Venture capital investing: What's next?

For the past two years, venture capitalists have been betting on social media start-ups with an enthusiasm reminiscent of the dot-com heyday.

Now that the economic downturn has somewhat cooled early stage investing, some venture capitalists say there's no better time to take a longer-term view. So what's on the horizon? CNET News talked to venture capitalists from the San Francisco Bay Area, New York, Southern California, and even Israel to get a read on where consumer Internet investments are heading. Some of it plays into the obvious (like iPhone ventures), but VCs aren't always predictable.

Investors are eyeing myriad opportunities, including new ways to make money from all of those social media sites and building the next generation of the Web. To some that's the creation of the "implicit" Web and to others it's the "semantic" Web. Some of the companies they're investing in are already well-known to hardcore techies. But all of them will likely help change how people experience the Internet.

It's all about the data
The first wave of Internet investing dealt with commercializing the Web, helping companies like Amazon.com and eBay get on their way. The second wave has been about helping people socialize and connect through sites like Flickr, YouTube, and Facebook. The third, venture capitalists say, will be about making sense of all the data people create around the Web, and then searching for patterns in the data to improve the delivery of personalized content, search results, or advertising.

One approach to this will be in cross-connecting the back-end databases of sites like Facebook, YouTube, and Amazon so that information flows more freely between them. That way, people will get more relevant information as they traverse the Web. Some investors call this the "implicit Web."

Another area for advancement, investors say, is in building an intelligent system that understands the relationships between Web sites and how people use them--with the use of algorithms that understand keywords, context, and natural language on a massive scale. VCs, for example, are looking to so-called semantic technology to significantly boost the amount of searches that result in an advertising "click." Right now, an estimated 30 percent to 40 percent of Web searches do not return advertising revenue. But if a search engine understood the context of a person's Web search more often, those numbers would improve, they say.

An early company in this field, Powerset, was recently bought by Microsoft for about $100 million. Google is funding research in semantic Web technology at several universities, and it has ongoing internal efforts in the area.

"This keeps building on the Net's evolution, processing people's usage and behavior. But to do that at a massive scale, you have an intelligence system. This is an area evolving in many different ways, with a number of different companies and verticals," said Tarang Shah, an associate at SoftBank Capital, who's long worked in wireless investing.

Following the money
Investors are also interested in data for improving e-commerce.

"Everyone talks about all the data that's being created and how valuable it is, but the way you make it available is by doing something actionable with it," said Rob Hayes, partner at First Round Capital.

One example of this would be an application that tells an executive who he or she e-mails the most and responds to fastest. Is it a boss or a co-worker? Xobni, "inbox" spelled backwards, is a plug-in for Outlook that provides that kind of information, including context from the Web about a person who's just e-mailed you.

Companies to watch:

• Mint.com is another example of pulling together silos of information. It lets people combine personal finance data from 401K, mortgage loan, and credit card accounts, among others. By making connections from all that data, it might notice that a user spends a lot of money on gas, but isn't using a credit card linked to a rewards program that could save money for that person.

• Qitera is a San Francisco-based search service that uses semantic Web technology. Still in quiet mode, it lets people store, share, and filter their search activities by topic or other parameters.

• Radar Networks, also based in San Francisco, runs a service called Twine, much like Qitera. People can use it to store links, documents or e-mail, and the technology draws connections between them.

• Israeli company Dapper is working on technology to improve the relevance of content on the page. Many editorial pages show related stories handpicked by an editor. Dapper uses technology to understand the gist of a story and show related material automatically.

• ThisNext, in Santa Monica, Calif., is an example of where the implicit Web is headed. It uses data to provide more relevant shopping or connect people with similar shopping tastes so that they can chat while they're buying a skirt, for example.

Hyper-advertising
Data will also make the difference in delivering on online advertising's promise of highly personalized communications between the marketer and consumer, investors say.

