Jason Katz is the founder and CEO of Paltalk.com. Jason oversees the strategic direction of Paltalk and also manages the company’s system architecture. Jason is an authority on instant messaging as well as web based voice and video. Jason previously co-founded MJ Capital, a money management firm. Earlier in his career, he was a corporate lawyer at the New York City office of Fulbright & Jaworski.
SM: Jason, tell us about your background. Where are you from?
JK: I grew up in New York City in modest circumstances. Growing up in the city was not a great way for me to grow up because I like outdoors and sports. It was hard finding places to play sports sometimes. My family story is the typical American story. My grandparents came to this country with nothing in their pockets. I credit my father as being the most entrepreneurial of them. I knew early on that I would rather start a business than work for someone else.
SM: What about education?
JK: I went to the University of Pennsylvania. It was an excellent place to be and I graduated with a degree in economics. The Wharton School is a very good school that gives you many different opportunities. I like economics because I enjoy the challenge of trying to understand how world economics work as a whole.
My next step was law school at NYU. A legal background is very good as well for entrepreneurs. I did take the bar and am admitted, but I knew very early on that I was never going to practice. The NYU curriculum was substantial and allowed me to elect courses to enhance my business background. Students also gained access to the NYU business school, which enabled me to complete some coursework there.
SM: What did you do after law school?
JK: I graduated in 1988, which was a year after the stock market crash. Any job in business was extremely hard to come by at the time. Wall Street was laid off all over the place. Law jobs were readily available, but I knew that I did not want to work in law. Fortunately, during my first summer at law school I interned for a risk arbitrageur. That is somebody who invests in companies involved in mergers and acquisitions. I levied that experience when I left law school.
I decided to co-found a business, MJ Capital, to create a boutique investment company that could supply people with advice about stocks, bonds or commodities. It was like a full-service firm, just smaller. I obtained my Series 7 license for stock, a Series 3 for commodities, and a Series 23 which was General Principle. We worked at that business for five years and built a very nice clientele.
For various reasons we split up. The majority of the company went to Oppenheimer and I left. I then found myself working with a family business, which is where I gained my love of technology. I spent five years running and building computer networks in the early days of the Internet. I started learning about computer to computer voice calling as well as instant messaging. In 1998, I came up with the idea of combining an IM with the ability to talk. Skype did that many years after but we were the first company to combine a buddy list and allow voice conversations. That was really the first version of Paltalk, which was launched in 1999.
SM: When you had your first IM client, who were your competitors?
JK: At that time AOL and ICQ were had the primary instant messaging clients. MSN, Yahoo and Skype had not yet entered the field. Of course, those IM clients were text only and did not involve a voice component like ours.
SM: You envisioned the concept; who designed it? How did you get it built and sustained?
JK: In the early part of 1998, when I came up with the idea, I got introduced to some programmers in the New York area through my professional network. Some of the programmers liked the concept, so they came to work and it took us six months to build the first version of the software, which was launched in January 1999.
I self-funded the company during that time. I wanted to prove that we could build the product and prove that it would be used. If nobody wanted to use the product then there would be no need to raise funds. Once we deployed the software, we found that people liked it a lot. It grew in true social software fashion and our user base is now all over the world. Once I had real software that was working I decided to raise some money.
SM: Once you had proved your concept, what was your next step? How did you validate that users were actually using the system and not just downloading it?
JK: CNET and Download.com were the main distributors. We saw the number of downloads from there. We had also built a recommendation engine within the software. Once people downloaded the software they could recommend it to friends and family. It was easy to e-mail around and enabled our viral growth. On average, every user who downloaded our software would invite five other users. We did zero marketing and grew solely via word of mouth.
SM: You launched an advanced product for 1999.
JK: We did, but our software package was only 200K. Most people used dial-up, there were no USB ports, and the only cameras that existed were not popular at all. There was no real bandwidth for video so we were just doing audio. Within a few years USB ports entered, bandwidth expanded, and we started going to video.
