Big widget company RockYou raises a mere $1M, to tide it over

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RockYou, the Silicon Valley that lets people post photo slide-shows on Web sites, has raised $1 million to tide it over while it decides whether to proceed with a larger financing round or to sell.

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The San Mateo, Calif. company is navigating some stormy changes in the market recently, where investors are more cautious about investing in social media start-ups that may not grow as quickly going forward as they have been.

VentureBeat first reported last week that RockYou recently changed its fundraising plans: While RockYou had wanted to raise up to $70 million at a whopping valuation of $400 million, we learned it was having trouble doing so on terms it was comfortable with. The company signaled to me that it had changed its plans, but chief executive Lance Tokuda (pictured left, with co-founder Jia Shen, right) wouldn’t elaborate.

VentureBeat has since learned the company this week raised $1 million from Doll Capital Management (DCM), a Silicon Valley venture firm. I’ve asked the company for comment.

DCM, a firm co-led by partner David Chao (pictured below), has invested strategically in Internet companies, sometimes later in their development cycle. I don’t know what the valuation of the RockYou round was, but it was very likely between $200 million and $400 million, where offers to Rockyou came in over the past two months. DCM may have wanted to invest in the company at a high valuation for opportunistic reasons: If RockYou ever goes public or gets sold, DCM can point to RockYou as an example of a successful company in its portfolio, even if the profit DCM eventually gets from the deal may not be all that great.

Venture firms typically like a return of about two or three times their money when they invest in a late-stage company like RockYou. However, RockYou is increasingly unlikely to produce such a return, at least if a deal happens at a very high valuation of say, $400 million. At least, many investors don’t think RockYou will produce such a return in the short run, which I’ll explain below. On the other hand, $1 million is such a small amount of money for a firm like DCM to invest (DCM has a $500 million fund), the deal may be worth it for publicity reasons.

DCM made a similar late-stage investment with SMIC, a Chinese semiconductor company that went public in China several years ago, but which had a rocky ride afterward — though DCM’s investment of double-digit millions into SMIC was part a classic “mezzanine” strategy that many VC firms practice, and can make good sense. I’ve reached out to DCM for comment, but haven’t heard back.

Here’s what’s happening in the market right now, based on some interviews I’ve had with venture capitalists: They say the market is suffering from a social media hangover. Glam and Slide were valued in the $500M range, because the assumption was their growth would continue. But sentiment has changed, and increasingly investors are negotiating deals based on what happens to a company if its traffic is leveling off. That’s why RockYou won’t be supported at the $500 million level or more, according to some investors I’ve talked with, even if RockYou’s growth has continued so far (traffic directly to its site has stagnated, according to Compete, but its global network growth is growing, according to Quantcast. The network includes traffic to sites where RockYou’s products are featured, but which aren’t directly owned by RockYou).

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Sure, Facebook is an anomaly, and was able to command a stratospheric $15 billion valuation (keep in mind that Microsoft got an exclusive ad deal in return for its investment in Facebook, which helped push up the value Microsoft was willing to give Facebook). And Google bought YouTube for $1.5 billion, but that was buoyant Google. Otherwise, there’s no evidence of social media companies deserving a value of more than $1 billion. Club Penguin was sold for $700M, and Bebo at $850M, but those sales were part of the euphoric era.

There’s a realization that the big, industry sweeping “platform” companies like Facebook and YouTube really are exceptions. The Slides, the RockYous, the Gaias and Hi5’s of the world may not be able to compete at the platform level. They’ll still get good traffic, but these companies are looking at exits of between $400 and $600 million at the high end. Investors are willing to take a two or three-fold return at the mid- to late-stage of a company’s growth, which means they’ll invest at a much lower valuation.

In some ways you can draw an analogy to the old TV era. You had three networks, CBS, NBC and ABC, and entrants such as FOX and CNN as a viable competitive platforms. However, there wasn’t much more room for more. Animal Planet and History Channel could get niche audiences, but weren’t able to expand too much beyond it.

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On measures like overall user traffic, RockYou is still neck-and-neck with Slide (indeed, faring better than Slide, if you believe Quantcast; see chart below), but RockYou has been a step behind in its fund-raising. RockYou raised $11 million last year, at the same valuation of Slide did a bit before — around $50 million. Before that, RockYou raised $1.5 million from Sequoia. It has now raised a total of $13.5 million.

Of course, there’s always the chance of a wild-card investor, which RockYou is probably hoping for. Here’s an outline of what investors are thinking about Internet valuations. While most venture investors have sobered, some big public market players are still willing to take big risks, borne out by Meebo’s raise of $25 million on a valuation of $200 million.