Money flows into IM startups after big players open up platforms

After a period in which venture capitalists believed Yahoo, AIM and MSN had locked up the space, a number of instant messaging startups have begun to attract the attention of users and reawakened VC interest in the IM market.

Meebo, which enables users to access any IM platform—Google, MSN, Yahoo or AOL’s AIM—from a single site with one password, just raised $3.5 million from Sequoia Capital. Another instant messaging service, IMVU, brought in $8 million from Allegis Capital, Menlo Ventures and others. Meebo and IMVI join a host of startups targeting IM, including eBuddy, Meetro, RadiusIM, Tello, Trillian and Wablet.

Why all the interest? And why now?

“We saw limited VC investment in IM-related startups in the past because people thought the market was done,” says Chamath Palihapitiya, who formerly ran the AIM division at AOL and is now a principal at Mayfield Fund in Menlo Park, Calif. “They thought it was Yahoo, AIM, MSN and that’s all. There was a feeling that the market began and ended with the entrenched giants and that you could not build a lasting asset that is independent. People were very hard pressed to say there was a lot of opportunity in the IM space.”

But a handful of entrepreneurs noticed the inaction in the IM market and saw room for new services.

VCs are very curious about the space because they know it’s prime for blowing up”

Paul Bragiel, CEO and founder, Meetro

“To me it looked like an opportunity,” says Paul Bragiel, founder and CEO of Meetro, a Palo Alto, Calif.-based startup that combines messaging with location and social networking features. “Instant messaging hadn’t really moved in five or 10 years. So it was ripe to be redone. We saw a chance to add a lot more data and information to conversations.”

Meetro calls itself a “location-aware social messenger.” When users log on to the free service they see who else is signed in and can start sending messages instantly. One user claims to have borrowed a vacuum cleaner from a neighbor he IMed using Meetro.

It was only in the past year (October 2005) that major players like Yahoo and MSN decided to open their doors and allow new services like Meetro to access their lists and link users across IM platforms. Not only that, the major IM networks also released their toolkits so that developers could build on their platforms.

“For a young company starting out, the smartest thing they can do is leverage these existing networks and bring added value,” says Palihapitiya.

Meebo is a one-stop shop that gives users a clean, Web-based interface from which they can access AOL and other major IM services without opening any of those programs. UserPlane, recently acquired by AOL, allows any Web property to integrate an IM client into its site by cutting and pasting simple code.

I’ve seen some technologies that are really amazing. The quality is amazing—low latency, no jitter, perfect voice synchronization.”

Chamath Palihapitiya, Principal, Mayfield Fund

Friendly users

Another factor in the explosion of new IM services is the popularity of instant messaging. Seventy percent of Internet users accessed IM services in 2005, according to an America Online survey. And IM is expected to get more pervasive. The number of worldwide IM accounts will grow from 944 million this year to more than 1.4 billion in 2010, according to The Radicati Group, a technology research firm based in Palo Alto, Calif.

Businesses have also embraced instant messaging. Five to 10 years ago, they shunned IM services, locking employees out of networks like Yahoo and AIM. Now they see it as a tool to improve efficiency and communication among workers.

“Especially for a small company, which isn’t likely to spend the money for full IT support or a large in-house application, these IM apps enable rich presence and collaboration,” says Gary Rubinoff, a managing partner at BCE Capital, a Toronto-based venture fund that focuses on communications. “They let employees communicate with colleagues when they want and that’s a big value proposition. Pop it on your PC, click on the people you want to find.”

In July, Rubinoff led a $10 million series B round in San Mateo, Calif.-based Tello, which enables users to connect via voice over IP and instant messaging. If the boss wants to call a meeting of senior managers, he or she can know where they are and the devices they’re connected to. It’s cheap, effective and makes for a more efficient company, even as the business environment grows more complex.

A business tool

[IM apps] let employees communicate with colleagues when they want and that’s a big value proposition.”

Gary Rubinoff, Managing Partner, BCE Capital

Paul Kedrosky, a venture partner at Vancouver-based Ventures West, says he’s in talks with four or five young companies that are looking at various options enabled by the new, simpler IM architecture. “IM has become a legitimate communications tool inside of businesses,” Kedrosky notes. “Before, it was used stealthily, but now it’s ubiquitous in large organizations. It’s part of the culture change—young employees are moving up the ranks and using IM more and more as a delivery mechanism.”

Another reason VCs like the new instant messaging companies is that IMs can carry a lot more than just personal messages. “From a VC perspective, the really interesting thing is using the IM platform as a cheap delivery mechanism for media,” Kedrosky says. “This is like a really, really cheap Bloomberg. I think it’s time someone finally figured out that there’s a lucrative market for a desktop Bloomberg-killer providing real-time feeds of RSS traffic.”

This harkens back to the days of PointCast, he adds, noting that the tool was ill-designed from a bandwidth and architecture standpoint. Now, there’s an opportunity with IM to perform the same functions properly, inexpensively and robustly. That puts instant-messaging platforms in position to take on billion-dollar media companies whose business model is predicated on charging a very high price for their information.

For his part, Palihapitiya thinks the next big opportunity in IM is video, a space he calls “wide open.” He sees a need for a video service that can integrate seamlessly with IM, because there’s a large user community that wants to communicate via video.

“I’m looking at two interesting opportunities here,” he says. “I’ve seen some technologies that are really amazing. The quality is amazing—low latency, no jitter, perfect voice synchronization. It’s like the person at the other end is standing right beside you.”

Before, it was used stealthily, but now it’s ubiquitous in large organizations. … Young employees are moving up the ranks and using IM more and more as a delivery mechanism.

Paul Kedrosky, Venture Partner, Ventures West

Innovation in the IM space is coming from both incumbents and startups, especially as incumbents open up their platforms and realize they can leverage their user communities to invent new features without doing all the brainwork themselves.

Food for big fish?

As always, the big question for VCs is how will the new crop of IM companies make money? The most often mentioned revenue stream is advertising. It’s a source that’s accessed now by the large players, like Yahoo. “They could go a lot of different ways,” says Matt Anderson, IM analyst for The Radicati Group. “I’m sure a company like Meebo is looking at advertising. As popular as they’re getting, they’ll figure something out, and advertising is the most obvious thing.”

But can new IM companies stand alone and make money? Palihapitiya, for one, believes some of the emerging IM companies are potential billion-dollar businesses. Others say the startups will most likely be acquired by bigger players. For example, UserPlane realized that its technology, while new, was not innovative enough to build a business on, so it sold out to AOL for an undisclosed amount in August, analysts say.

To the dismay of some VCs, some IM startups aren’t seeking capital. Meetro founder Paul Bragiel, who previously founded game-development house Paragon Five, says he fields phone calls from VCs all the time. “We chose not to take money because, well, I can pay for it,” he says with a laugh. “VCs are very curious about the space because they know it’s prime for blowing up. If one big guy goes in, then everyone else says, ‘Huh, what’s my play on that?’ It’s like if Sequoia wants to do it, then everybody wants to do it.”

Not every VC will emerge a winner, of course, but it’s clear that there is potential for substantial growth in the instant messaging market. As Bragiel notes, everybody’s doing it.