SM: How many users did you have in 1999?
JK: We launched in January and had 30,000 users by April. That was a fairly good ramp for new software with no marketing. Our software was free, which is really important. That is the same model used today. The CPMs were much better at that time so we thought that was going to be the way to make money. Of course a couple of years later the dot-com crashed happened and the CPM for adds disappeared. I then realized in 2001 that we would need a subscription service. The key was finding the right subscription features that people would be willing to pay for.
SM: When you first started were there any other companies competing in the social IM space?
JK: There were some companies that came out focusing on voice conferencing via the Internet. LibStream, FireTalk, and HearMe were the most significant, and all were well funded. HearMe was a public company and had $270 million in public and private funding. At one point it had a $1 billion market cap. Ultimately, all of those companies went out of business. The existence of those companies further reinforced the idea to me that companies wanted to do voice conferencing over the Internet.
We altered our Paltalk software as we went along to allow for the creation of groups. Not only could we do groups of two or three, but we could handle groups up to 500. We would broadcast voice through our servers to everyone in the group. Soon we started adding video capabilities into our feeds. We would denote who was publishing, and we would allow users to click on whomever they wanted to view. It is not possible to allow 500 people to be viewed, but we would allow the 500 users to select which individuals to view. A group might have five or six different people with video broadcast to a group of 500, and the ‘listeners’ could elect to watch all five or six, or just one or two.
SM: In 1999 when you started, it was audio software. When did you start doing video? Did you raise money from the VCs based on audio or video?
JK: We raised $1.2 million in 1999 based on the premise of audio-only capabilities. We had 30,000 users when we raised that money. People were certainly looking for Internet companies to invest in at that time.
SM: Soon after the market crashed.
JK: It did. My timing was just about perfect because a year later I raised another $2.7 million. Between April 1999 and April 2000 we raised $3.9 million total. To me that was a great deal of money, although many in the Internet world did not think it was a lot. Fortunately, I never stepped up in a great way. I always thought we needed to make money on an operating basis because that is what business is about. At that time people were just talking about eyeballs and not focusing on the money.
Some time in 2001 I was able to go cash flow positive by putting in a subscription model. That model was straightforward. If I wanted to do a video call from my buddy list, one on one, the service was free. If I wanted to be involved in one of the groups, of which we have 4,000 user-created groups, then you had to pay for that service. If you were in one of the user-generated rooms, you could type or broadcast for free, but if you wanted to view somebody else’s video feed then you needed to have a paid subscription account.
We were intelligent about the way we did it. If a user wanted to view somebody else’s video stream we did not make that person pay immediately. We would allow them to see ten to fifteen seconds of video and then we stopped it and put up the ‘paid feature’ notice. That induced a lot of people to pay, and that has been our model. We have focused on enhancing the quality and capability of our service since.
SM: How does your revenue break down between subscription and ads?
JK: About 85% of our revenue comes directly from consumers paying. The other 15% is from advertising.
SM: A lot of people have created groups using your service. In your mind, what types of group do you serve best? What scenario would illustrate Paltalk as a ‘killer application’?
JK: It is a real-time social network. A lot of social networks have endured being asynchronous. Nowhere does a social network exist that allows video conferencing in real time. That has been my thesis from the beginning. When you have buddy lists, you know when other people are online.
SM: You have a one-on-one model there, but do you monetize that?
JK: We do not monetize our one-to-one model. We give the software and service free at that level. We find that people like to chat in groups. Instead of trying to program those groups, I will let users program them and be their own administrators. Chat always had a negative connotation because you may not know whom you are typing to on the other end. With our audio and video service you know who you are talking to. It’s harder to hide there.
SM: If you have five people on your buddy list and you want to have a chat with all five, is that free or paid?
JK: That is free. We call it Super IM. We allow up to ten people for free. Each user is assigned a Web URL to use. They can disseminate that URL to people who do not have Paltalk. As long as the other person can open a Web browser that person can also video conference; no software download is required. That is a big idea and it is different from other companies that require you to have their software running. I don’t think you should require people to use any particular software. I like the idea of giving users a URL that lets anyone join.
