Prime time

You won’t hear venture capitalists complain that there’s nothing good on TV.

While they’re probably not spending their time watching “Big Brother 9” or “America’s Next Top Model,” VCs are taking a close look at the viewing habits of the average American—and they like what they see.

“We are at the beginning of a fundamental shift where broadcast content is moving from the television screen to the Web, and both the eyeballs and dollars are starting to follow,” says Todd Dagres, a general partner at Spark Capital, a venture firm focused on the confluence of media, entertainment and technology.

He and many other VCs believe the current TV market, along with the approximately $80 billion it generates each year from advertising, is ripe for disruption. Until now, these riches were hoarded by a select group of cable companies, television networks and content producers. But nimble startups now have a rare opportunity to capitalize on the changing market dynamics and grab a greater slice of the pie.

That’s why VCs are furiously pouring money into the sector. In the first four months of this year alone, VCs invested more than $120 million in more than 20 TV-related companies (see table). They are investing in everything from IPTV infrastructure companies that deliver high-definition digital television services over broadband to production companies that are developing Internet-specific TV content to online destinations where viewers can watch and talk about their favorite programs.

The big challenge, of course, is making the right bets, especially since so many TV-related startups are being formed and funded. “The market opportunity is unbounded, which is why you’re seeing so many companies out there,” says Art Marks, general partner at Valhalla Partners. “The ultimate direction is obvious, but how we get there is anyone’s guess.”

Online video is rapidly moving mainstream. IPTV will transform how we experience digital media for years to come.”

Art Marks

Fortune-teller

Marks says he knows what the future will look like. Ten years from now, consumers will be able to use any computer platform—whether it’s a laptop or mobile handset—to watch any video content they want at any time without having to pay an extra penny out of their pockets. What’s not so clear, however, are the business models and technologies that will support this seeming inevitability.

For instance, what will the content itself look like? Will it be exactly the same as the TV experience or will the content be more interactive and tailored to an online audience? What about advertising? Will commercials be embedded in the content and played throughout? Or will it be a different paradigm, one where viewers will be able to click on an actress’s dress and to see who makes it and where they can buy it?

Even though the picture remains fuzzy, Valhalla Partners is seeing four to eight new deals come through the door each week. The firm has placed three big TV-related bets in the last several months and is continuing to identify and invest in additional opportunities in the IPTV sector.

Already, Valhalla has taken a lead-investor role in the early round funding events of Avail Media, KZO Innovations and TidalTV. “Whether you want to call it evolution or revolution, online video is rapidly moving mainstream,” says Marks. “IPTV will transform how we experience digital media for years to come.”

But will the charge be led by startups or the entrenched cable companies and broadcast networks that have the most to lose? Success clearly hinges on the ability of both of those groups to work hand in hand with each other rather than as direct competitors, say industry watchers.

With new companies and bigger players coming into the market, we thought it was good time to partner with a large entrant that could take the MeeVee technology and community to the next level.”

Larry Kubal

Burning issue

VCs also have to worry about backing startups that may require more capital than they bargained for. “I’ve seen some deals where the business model is to pay the carriers a lot of money to cooperate, and then acquire customers by putting up a really cool website that costs even more,” says Marks. “Here’s the real question: How do you build a business where you can prove value in steps with a modest amount of capital, and then branch out from there in the most cost-efficient manner?”

One way, says Spark’s Dagres, is to avoid investing in the “hits” business, such as a typical production company. These companies spend a lot of money developing a TV series on spec and then pray the show is a hit so the networks will pay for more episodes.

Dagres says he wanted to invest in the space, but without taking such a huge risk. That’s why he recently led a $5 million round in an online production studio called EQAL, the creative force behind the “lonelygirl15” phenomenon on YouTube. “EQAL can keep costs down by leveraging corporate sponsors that help pay for the production and by testing shows early with Web audiences,” says Dagres, whose firm has also invested in Veoh, an Internet TV broadcast network, and Next New Networks, a media company that is creating micro television networks over the Internet for targeted communities. “You may not always have a hit, but you won’t have a bomb either.”

