What Do Venture Capitalists Look for When Investing in Online Video?

/ Sep 9, 2013

moneymoneymoney

For an industry consistently plagued by questions about how it will turn a profit, online video hasn’t had a lot of trouble convincing others to give it money. From YouTube-based multi-channel networks to tech startups with the next great platform play, major media companies and investment firms have poured money into the industry over the past couple of years. Notably, there was Time Warner Investments leading a $36 million round in Maker Studios last December, which followed a $35 million investment Google, Redpoint Ventures, and MK Capital made in fellow MCN Machinima earlier that spring. This year, Fullscreen raised a reported $30 million Series A round from The Chernin Group, Comcast Ventures, and WPP Digital and VEVO received an investment from Google/YouTube in the $40-50 million range. And in May, the industry witnessed its biggest acquisition to date with DreamWorks Animation agreeing to purchase AwesomenessTV in a deal that could be worth over $100 million.

These deals are the most high-profile because of the companies and the amount of money involved. But if you peer deeper into the industry, you’ll also see startups such as Big Frame, Tubular, ZEFR, Tastemade, and Base79 having received money from the likes of FirstMark Capital, Lerer Ventures, Launchpad LA, Bedrocket Media, First Round Capital, and Machinima CEO Allen DeBevoise*, among others.

Generally, online video startups face the same questions as any other type of startup when looking to raise capital. In most cases, they can be broken down into the following framework: Why have you chosen to work in this space, why is your idea worth an investment, and why your team?

It’s that last question which typically becomes a big deal for early-stage startups. “Assume 12 people are also pursuing your idea,” says Rob Gabel, founder and CEO of Tubular Labs, a provider of an enterprise-level marketing and analytics platform for YouTube that has received capital from the likes of FirstMark Capital and Lerer Ventures. “So it comes down to the team — who is on it and do they have the right background?”

“One of the things that I continue to hear is that people invest in people,” says Damon Berger, co-founder and CEO of What’s Trending, a show that covers and curates the trending videos on YouTube. What’s Trending recently raised funds from Bedrocket Media Ventures. “Venture capitalists invest in the strength of the entrepreneurs in terms of their track record or the kind of character they exhibit. The investment is really in the entrepreneur as much as it is any prototype or product they have.”

This shouldn’t come as a surprise to anyone, and feels like the obvious answer when asking VCs what they look for when considering an investment. In fact, Adam Lilling, founder and managing partner at Plus Capital and co-founder of Launchpad LA, and Joy Marcus, managing director at Gotham Ventures, both corroborated as much when I asked them that very same question.

So let’s say the startup has the right team with the right experience and know-how in place, then what? Then it becomes a question of the idea at the center of the startup and the opportunity for that idea to be successful. For VCs, it becomes a question of scale.

It’s here where things get interesting for online video startups, which more often than not fall under two categories: a company with a focus on producing and aggregating content, or a company with technology as its core offering.

“VCs prefer to invest in companies that have dependable programmatic scale,” says Adam Lilling. This can be troublesome for a startup that focuses on producing, distributing, and aggregating content. Because as Lilling, Marcus, and Berger describe it, content is a “hits-driven” business, which doesn’t align that well with the traditional VC model. “I think [hits-driven businesses are] troublesome for the traditional VC model, which is to invest in 10 companies, four of which will fair, another four of which will be considered median successes, and two of which would be considered true successes,” says Marcus.

“The VC game has historically been driven by seeing giant returns — 50 or 100 times their initial investments,” adds Gabel. “Institutional VCs are looking for startups that can quickly become billion dollar companies.” This is easier to do with a tech-based startup than a content-based startup. “The cost of copying the software for another person to use is almost nothing,” adds Gabel. “You can literally sell the same software to 100 times more people, with relatively little cost. With media companies, to scale revenue 100-fold, it would require having 100 additional productions with 100 additional camera crews,” and so on and so forth.

Yes, it’s possible to “blow out” really successful IP, according to both Gabel and Berger. But those are relatively few and far in between. Not everything is Star Wars, or Harry Potter, or Toy Story.

This doesn’t mean VCs won’t ever invest in video/media-based startups, it’s simply that they are less likely to get involved during the early stages of the startup cycle. “I think at the end of the day, if you get far enough along, once a startup has proven that its revenue is scaling, then all bets are off and any VC could like in,” says Gabel.

So what about content-based businesses, how can they play the VC game (so to speak) if they have already started out on the wrong foot when compared to their tech brethren?

Lilling suggests focusing on scale, but not via a proprietary technology platform, but by aggregating an audience. “I invest in content plays that are not just about creating content but also building communities around that content,” says Lilling. “There are very few VCs investing in content, but those that do invest in startups that focus on building audiences as well as a platform to take them to.”

“In an ad-supported business, you need scale before you can get to monetization. Advertisers won’t care if you don’t have a big audience,” Lilling continues. He points to cable networks as an example — cable networks started out by licensing and syndicating shows and movies before eventually taking the step to original programming. This process took some time, which Lilling reminds is important within the context of web video, an industry still in its early stages.

Joy Marcus backs up Lilling’s thoughts on building an audience. Back when she was general manager of North America for Dailymotion, she led a team consistently working on building a quality video streaming platform and an audience around that platform. She says it paved the way for the company to eventually be fully acquired by Orange for roughly $168 million.

Even if it’s not VC-led funding, content-based video startups still have options.

“I think we are in a position where in the next five years we are going to see a lot of traditional media companies acquiring new media companies,” says Berger. He sees these online video companies becoming “innovation centers” for the larger traditional companies, which are generally lacking in the digital video department. “[Traditional media companies] know they are going to have to spend in this area in bigger ways,” says Berger. It would make sense to grab those already successfully reaching audiences (especially the coveted younger demographics) online. We are already witnessing the beginning of this trend, adds Berger, with DreamWorks’ purchase of AwesomenessTV and Time Warner and Comcast’s investments in Maker and Fullscreen, respectively.

In addition, it’s not really required that video startups silo themselves into being a content or tech company — with digital, it’s very much possible to do both.

“The intersection of tech and entertainment, that’s an interesting place to be,” says Berger. “To me, the first LA entrepreneurs were film producers, who had to go out and raise money for an idea. If you look at LA as a potential hub for VC acivity, it’s a really interesting spot for that intersection. LA has a lot of money and likes to spend it.”

Though Rob Gabel adds: “The question becomes, if you’re doing both, what happens when great people do one or the other?”

This question and other topics relevant to VCs and startups in online video will be covered throughout this week in VideoInk’s week-long special issue covering investor-land. Come back tomorrow and the next day and the next to check out profiles of prominent investors and firms in our industry (as recommended by our readers).

* Full disclosure: Machinima CEO Allen DeBevoise, who is known for investing in a lot of online video startups, is also an investor in VideoInk.

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