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Anatomy of a risky deal
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October 20, 2000: 9:01 a.m. ET
Hummer Winblad partner discusses the decision to invest in popular, but controversial Napster
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NEW YORK (CNNfn) - The decision to back an extremely popular, highly controversial, unprofitable company facing a legal challenge that could well destroy it was one of the riskiest Hummer Winblad Venture Partners would ever take.
"We went into it with our eyes wide open," said Dan Beldy, a Hummer Winblad partner. Beldy was referring to the Silicon Valley venture firm's decision to take an ownership stake in San Mateo-based Napster last May.
It was a rare move even in venture capital's high-risk, high reward environment. Fully aware that the Recording Industry Association of America would take Napster to court for copyright infringement for its technology that allows users to share music over the Internet, Hummer Winblad took the plunge to the tune of $15 million.
No regrets, so far ...
So far, according to Beldy, it has not been a decision that the 11-year old venture firm has come to regret. That is not to say it has been a carefree ride for San Francisco-based Hummer Winblad since the decision to back Napster.
In July, the first legal decision was handed down in the case of RIAA vs. Napster and it wasn't favorable. A District Court judge in San Francisco issued a preliminary injunction against Napster, ordering it to stop distributing copyrighted songs.
Two days later, however, the Ninth Circuit Court of Appeals stayed the injunction, siding with Napster. Napster has argued that its technology does not violate copyright law because the Audio Home Recording Act protects consumers who record copyrighted as long as it is used for non-commercial purposes.
Napster was back in court by Oct. 2 after the Justice Department filed a brief in the Ninth Circuit saying Napster should not be protected because home computers are not recording devices, which are protected under the Audio Home Recording Act.
This is definitely not a limb that every venture capitalist would be willing to climb out on. In fact, many passed on the opportunity to fund Napster because they considered it too risky. Hummer Winblad not only stood by Napster, it installed one of its own partners, Hank Barry, as interim chief executive officer.
One of the unanticipated by-products of the Napster deal, said Beldy, is the favorable response from entrepreneurs who have said they respect the way Hummer Winblad's willingness to take on enormous risk and go all out to see the fledgling company through an extraordinarily difficult time.
Hummer Winblad's decision, considered reckless by some, hasn't scared off investors either, said Beldy. "There have been a lot more questions," he said. But the firm is about to close a new fund, he said, and they haven't had a hard time raising the money. He wouldn't say the precise size of the new fund, only that it would be somewhere between $350 million and $1 billion.
He also hinted that Napster would soon get a second infusion of cash, perhaps from another venture capital firm or a corporate strategic partner, some time in the near future.
In the end, said Beldy, the decision to finance Napster came down to the simple question of numbers. Not revenue numbers because the 10-month-old company has not turned a profit. In the number of users, however, it soared from 0 to about 20 million in less than six months with no marketing. More than a company, Napster was a phenomenon.
"We had never seen metrics like that," he said. "It was interesting because of its viral nature."
Future is still uncertain
As for the pending lawsuit with the RIAA, the Washington DC-based lobbying group for the music industry, and the company's chances of survival, Beldy couldn't and didn't say much.
"I'm optimistic that it will work out, but realistic that it may not," he said.
The optimism stems from Hummer Winblad's long-held belief that Napster's service is legal. They have also maintained that the recording industry can ultimately profit from Napster's service. Napster has compared the MP3 files available on the Internet to videos of movies. Once considered a threat to the film industry, videos instead created an additional revenue stream.
The lawsuit has been a real drain on resources, he admitted. Part of what Hummer Winblad has been doing with Napster is helping them to plan for that drain.
Furthermore, the RIAA doesn't gain anything by destroying Napster, said Beldy because technology has changed the music industry for good. Many artists, including several notable names like Offspring, Prince, and Aimee Mann are already distributing their music over the Internet. They will also not be able to completely end downloading and sharing music over the Internet because so many companies have already created competing file sharing technology.
Among the RIAA members who are party to the lawsuit is Time Warner Inc.'s Warner Music Group. Time Warner is also the parent company of CNNfn. 
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