposing and generating better companies in the end.” What will happen, he says, is that founders and investors in early stage efforts will try to prove more on less capital, so Series A funding will take companies further along – and if they’re headed to another round it will be one where they can show a lot of proof.

Of course, startups that start to see things aren’t working have a lot less room to adjust under today’s restrictions. With more limited A round investments, it’s over when hard and defined milestones get missed. “It seems like you don’t give the entrepreneur a lot of rope,” says Butler. “It feels like the other part of that is that you are going to do things that are more incremental investments than something more revolutionary.” Thomvest has seen some outfits that want to do some major consumer- facing search engine to compete with Google — but do it better because of semantic technology – and that takes cash, a lot of it, “and that is so difficult to do. Some great companies have tried and failed at that. So that’s almost too much risk for us, and the capital requirements — we run a $150 million fund and you need a deeper set of pockets to execute that.”

Still, both ALTOS and Thomvest say that at their VC firms, it’s more a time to push forward than pull back. “We’re looking five to ten years out, not at what the markets are doing today as much,” says Lee. ALTOS is being pretty aggressive in that direction, but because the investors there tend to be very active with the companies they get involved with the VC firm tends to limit the number of entrepreneurs with which it will partner. Butler says this is a good time for a smaller VC such as Thomvest, which is the active private equity vehicle for Peter J. Thomson (whose family controlled The Thomson Corp. through The Woodbridge Co. for which he is a co-chairman) to become better known. During the downturn, of about 16 portfolio companies one didn’t pan out, which sounds good, Butler says, but actually “probably means we were overly cautious.” When Thomvest’s principal said there were some great companies starting up, and other investors began reaching out to the firm, it was time to up the ante. So last November they raised the fund from $100 to $150 million and have been ramping up investments since.

“After we went through a review of the market as a whole we said this is the time to step up investments rather than clamp down,” says Butler. The focus, however, stays on capital efficient companies keeps opportunities mostly where companies are raising less than $10 million.

How much of a role will companies with a semantic heritage have among investment circles? Butler speculates that the day will come when semantic web technologies will be just like databases, inevitably infusing what the organization does as much as MySQL or Oracle is part of companies’ tech stacks now. “I wonder in the future if a lot of companies out there won’t have a similar semantic layer as part of the presentation layer — semantics built in as some sort of filtering or presentation layer,” he says. And for those where semantic technology girds their market offering and not just their internal workings, one has to remember what Lee reminds us: “I’m sure people have told you this before – some of the best companies, coincidentally or maybe not, are started up during a recession when people have to be smart and more disciplined.”

Next in this series: Advice from the investors for sem web startups.

(Photo: ArghMonkey//Flickr )

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