In Depth

Panic, Pause, Invest: VCs Bet on Web Video

Backers Find New Faith After Market Dive

Memo from venture capitalists to online video entrepreneurs: Contrary to early indications, the spigot has not been turned off for 2009.

Despite the credit crisis and the contracting economy, investment firms that fund digital media still have cash to dole out. In the past month alone, venture capitalists at 406 Ventures, Flybridge Capital, Spark Capital, Union Square Ventures, Evergreen Ventures and others have funneled money into new-media properties, and they plan to keep doing so in the year ahead.
While the prospect for quick-turnaround company sales (and fat exits for founders) in 2009 has dimmed, the spending outlook for the next year is promising for online and mobile video startups that can deliver targeted advertising, analytics and money-making vehicles for big media.

But here’s the rub: Investors intend to scrutinize business plans more closely. They want proof that a business can generate revenue, and they expect their portfolio companies to deliver timetables for profitability.

2009 could be a challenging but also a “potentially explosive year,” said Ross Levinsohn, former president of Fox Interactive Media turned partner with new-media investor Velocity Interactive.

“It is in these types of markets where fortunes are made if you are bold,” said Mr. Levinsohn, whose firm is invested in online video shops Next New Networks and Generate.

When the credit crunch first shook Wall Street, most venture capital firms ground to a halt in October, holding off on funding as they assessed the situation. Some were outspoken in saying that the coffers would stay locked up in 2009, too. Though the markets are still bearish, some of that panic has dissipated.

Venture investors who have run through their existing funds have no choice but to sit on the sidelines during the coming lean times, because they aren’t likely to raise more money right now. However, firms that have just begun to tap into their funds appear well-positioned because prices are good in this environment.

“We are only one-third of the way through our fund,” said Maria Cirino, a managing director at 406 Ventures, who is tapping into a $170 million kitty and recently led a $12 million round in Digitalsmiths, which powers online video and search for big media firms. “We are sitting on a lot of dry powder, and during a time when a lot of funds have shut their doors and hunkered down, now is the time to do some great deals against very differentiated technologies solving big problems at an attractive valuation.”

The venture capital world also is somewhat removed from the day-to-day whipsawing of the market because it has a much longer cycle than the rest of the economy, said Erez Shachar, general partner at Evergreen Venture Partners, which led a $4.5 million round last month in Taboola, a video recommendation firm.

“When we invest, we expect it to mature and be ready for an IPO or acquisition seven or eight years down the road,” he said.

Early-stage startups are especially insulated during tough times because they will spend the next few years on research and development, rather than sales.

Another benefit that comes in a downturn is access to great talent, Mr. Shachar said.

“A lot of the people who would have went to investment banks or people from Harvard Business School or Stanford Business School will look at entrepreneurial ventures now,” he said.

However, the bar is higher in harder times. Venture capitalists normally will take bigger gambles on companies that might not yet have clear business models. That won’t happen in the months ahead.

In being more selective, Mr. Shachar and other venture capitalists say they are keen on firms that actually make money from online video.

“The big challenge in online video is bridging the gap between the fact it is one of the most viewed mediums worldwide and is still getting a minuscule portion of ad dollars, so monetization plays in video will be the most interesting companies,” he said.

That’s why, Ms. Cirino said, 406 Ventures funded Digitalsmiths. The startup helps media companies make money from their existing video content on the Web.

“That is a good bet in a down economy because it will help [media companies] make and save money,” she said. “Show me how to save money or make money and I will spend money on that.”

Digital media is one of the few funding categories that will see growth in 2009, especially startups that do search marketing, affiliate marketing and word-of-mouth marketing, said Jeffrey J. Bussgang, general partner with Flybridge Capital Partners, which invested $8.25 million in mobile video technology firm Transpera in November.

Venture capitalists are risk-takers by nature and a down market can be a good time to buy, said Fred Wilson, managing member for Union Square Ventures. Along with Spark Capital, Union Square contributed to a $4 million financing round last month for Boxee, a software that delivers many Web video sites and services directly to the television set.

“We are also a bit contrarian and like to buy when others are not buying,” Mr. Wilson said.