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Venture Capitalists Turn Attention to the 'App Market '

The iPad has caught the eye of the venture capital world.

Two notable entrepreneurs have teamed to create a multi-million dollar fund that will help finance, develop and market applications for Apple’s tablet computer. Kevin Wendle, co-founder of CNET and E! Online, and Daniel Klaus, co-founder of Music Nation, teamed to form AppFund, a firm that will help developers build and debut applications for Apple's iPad.

Apple iPad
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Apple iPad

“The iPad feels more revolutionary than the iPhone was because of the business potential,” says Klaus. “I think over next few years, there’s going to be a tremendous amount of trial and error. Our belief is that apps that are real utilities — that can become a part of people’s everyday lives — those are the apps people are going to to keep coming back to and will use time and again.”

The app-making world has exploded since the launch of the iPhone. Developers range from one- or two-person garage shops to dedicated companies. And several publicly traded firms have tasked part of their development teams to ensure they have a presence on Apple’s devices.

Exactly how many people and companies are making the widgets is impossible to say. The North American estimate is in the tens of thousands — with double or triple that number worldwide. There are, to date, over 145,000 different apps for the iPhone.

Part of the appeal has been the general low cost of creating applications. Apple makes the tools readily available, so anyone with basic coding knowledge can put together at least a rudimentary app. For pro developers, the turnaround time is considerably shorter than it is on other platforms.

Take games—the most popular category on the iPhone. In the traditional video game industry, it takes a development team a minimum of one year to create a retail product— often two or three years. But companies focusing on the app market can turn around a professional-looking game in 6-8 weeks, then continue to build on it.

The costs and overhead are significantly lower, as well—which raises the question: If apps—whether for the iPhone or, presumably, the iPad—are cheap to build, why would developers want to give up a stake in their company to a venture capitalist?

“One of the beauties of the app business and the new generation of the web business is it doesn’t require heavy capital investment—certainly on the developer side,” says Klaus. “I think where the real investment starts to come in is in marketing and in getting the apps out into community.”

Standing out from the pack is the real trick. Virtually every hit on the iPhone has been a viral sensation. Traditional marketing has been less effective, though the AppFund team thinks it can overcome that hurdle.

Hoping iPad Owners Will Spend More

Apps are hardly exclusive to the iPhone, of course. Developers also create widgets for Research in Motion’s Blackberry and devices that use Google’s Android operating system. But Apple products have held the leadership role in the market since their introduction.

After investing in the developers, Wendle and Klaus hope to see returns based on the sales and other income models (such as micro-transactions and in-app advertising) of the app. iPhone applications that charge more than $10 typically don’t do well, though, and have to sell tens of thousands of copies to be legitimate hits.

The AppFund is counting on iPad owners to be willing to spend a bit more.

“I do think the iPad will probably be a little less price conscious,” says Klaus. “I would like to think the applications developed for this device are more tailored for daily use and daily consumption.”

Typical investments for the fund will range from $5,000 to $500,000—and it will announce its first investment in the coming days. Klaus declined to discuss how the company structures fees, noting that it will vary from investment to investment.

Analysts say there’s some risk to iPad-exclusive venture firms, since the device will run all existing iPhone apps (and it’s relatively easy for developers to optimize existing apps for the device), but the early bet could pay off down the road.

“You’re talking about a real fund that’s making micro-investments, to some extent,” says Colin Sebastian of Lazard Capital Markets. “That’s not a traditional venture capital route. That way you can make lots of bets across a lot of developers. … If the iPad even comes close to the success of the iPhone and there’s a lot of demand for apps, then it doesn’t sound like a bad idea.”

AppFund is certainly not the first venture capital interest in the app space. British firm Northern Film and Media launched an iPad fund for developers in northeast England less than 24 hours after Apple CEO Steve Jobs unveiled the device.

Meanwhile, one of Silicon Valley’s top VC investors, Kleiner Perkins, has established the $100 million iFund that specifically targets applications for the iPhone. That initiative has made seven investments to date. Norwest Venture Partners and Maples Investments are also investing in application developers.