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When raising a $10 million series B round, online local advertising pioneer MerchantCircle stuck with its faithful early-stage investors, while adding a pair of key strategic partners.

Two years ago, Los Altos, Calif.-based MerchantCircle landed an initial $4.1 million series A round from Rustic Canyon Partners of Santa Monica, Calif., and Scale Venture Partners of Foster City, Calif. and Steamboat Ventures, the corporate venture affiliate Walt Disney Co. of Burbank, Calif., based largely on founder and chairman Ben Smith's credibility with previous technology ventures including early social media startup Spoke Software Inc. of San Mateo, Calif. (Rustic Canyon Group is an investor in The Deal LLC).

Smith would not disclose a valuation for the new round, but said it came at an increase to the 2005 series A round.

While sticking with its prior venture investors and reducing dilution, MerchantCircle brought in strategic investors Square One Bank of East Palo Alto, Calif., and IAC/InterActive Corp of New York. The startup expects the strategic investors to provide important financing and deal flow assistance in pursuing a growth strategy that may include acquisitions. Square One is a venture debt and equity provider, and IAC/InterActive is Barry Diller's media company, which recently announced a restructuring.

"We had a couple of quick conversations with other potential investors, but we had done kind of a weird thing at the beginning in bringing in three firms in the Series A, and we didn't really see any value in adding more venture investors," Smith said. "We had previous relationships with Square One and wanted access to leverage as we grow, and IAC approached us and we were excited about working with them because of their experience in media acquisitions."

Smith said the company expects to seek acquisitions in the fragmented market of local online advertising market, as the sector continues to grab market share from traditional local small business advertising outlets such as yellow pages, newspapers and radio. Investors said the new investment is an endorsement of the company's success in defining the sector.

"We are typically a mid-stage investor, but we looked at 10-15 companies in the local advertising area and most were trying to partner with yellow page publishers or other existing companies or were consumer-facing," said Sharon Wienbar, a Scale managing director. "But MerchantCircle had a completely different strategy by focusing on merchants and taking the cost of selling out through automation, and it wasn't going to take a lot of money to find out if it worked."

Smith said the company launched a beta site within weeks of its Series A round in March 2005 and began testing features to attract local merchants with online tools and social networking opportunities. The company launched a commercial site in June 2006. MerchantCircle has about 250,000 small business members, from which the company derives revenue based on its own display advertising, though Smith would not disclose how many of those buy advertising from the company.

MerchantCircle is addressing the roughly $25 billion market for local advertising, about half of which goes to yellow page publishers. Unlike yellow page and local newspaper publishers, which spend an enormous amount on direct sales calls, MerchantCircle set out to build a network of merchants by providing content and features, then automating sales to them using a viral marketing system.

"From Day 1 we looked at the history of online advertising and what held back local advertisers, and we bet that the ad networks would be there, and the people would be there," Smith said. "The question was how do you get Mom and Pop businesses to move there in a cost-effective way."

Smith said MerchantCircle did not require additional working capital, but said the company expects to focus on acquisitions for content and features that will help the company to continue to build its network primarily with viral marketing.

"We are looking to buy anything that can help merchants get to local customers," Smith said.

MerchantCircle used no outside financial adviser for the new round, and had legal work on the deal from Anthony McCusker of Gunderson Dettmer Stough Villeneuve Franklin & Hachigian LLP in Menlo Park, Calif.

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