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OCT
24
9 MOS

Maker Studios Lawsuit: Inside the War for YouTube's Top Studio

They're the type of numbers that make Hollywood execs wake up in a cold sweat. While AMC congratulated itself when its Breaking Bad finale on Sept. 29 lured 10.3 million viewers, a few months earlier, Maker Studios' Epic Rap Battles of History YouTube station ended its second season with Rasputin vs. Stalin, a 3½-minute spoof in which unknown actors played the Russian historical figures in a ridiculous hip-hop face-off. Unlike Breaking Bad, which cost millions of dollars to produce, this Rap Battles installment cost just $110,000 to make and nearly nothing to market. Since premiering in April, it has been viewed 28 million times, following in the footsteps of Steve Jobs vs. Bill Gates (62 million views) and Mr. T vs. Mr. Rogers (49 million).

And Rasputin vs. Stalin is just one of about 10,000 videos uploaded to YouTube each day by Maker Studios from its 71,000-square-foot campus in Culver City. The videos, produced by a roster of 50,000 individual creators, are sold to advertisers and distributed via YouTube's most-subscribed channels, which together generate more than 4 billion monthly video views. A self-proclaimed digital version of United Artists, which was founded nearly a century ago by Hollywood's top talent intent on controlling their own interests, Maker today boasts a roster of online superstars including PewDiePie, Toby Turner and Shay Carl, whose not-quite household names leave anyone over the age of 35 scratching their heads and many under that age in their thrall.

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The money, however, is the big question. Although Maker has enjoyed investments from top venture capitalists, media companies and such Hollywood luminaries as Robert Downey Jr. and Avatar producer Jon Landau, it is far from making Hollywood money. Breaking Bad commanded $400,000 for a 30-second commercial during its finale. Maker Studios' take from YouTube for Rasputin vs. Stalin? A fraction of that amount. Or, really, a fraction of a fraction of that amount.

But the economics are changing, of course, and therein lies the tension at the heart of one of the most closely watched lawsuits in both Silicon Valley and Hollywood. Its players and possible outcome will speak volumes about the value of content -- and who should control it.

The origin of one of Hollywood's hottest young companies can be traced back a decade to a federal penitentiary in Lompoc, Calif. It was there that Danny Zappin bided his time drawing portraits of other inmates and thinking about where things went wrong. In his 20s, he moved from New York to Los Angeles to be an actor, but after unsuccessfully confronting Hollywood's "gatekeepers" -- his word to describe the agents, producers and casting directors who keep the wannabes from working -- Zappin needed money. So he smuggled Ecstasy, got caught and was sentenced to two years in prison.

When he was released to home confinement in late 2004, Zappin had nothing but time on his hands. Surfing the web, he happened upon YouTube, the then-months-old video-sharing platform that later would be acquired by Google for $1.65 billion. Exploring the site, he encountered actors and creators who were doing online what he had failed to do in Hollywood: break through the gate.

With money from parking cars, Zappin purchased a few cameras and began uploading videos like the one where he danced as goofily as he could and challenged others to top him. Calling himself Danny Diamond, he quickly grew a following and became a leader of sorts in a ragtag community of young YouTube stars trying to figure out how to monetize their audiences. By 2009, Zappin, on-and-off girlfriend Lisa Donovan and a few others had come up with the idea for Maker Studios. The goal was to create a "studio" for YouTube that pooled the talents of digital A-listers.

STORY: Maker Studios Power Struggle Detailed in Former CEO's Lawsuit

"There's no gatekeeper," says Zappin. "You can create whatever content you want. And if you understand how the site works -- which I really studied and learned extremely well -- you can drive audience."

The success was immediate: Maker became one of the first YouTube content providers to hit 1 million views, then only three years later, it hit 1 billion views. Its current roster of producers churns out such videos as Harlem Shake FAIL (18 million views), Justin Bieber Kisses Selena Gomez! (30 million views) and Screw the Nether (Moves Like Jagger Parody) (27 million views). Maker's annual revenue now is in the nine figures, according to insiders, and its meteoric growth has attracted venture capital firms including Greycroft and Upfront Ventures and Hollywood investors such as Downey, Shari Redstone and Elisabeth Murdoch. In December 2012, Time Warner bought about a 10 percent stake in the company for $25 million, and Canal Plus and telecom giant SingTel also have contributed financing. The investments have valued the 365-employee company at several hundred million dollars, an astonishing figure for a content-only venture that hasn't reached its fifth birthday.

Zappin, now 38, shakes his head when he hears those numbers. Today, he effectively has been ousted from the company he helped build. Zappin, whose impatient demands and polarizing fights with talent were as troublesome to colleagues as his salesmanship and vision were beneficial, resigned as Maker CEO in April. Afterward, he claimed he was induced into stepping down by others at the company who had misled and pressured him. In June, he sued to challenge Maker's handover of leadership to Ynon Kreiz, the Israel-born former chief of Endemol, the international TV production company behind Big Brother, Wipeout and Deal or No Deal. Court papers filed in Los Angeles Superior Court allege that Kreiz, along with Maker's other co-founders, investors and lawyers, were motivated by greed and conspired to line their pockets with Maker's assets.

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The Maker case is playing out like a Hollywood version of a story familiar to Silicon Valley upstarts, from the battle Mark Zuckerberg fought with Eduardo Saverin over Facebook to the tale of betrayal that led Twitter to oust co-founder Noah Glass. At stake is control of Maker at a key time, as the online video space transitions from novelty to monetization. "I wasn't allowed to be the CEO or on the board of directors," says Zappin, "because I was a creative."

