Venture Firm Shares a YouTube Jackpot

SAN FRANCISCO, Oct. 9 — Even in Silicon Valley, it is rare for so much money to be made so fast — and by so few.

The biggest winners in the $1.65 billion acquisition of YouTube by Google are YouTube’s founders, Chad Hurley and Steve Chen, who have parlayed their stakes in the 19-month-old start-up into Google shares that are probably worth tens of millions. YouTube’s roughly 60 employees are no doubt celebrating as well.

But only one venture capital firm — Sequoia Capital — got in on what has turned out to be one of the hottest Internet deals since Google went public in 2004.

Sequoia, which is among the most successful venture firms in Silicon Valley, invested a total of $11.5 million in YouTube from November 2005 to April 2006. It may be walking away with more than 43 times that amount. Its stake in YouTube has been estimated at roughly 30 percent, which would give it a value of $495 million.

That kind of payday, especially for an investment that is less than 12 months old, is unusual even in Silicon Valley. But it is not likely to rank among Sequoia’s biggest. The firm, which was founded in 1972, has backed a roster of technology superstars including Apple, Cisco, Oracle, Yahoo and Google itself.

Sequoia’s go-it-alone investment in YouTube represents the kind of aggressive move for which Sequoia is known. A more traditional and safer approach would have been to share the risk and rewards with other investors. That is especially true with an early-stage investment in a company that since its inception has faced the prospect of costly lawsuits over the copyrighted material that peppers the site.

“They had an absurdly high level of confidence with what they were doing,” said Paul Kedrosky, a venture capitalist and author of the blog Infectious Greed.

Sequoia did not return calls seeking comment.

The connection between Sequoia and YouTube can be traced back to Mr. Chen’s and Mr. Hurley’s days at PayPal. After PayPal was bought by eBay, the two men were looking for a new company to start. They hit upon the idea of a site that would help users exchange video files.

In the summer of 2005, the pair showed their site to another PayPal alumnus, Roelof Botha. Mr. Botha, who had been chief financial officer at PayPal, was by then a partner at Sequoia. In November 2005, he agreed to invest $3.5 million in YouTube. Five months later, Sequoia put an additional $8 million into the site.

“It wouldn’t be surprising if they owned 30 percent,” said Michael Kwatinetz, a founding general partner at Azure Capital Partners.

The fact that the man who is perhaps Sequoia’s best-known partner, Michael Moritz, sits on the board of Google could have given the search giant more insights into the legal risks associated with YouTube, and therefore more confidence in pursuing a deal, Mr. Kedrosky said.

The deal by firms that share an investor is right out of the playbook of Kleiner Perkins Caufield & Byers, the venture firm that imported from Japan the notion of a keiretsu, or network of companies with interlocking relationships, Mr. Kedrosky said.

“The whole idea of the keiretsu was friends selling to friends,” he said. “The model worked gangbusters for Kleiner Perkins.”

Venture firms like Sequoia typically raise funds from large institutional investors like pension funds and university endowments. They then invest those funds in promising start-ups, although they often end up with more misses than hits. At successful venture firms — and Sequoia ranks among the most successful — hits on the scale of YouTube more than make up for the misses.

A venture firm makes money only when the start-ups it has financed are sold or go public. It then splits profits among its investors after taking a share, which can be 20 to 25 percent.

The YouTube deal was the first major acquisition in the booming Internet video sector. In a conference call, Eric E. Schmidt, Google’s chief executive, called it “one of many investments that Google will be making to make sure that video has its proper place in people’s online lifestyle on the Internet worldwide.”

A Google spokesman said Mr. Schmidt was not necessarily talking about more acquisitions. But the prospect of more deals still has other venture capitalists and entrepreneurs salivating.

“It’s good to hope,” said Peter Clemente, chief marketing officer of ManiaTV, a Denver company that produces live video programming for the Internet. ManiaTV is backed by Benchmark Capital, Intel Capital and Centennial Partners.

Mike Hirshland, a partner at Polaris Venture Partners in Boston, said, “This is obviously the talk of the sector.” Polaris has invested $11 million in Heavy.com, an Internet video site founded in 1999 that aims at men ages 18 to 34. Mr. Hirshland called the deal the “first major venture-level return for an online video company, a sector that’s probably the most-watched and commented-on sector around the Internet.” He added: “It’s certainly the most hyped.”

The possibility of hype is leading some to worry about a bubble.

“It certainly starts to heat up the space a little bit,” said Mr. Kwatinetz, warning that Internet video might follow the same trajectory as, say, reality television, which was ignited by the success of “Survivor,” a show that was followed by a long list of imitators.

Indeed, the success of YouTube, as well as MySpace, the No. 2 video site on the Internet, has spawned a generation of competitors focused on the creation and sharing of videos, said Josh Felser, president of Grouper, a video sharing site purchased this year by Sony Pictures Entertainment for $65 million.

“There are hundreds,” Mr. Felser said. Some companies have already risen above the fray. In March, Enterprise Partners Venture Capital announced it had invested an undisclosed sum in vMix, a site that lets people upload videos and slide shows.

In April, Veoh Networks, which lets people share and watch videos, received $12.5 million from Spark Capital, Time Warner, and the Tornante Company, which is controlled by the former Disney chairman Michael D. Eisner.

Also in April, Revver, a video sharing site, received $8.7 million from the venture capitalists Draper Fisher Jurvetson and Bessemer Venture Partners, among others. The company has since received more funding from Comcast Interactive Capital and Turner New Media Investments.

Joe Lazlo, a senior analyst with Jupiter Research, said the companies that are attracting funding are ones that are finding ways to differentiate themselves. He said one creative concept was that of Break.com, which allows people to post videos, then buys the more popular ones and runs ads with them.

But so far at least, Break.com is not biting at venture capital offers. Keith Richman, its chief executive, said the company had declined financing a number of times as it tried to build the business on its own.

Mr. Felser, the president of Grouper, said there was a limit to how much a video creation and sharing company can hope to grow independently, because of the expense of bandwidth and advertising infrastructure.