What’s more, EQAL is developing TV-like content expressly for a Web audience. The shows are “interactive” in that they invite the audience to actively engage in the production through social networking and community features.

Tougher than it looks

The day consumers realize they can watch any TV content at anytime on any device without having to pay anything extra, that’s the day this opportunity really becomes huge.”

Robin Axon

Another huge challenge in this market, says Larry Kubal, a managing director at Labrador Ventures, is investing in differentiated companies with sustainable competitive barriers. “If you are providing access to free content that’s already out there in other forms, what value do you add?” he asks. “You don’t want to be a non-value add middle man.”

Kubal believes VCs must find businesses that add value either through organizing and delivering content or through underlying technology that cannot be easily duplicated.

Labrador portfolio company MeeVee, which brings together traditional TV listings and online video from hundreds of sources, certainly has this kind of technological advantage, but even that’s not enough to guarantee success. After raising $27 million from Labrador, the Bay Area Equity Fund, Walden Venture Capital and others between 2004 and 2007, MeeVee is actively seeking a strategic acquirer.

Kubal says the company got a little ahead of itself with what it wanted to accomplish. It also faces increasing competition not only from well-funded startups such as Joost, a next-generation Internet TV network, but also from entrenched players such as News Corp. and NBC Universal, which joined forces to create online video service Hulu.

“When we looked at MeeVee, we said we could fight this fight for a few more years,” reasons Kubal. “But with new companies and bigger players coming into the market, we thought it was good time to partner with a large entrant that could take the MeeVee technology and community to the next level.”

At least one MeeVee competitor is happy to go it alone, at least for now. BuddyTV, which provides articles, news and interviews on a broad range of television content to about 4 million unique visitors each month, recently raised $6 million from Madrona Venture Group. “We became very excited about the growth of BuddyTV,” says Geoff Entress, a venture partner at Madrona. “We believe they can be a dominant force as the largest social network for TV.”

These deals are not for the faint of heart. You have to have a good sense for the entertainment side of the equation as well as the technology side. Most people don’t have that, and they will get hurt.”

Todd Dagres

Buddy system

BuddyTV plans to start offering TV shows and other video content on its site in the near future. “Right now, people come to the site to talk about their favorite shows,” Entress says. “But if they come to us to watch the shows and chat about them, that would be a richer experience.”

And the more users who come, the more valuable the site becomes. Though rumors were flying recently that Comcast was set to acquire BuddyTV, nothing had happened as of VCJ’s press time on May 15. Entress doesn’t deny that BuddyTV might make a very attractive acquisition target one day. “I think the exit long term is acquisition by a large media company,” he says, “but we invested because we see opportunity for growth and believe it can become a very interesting standalone business.”

While most companies in the space are focused on bringing TV to desktops and laptops, some are reaching farther afield by targeting mobile handsets. For example, QuickPlay Media, a Toronto-based developer of wireless television platforms, recently completed a $15 million financing round led by Ventures West. QuickPlay can stream TV content to mobile devices such as the Blackberry so there are no long download waits to view the content and no additional storage is required.

The iPhone is another platform that could provide a big opportunity for TV-related startups. Apple has sold about 4 million of the phones and hopes to sell 10 million this year. With its big display and a rumored 3G version coming next year, the iPhone could pair nicely with mobile TV services, such as VC-backed MobiTV, which lets people watch 35 TV channels on their cell phones for about $10 a month.

Robin Axon, a partner at Ventures West, admits that the mobile video market is still in its infancy, but he says it’s only a matter of time before the technology is embraced by viewers. “The day consumers realize they can watch any TV content at anytime on any device without having to pay anything extra, that’s the day this opportunity really becomes huge,” he argues.

The upside of these investments is undeniable. That’s probably why so many startups and VCs are jumping into the sector. But for every success story, there’s sure to be a dozen failures. “These deals are not for the faint of heart,” says Dagres. “You have to have a good sense for the entertainment side of the equation as well as the technology side. Most people don’t have that, and they will get hurt.”