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Court ruling could squeeze P2P pennies

Grokster ruling is likely to give investors pause when faced with the prospectus for a file-sharing start-up.

A landmark ruling by the U.S. Supreme Court is expected to put a financial pinch on file-swapping companies, but a number of them may escape the grim reaper, say financial experts and attorneys.

That assessment came quickly Monday after the Supreme Court handed a major victory to record labels and movie studios, which had filed lawsuits against peer-to-peer file-swapping companies such as Grokster for allegedly allowing copyright infringements to occur on their networks.

"Investors will be careful in the future to consider whether these kinds of companies and their operations comply with the Supreme Court ruling. Smaller companies may have trouble getting funding in the future," said Bill Abrams, an intellectual-property attorney with Pillsbury Winthrop Shaw Pittman.

Concern among investors, in light of the ruling, is whether these companies will be able to find other ways to innovate and have a viable business plan.

But chipmaker Intel, which earlier this year filed a brief with the court, believes innovation can continue, despite the justices' ruling.

"We need more time to study the court's decision, but it seems to have upheld the Sony Betamax standard, and we're pleased with that," said Jennifer Greeson, an Intel spokeswoman.

The 1984 Betamax decision laid a legal foundation for the sale of VCRs, despite their ability to copy and play video recordings. Greeson noted that Justice David Souter focused on active inducement, which addresses an issue outside the scope of the Betamax decision.

Hewlett-Packard also weighed in on the court's decision, noting that it "supports strong copyright protection" for the entertainment industry.

"HP supports the entertainment industry's efforts to develop new business models that assign fair value to its content and meet consumer demand for new digital entertainment experiences," the company said in a statement.

Nonetheless, file-swapping companies may encounter a repeat of the funding freeze concerns that occurred in 2000 when Napster, and Scour were slammed with a number of copyright infringement lawsuits.

Venture capital experts and investment bankers said that legal entanglements can dampen investor enthusiasm.

"In general, investors are concerned about any company that has the potential to be shut down from a ruling like this," said John Gabbert, research director with VentureOne.

Start-ups will not only have difficultly convincing venture capitalists to throw another funding round their way, but also in getting to the public markets via an IPO, said one investment banker who specializes in Internet companies.

And start-ups in the file-swapping industry may find it equally troublesome to land a buyer for their business, should private financing dry up.

"These companies will also have a difficult time finding a legitimate business to acquire them, even if the buyer has deep pockets," said the banker, who requested anonymity.

The Supreme Court, however, drew a distinction between companies that create file-sharing networks with the intent the technology could be used to circumvent copyright laws and those that develop technology that is largely used for other means.

"The important thing is the court's focus is on the promoters of technology and not the technology itself," Abrams said. "The court put the spotlight on people who use technology to violate copyright law, while acknowledging the technology itself could have different uses."

This distinction offers hope to some peer-to-peer companies, such as Snocap, Peer Impact and Mashboxx, which use the technology to distribute songs they have licensed through the record labels or artists.

Snocap, for example, has received funding in the past from such venture capital firms as WaldenVC and Morgenthaler Ventures.

"The court's ruling won't be the death of the industry," Abrams said. "The significance of the ruling is it's provided guidance on the rules they need to follow."