Venture money going to companies taking on Web advertising
A new crop of Internet start-ups seeded with venture capital is taking root in fields ranging from video and gaming to social networking and digital media. But the proliferation of so-called Web 2.0 companies - nearly all with business models built around advertising - has raised questions about how many can succeed.
Nationwide, investments in Internet companies have exceeded $1 billion in six of the past seven quarters, hitting $1.3 billion in the three months ended March 31, according to the new MoneyTree report prepared by accounting firm PricewaterhouseCooper, research firm Thomson Reuters, and the National Venture Capital Association.
That's more committed cash than in any period since the ill-fated dot-com boom of the late 1990s. The number of financing deals for Internet start-ups, meanwhile, has climbed to about 200 per quarter.
"With the huge flow of money into that sector, we're absolutely going to see a shakeout in the next 12 to 24 months," predicted Michael Hirshland, general partner at Polaris Venture Partners in Waltham. "But we're not going to see a collapse of the entire sector."
"The risk in Web 2.0 is speed to market," warned Jonathan Karis, partner and group leader of the emerging companies practice at the Boston law firm Nixon Peabody LLP. "Because the industry changes so fast, what's hot today is not going to be hot tomorrow. So unless you can get your idea out there quickly, you're going to miss the window."
Web 2.0 companies, in contrast to the first generation of Internet companies, seek to capitalize on advanced technologies, an explosion of interactive behavior online, and a greater broadband penetration in households and businesses.
They especially seek to take advantage of a global Internet advertising market that is projected to grow from $45 billion this year to $147 billion in 2012, according to the Kelsey Group research firm in Princeton, N.J.
But even the best-known and most heavily trafficked Web 2.0 brands, such as YouTube, Facebook, and MySpace, have yet to solve the puzzle of how to make their websites profitable advertising vehicles.
And some recent events - notably Microsoft Corp.'s bid to buy Yahoo Inc. in an effort to challenge Google Inc. and a reported slowing in the US growth rate for search advertising - have underscored how challenging it can be.
"There will definitely be winners and losers when it comes to who will be able to succeed with the advertising model," said Will Richmond, broadband media analyst at VideoNuze, an Internet video industry website based in Newton. "And the characteristics of the winners will be scale, targeting, and sales skill and competency."
Almost everyone who has invested in Internet start-ups is taking stock of the market realities, though many remain optimistic.
"People who have high-quality inventory or can target very specific demographics will find a way to monetize their sites," contended Neil Sequeira, partner at General Catalyst Partners in Cambridge. "If you can target a group, that's much more valuable to advertisers."
One emerging niche that could prove as profitable as Internet content providers is a new breed of analytics and data collection start-ups that help Web 2.0 companies target customers, track online habits, and sell that information to advertisers.
Testing companies like Kaplan and Princeton Review, for example, would be interested in advertising on sites geared to college students looking into master's programs.
General Catalyst has bankrolled two such Boston companies: Visible Measures, which tracks viewers' video interactions, and ScanScout, which helps publishers home in on advertising opportunities.
But formidable hurdles still face companies in Internet video, a field rich in promise, illustrating why questions are suddenly dogging the Web 2.0 sector overall.
Some companies have achieved scale in their audience, but continue to struggle to attract advertisers, experimenting with formats such as pre-rolls, mid-rolls, post-rolls, overlays, display ads, and keyword ads. Even under the corporate umbrella of Google - its new parent company - YouTube, which draws hundreds of millions of viewers daily, has yet to settle on a successful advertising strategy.
Similar challenges persist in other fast-growing Web 2.0 fields, such as social networking, gaming, and digital media.
Hirshland at Polaris, which has invested in Internet companies like Automattic, the San Francisco operator of the WordPress blogging platform, and Turbine, a Westwood social gaming and virtual reality company, said Web 2.0 companies today are in the stage that search engines were in before Google fused its engine to Internet ads.
"You see Google working hard at doing that for YouTube," Hirshland said.
"Facebook is in the early stages of figuring that out. MySpace, under News Corp., is a little farther along. But clearly none of these companies have been monetized the way we think they should be. The next step is figuring out how you translate audience into revenue and profits. That hasn't been solved yet, but it will."
Robert Weisman can be reached at weisman@globe.com. 