Social networks and social media sites have created so much new ad inventory on the Web, but they have yet to make significant money from it. In fact, the popularity of sites like Facebook and Flickr has reminded many dot-commers of the Internet heyday, when the predominant philosophy was to build a "sticky" site and then figure out a way to turn a profit. Facebook Chief Operating Officer Sheryl Sandberg outlined such a business strategy during a recent Fortune conference.

That's why venture capitalists are looking for new ways to skin a cat, with new advertising targeting technology that can make display ads more measurable and effective. Call it hyper-advertising. The online advertising market is worth a little more than $21 billion annually. Investors want to push that estimated 8 percent of the total U.S. advertising spent into double-digit percentages sooner rather than later.

"We are really fascinated with data and the ability to use it to increase effective (cost per thousand) for ads. There's this explosion of inventory, but people haven't figured out how to monetize it yet--data will be the difference," said Fouad ElNaggar, a principal at Redpoint Ventures.

Similarly, venture capitalists are scouting for companies that can help advertisers bring down the cost of production on digital commercials, and help improve the measurability of those kinds of brand ads.

Of course, companies in this area will have some major consumer privacy hurdles to overcome.

Companies to watch:

• Opinmind, a Santa Clara, Calif.-based ad targeting company for social media. Opinmind uses machine-learning techniques to figure out people's upcoming purchase intent by monitoring comments and instant chat on social networks. For example, if someone says on a social network that their car just broke down in an instant message, they may be a candidate for buying a new one in the next few months.

• New York-based 33Across has developed an analytical engine that can look at behavior patterns of members of a social site in order to track who, in the so-called social graph of friends, is most influential to others.

• Ad Nectar is an ad network of virtual goods based in Seattle. Brands like Nike can create a virtual sweatshirt and have it placed on Facebook so that the company can measure how many people "gift" or buy that shirt on the social network.

• NebuAd is a Redwood City, Calif.-based company that collects data on people from ISPs so that it can target ads to their behaviors as they surf the Web.

Mobile is the next new, old thing
Investors in the mobile market will tell you the business has been "on the verge of exploding in the next two years" for the past 10 years. But now with Apple's iPhone and Google's coming Android platform, investors say the phone is where the Internet was circa 1995. The iPhone shows a shifting balance of power between handset makers and carriers, opening up a whole new world for start-ups seeking air time on the deck of AT&T or Verizon-connected phones.

Investors are eyeing everything from analytics-and-advertising platforms for the iPhone to the equivalent of a Norton Utilities for the handset. Companies with rich content for the mobile phone are also a good bet, investors say, because the U.S. will eventually catch up with usage trends in Asia when bandwidth for phones improves. Companies that help you send a book, video, or TV show to a mobile phone, or play an interactive game, are the ones to watch.

"The iPhone introduction has begun to cause a shakeup that is long overdue in mobileland," said Michael Eisenberg, a partner at Benchmark Capital, based in Israel.

Early companies to watch in this market include Pinch Media, a New York-based analytics platform for the iPhone and application developers to assess the popularity of mobile apps and measure how ads perform within them. There's also Amobee, a Redwood City, Calif.-based platform for advertising on the mobile phone. Amobee says that it has a single platform for inserting ads into mobile content, entertainment, or messaging.

Gray matter
Apart from cloud computing, investors say there's an emerging opportunity for companies that help other dot-coms manage their application protocol interfaces, or APIs. Twitter, for example, was recently reamed for its trouble managing traffic demands from its APIs, such as Twitterific. It teamed with a company called Gnip, or ping backwards, to queue that traffic in a way that's more efficient. People will only ping its servers when there's an update ready, for example.

"There's opportunity in the space between Web APIs and raw cloud computing," said Hayes, who is invested in Gnip. "Soon all you're going to need is a terminal and Net connection, but until then there are opportunities to build up file systems, system admin services, and other things we can do with Web APIs."

For his part, Vineet Buch, a partner at BlueRun Ventures, said this time represents a great opportunity for investors with a long-term perspective. "If markets appear tough right now, the likelihood of it rebounding is high," Buch said.