The following article was published in the Financial Times:

Start-ups seek the arms of old foes

By Kenneth Li

Digital media start-ups, once flush with financing, are seeking refuge from the souring economy in the traditional media companies they once sought to usurp.

In recent months executives at top US media conglomerates including News Corp, Viacom and Walt Disney have fielded increasing numbers of pleas from entrepreneurs seeking funding or outright purchases, as once-plentiful capital dries up for those seeking a second or third round of investments.

Media companies used to jostle to buy digital properties. Former Viacom chief executive Tom Freston notably lost his job when he lost the MySpace deal to Rupert Murdoch.

Now, the tables have turned. Pleas from start-ups were picking up months before the current crisis and are expected to accelerate, according to interviews with senior media executives, bankers and venture capitalists. “Raising money right now is no picnic for companies, so they look to see if they can get a half decent buy-out instead,” says Jonathan Miller, a partner at Velocity Group and former chief executive of Time Warner’s AOL. “IPO exits are non-existent. M&A is the only exit.”

Getting deals done is another matter. Reluctance to invest in an uncertain economic environment ravaged by the global financial crisis could put start-ups out of business, warned serial entrepreneur Jason Calacanis – a longstanding cheerleader for the sector – in an e-mail urging entrepreneurs to prepare now.

“Make a list of every web 2.0 start-up to raise an A or B round and cross 80 per cent of them off the list, because they will not make it to their next round of funding or profitability,” he wrote.

The desperation has driven some into the arms of old media. One senior media executive recounts a September meeting with an entrepreneur seeking funding. Shortly after the meeting, “the CEO pulled me aside and asked ‘What about an acquisition?’ I said, ‘Let’s walk before we run.’ “

The offering price was a fifth of the $100m valuation of a year ago. “There are bargains out there,” the executive says. But for now, “we want to take a breath”.

The panic is taking its toll., a web publishing company run by Scott Sassa, former NBC Entertainment president, shut down in September after Vivendi’s Universal Music Group and Discovery Communications pulled their financing. Eyespot, a web video editing tools company, and Jellycloud, the ad network, closed last week.

In an interview, Mr Calacanis explains: “Nobody knows how bad it’s going to get. Consumers have no money to spend. Companies have no money to advertise . . . venture capitalists panic. And then there’s no funding.”

Although well-regarded companies continue to attract financing in a difficult environment – technology blog network GigaOmni Media raised $4.5m this week – investors for second and third-tier companies will be “few and far between”, says Spark Capital general partner Dennis Miller.

“There’s a fair bit of uncertainty in the market for start-ups,” says Noah Wintroub, JPMorgan’s head of internet and digital investment banking. “They’re asking: why are we going to raise money and increase our valuation expectation if we can get bought today?”

Deal values, which were previously calculated on a multiple of profits two to three years in the future, are now priced at one to two years, depressing valuations, Mr Wintroub says.

Groups are still bickering over valuations. “It’s still going to take a little bit of time before you start to bridge that gap,” Jefferies & Co managing director David Liu says.

For now, smaller deals are more likely to squeeze past bean counters. “There will be a lot of tuck-ins, sub-$100m [US] deals that help extend reach,” Spark Capital’s Mr Miller says.

Sellers’ expectations will have further to fall, says Mr Wintroub, who sees a 25-30 per cent reduction in valuations. Nevertheless, Mr Wintroub is cautiously optimistic about 2009: “No one is going to sit on their cash for ever.”

Copyright The Financial Times Limited 2008

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