SM: Are you seeing adoption in the business or consumer world?
JK: Our service is primarily consumer oriented. Very early on I did observe that some people might want to use our software for business applications. The free use case did not make sense to me for commercial use. In that scenario we require paying for the room. There are eight hundred customers who pay for their rooms. As a result, they receive additional capabilities that others do not have.
Some of those commercial uses include stock market information dissemination. If companies have subscribers to their service, they have to figure out how to disseminate information to their investors. Of course they could use newsletters or blogs, but if they purchase a room they can disseminate that information in real time. Their customers enter the room via a password and we have had upward of three thousand people in a single room.
SM: What does a commercial room cost?
JK: Costs range from $40 a month to over $1,000 a month. Our regular subscription is $15 a month or $60 a year. The commercial business has grown into a real business on its own. Our customers essentially demanded that capability. We listened and delivered.
SM: Who do you consider your competitors based on where your business is today?
JK: Skype certainly is when it comes to video conferencing. They did a great job with the PC to phone service, although we had that offering before they did. I personally think Skype did a great job recognizing that international calling rates were very high. Most of us U.S.-based companies missed the idea of having PC to phone calling systems which could go international. I really think that is what made Skype so popular.
I don’t know any other company that powers group conversations, including video, the way we do. That sets us apart. We also allow group conversations with people you know as well as with people you do not know. Over 70% of the people on PalTalk are on chat groups that they either run or administer the user settings.
Facebook is also somewhat of a competitor, although they are more focused on people you know and are text based. You can use us as a platform for meeting new people. That is one of the problems with the Internet; everybody has a different piece of software. At some point it becomes software overload. How many browser and IM clients do you need?
SM: What do you think of services like WebEx and other B2B business web conferencing software?
JK: I think they are good. We have a service called HearMe.com, which was a competitor about a decade ago. At the end of 2001 they went out of business and we bought most of their assets, which consisted of a lot of domains and source code and patents. We relaunched it as a business facing application. That is a very busy space, as you have point out. It is difficult to compete there because budgets are so tremendous.
We are working on customizing our messenger for a small business. We want to allow small businesses to have customized buddy lists, where all employees automatically have the same shared buddy lists. The system administrator just needs to put in the names of all the employees and everyone is automatically listed. We think that will empower small business in a way that is different than WebEx and everyone else. We think those platforms will continue to be used for sales, and I want to see our platform used as a video teleconferencing platform for small business. That is a market that has been missed and we are going after it now.
SM: It sounds like you already have a crude solution for that with your consumer-facing group video chat capability.
JK: We have some of that capability, it would just take an administrator a bit of imagination right now to get there. We will repackage that and make it a small business app. The buddy list is a key component for us. With WebEx or DimDim your presence is not really conveyed.
SM: Pricing will need to be at an affordable level for that market as well.
JK: We have a lot of infrastructure in place that will let us have very favorable pricing in place on an annual basis. We will probably give our service free for just a few users, and then charge based on company size. We will also have a paid service to give groups within the company their own phone numbers. That will be a unique feature as well.
SM: In the ten years you have been in business, how has the business progressed? Where have you made money and gained traction?
JK: We have had good traction. In the early years we were viral, explosive, and unique. That lasted for three years and allowed us to launch with no marketing money. When the market crashed it limited competition because nobody could get funding. If I remember, Friendster was the first to come out after the money started to thaw again. Once 2004 hit and VCs were investing again, we saw increased competition from companies like Skype.
We had a loyal base of customer and we had constantly been enhancing our service. When we started our offering was push-to-talk, now you can talk to an open mic. When we started we did not have video, now we can do large group video. We have better codecs, echo cancellation, and other technologies that consumers are not always aware of. At the same time consumers have had increased access to better bandwidth and better computers.
Nobody was thinking about wireless networks ten years ago. Today all these computers with good webcams and microprocessors are a nirvana for what we are trying to do, and they all have wireless. Suddenly, we now have smart phones and we are going to do these same things from the smart phones.
SM: Do you have an iPhone app?
JK: We do. It works on the iPod touch. We have a BlackBerry application. Video will follow on those soon, and our Android version will be out soon as well. The telecon possibilities worldwide are going to be exploited. Cell phone companies have made their living tariffing any kind of international dialing. If you have an app that goes around that then you can have a popular business. We have a good user base to do this with, a decade of experience, great engineers, and eleven patents with four pending.
SM: How did your revenue ramp from the beginning of your company through today?
JK: We have been able to ramp well. The first year we made six figure revenues, the second year we almost hit $1 million. The third year was well over $1 million and revenue doubled year on year for a long time. We hit a level where we had profitable growth and we have been able to grow each year. The key is growing profitably.
SM: Did you ever raise funding after your initial $3.9 million?
JK: We did raise money in 2004 because we already had money in the bank and we were making money. We did not actually need more money, but gaining access to some funding was a good way to grow faster. Our first round was really just friends and family. Gaining an institutional investor signaled that we were a good company with reliable technology. When you are hiring employees it is nice to have that validation. It has made it easier to do business. In 2009 we bought those shares back from Softbank.
SM: Why did you buy your shares back from Softbank, and why did Softbank allow you to do that?
JK: When VCs invest in a business, the have an expectation of a profitable exit. By 2009, Softbank had been invested for five years and we were profitable, but they had not received a return on their money. I approached them and told them I knew five years was a long time for a VC to be invested, and I expressed our interest in purchasing back their shares. They felt it was an interesting proposition, but it was apparent they did not normally exit that way.
Most companies do not operate in a way that would allow them to repurchase shares from their VCs at a profit. Softbank made a nice return on their money. I did not need their money anymore, so I was more than willing to let them have a nice return to regain control of those shares.
SM: Did the money you repurchased the shares with come from your profits?
JK: Absolutely.
SM: That could not have been a very large return based on what they invested.
JK: I guess the value of the profit they made is in the eye of the beholder.
SM: What is your current growth rate?
JK: We register about 500,000 new users every month. It is a matter of conversion and retention. Current initiatives involve internationalizing our client base. Right now we are only in English, and that was tunnel vision on our part. I missed the international phone rate opportunities. With different language packs our software will display properly, but we have not tailored anything yet. I expect that will be a substantial benefit.
SM: What are you trying to do with the company today from a structural point of view? Softbank may be out, but you still have some external investors in the company.
JK: I do still have the early investors. At some point they may seek an exit. Somebody once told me that Internet companies are bought, not sold. You have to become important to other companies and earn and exit that way. I operate the company and try to grow, adapt, and adjust as I go along. We make acquisitions ourselves to gain new technology. If we keep growing profitably the rest will take care of itself.
SM: I know Paltalk has filed lawsuits recently to protect its IP. Can you talk some about that?
JK: In 2006, we sued Microsoft for $90 million for patent infringement. It went to trial last year and was settled out of court when Microsoft agreed to license the two patents. Accordingly, IP remains very important to us. Server group messaging is very important to us. We also initiated a suit against Sony in 2009 on the same server group IP. Our core technology and our IP are very valuable assets to us.
SM: So, you are now able to generate IP based on your licensing revenue?
JK: We have. As a small company it is not always easy to do that. If you have a patent that is a property right, and we do try very hard to protect our property.
SM: Are you licensing your platform in any ways where you allow other people to build their own businesses on your platform?
JK: That is something we are considering, and probably something that we should have already done. Having an app store and letting others program to it certainly validates your platform. We have been very concerned about security over the years. We like having our server in the middle and proxying the traffic. When we first started we were P2P, but we moved to our current model to give our users more security.
SM: I really enjoyed listening to your story. This is an interesting story and is an interesting perspective on social networking. Best of luck going forward.