Maker insiders say Zappin's allegations come as a surprise. "When we funded the company, it was on the condition that he wasn't going to be CEO," says Mark Suster at Upfront Ventures, a Maker board member and a co-defendant in the lawsuit. "During due diligence, we found out that he had a felony."

But Zappin says his drug-dealing past is just an excuse. "This is one of the hottest companies in L.A.," he says. "We went from a $5 million valuation to $200 million in two years. We were at 2 billion views last December, and now we've got 4 billion. It's growing and definitely one of the biggest successes for our [venture capitalists]. So I wasn't failing. Let's put it that way."

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Born in Columbus, Ohio, to a church-going family whose matriarch ran a Christian heavy-metal record label, Zappin consistently has teetered on the line between mainstream and rebel. He says he was a straitlaced kid who avoided drinking or drugs, but after a few semesters at Ohio State, he went to Florida for spring break, had a blast and just decided to stay. He enrolled at a local college and studied film and business, but he never graduated. During the mid-'90s, he moved around, first to New York and later to California, where a pilot he made for Comedy Central went nowhere.

When he got out of prison, Zappin connected with others who had discovered the viral potential of social media and started wondering whether there was a business to be built there.

"One day, Danny called me and said, 'I have this idea,' " recalls Scott Katz, who worked at Maker in the early days, mostly on clarifying the business plan and finding funding. "It was about getting all these YouTubers together and forming a United Artists for YouTube."

The vision to create a talent-run studio that would give its creators promotional, management and ad-sales support wasn't Zappin's alone. Donovan's LisaNova channel pre-existed Maker and became so popular that she appeared on The Ellen DeGeneres Show and MADtv. When Maker launched in Venice, Calif., in 2009, with only seven employees, she went in to $200,000 of personal debt to help finance the new company. (She later got a grant from YouTube, and Maker also was supported with a $60,000 brand deal with Sanyo lined up by Zappin.)

EXCLUSIVE: Ynon Kreiz Joins Maker Studios as Chairman

Some of Donovan's money was spent leasing a home in Venice so that YouTube star Carl, a comedian who was posting big-traffic videos like him playing "inappropriate Pictionary" with his children, could move to Los Angeles. That 419 Grand Blvd. residence became a kind of mecca for the YouTube creator-community, a digital media version of 1960s Haight-Ashbury or the Sunset Strip. "Every YouTube star you could think of came through that place and either partied or crashed," says Zappin, mentioning such YouTubers as Shane Dawson and Ryan Higa, among others. "And thousands of videos were made there. We eventually got rid of it because it was becoming a liability. Too many parties."

Maker's network continued to expand, and the founders marveled at the escalating traffic and subscriptions. Maker's primary channel quickly became known for its humorous sketch comedy, celebrity impersonations and personal video logs. "Every second, every refresh, the numbers were crushing," says Donovan. "It was the fastest sub gain any of us had ever seen. The YouTube community was going crazy for it."

To accommodate growth, in 2012 Maker moved into a new headquarters in Culver City and the previous year brought in business-oriented execs including COO Courtney Holt, the former MySpace Music president. But along the way, Maker's success created tensions. Zappin's repeated fights with top YouTubers including Ray William Johnson, The Fine brothers and Philip DeFranco are legendary at the company. Zappin also cites the "stressful" time as the reason that he and Donovan broke up. But perhaps what ultimately has affected Maker most was the decision to take money from venture capitalists.

"I was always against it," says Katz, who no longer works at Maker and is a co-plaintiff in the lawsuit. "Bringing on VCs comes with a price. The flip side was Danny explaining to me that we needed to grow fast. And bringing on the money allowed deals with bigger YouTubers who required guaranteed [advertising revenue shares]. In the VC world, once you take funding, you are on a path."

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That path eventually led to Kreiz, who invested in Maker in spring 2012, bringing a very different skill set.

The 48-year-old established himself as chairman and CEO of Fox Kids Europe, which he co-founded with Haim Saban in 1996. It became one of the fastest-growing pay TV channels before eventually being sold to Disney for $3.3 billion. In March 2008, Kreiz was tapped to run Endemol, the world's largest independent TV production company.

At the time, Endemol had been saddled with debt from a 2007 buyout. Kreiz's main task was restructuring, but amid the global financial crisis, Endemol struggled and Kreiz stepped down in June 2011.

Kreiz says that after the Endemol drama, he made investments in nine companies and became interested in the burgeoning YouTube ecosystem and multichannel networks (MCNs) like Maker. "I saw this space as a particular opportunity," he says. "I traveled to Los Angeles to study the opportunity. Maker stood out because of their programming and content DNA. The founders had great intuition about how to navigate the company."

Kreiz met with Suster, the VC player who had become one of Maker's key financial backers. "He said he wanted to invest," says Suster. "I said, 'Absolutely, but would you consider getting more involved?' "

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At the time, Maker already had surpassed 1 billion views a month and was developing partnerships with Snoop Dogg, Robert De Niro's Tribeca Enterprises and Kevin Smith in addition to hiring dozens of engineers focused on scaling the enterprise.

While the viewership numbers are impressive, what Maker cares about most is a metric called "RPM," or revenue per thousand views. The money can come from YouTube through its Google AdSense program or from direct deals with advertisers. On YouTube, Maker videos typically earn about a $1 to $3 RPM. But 45 percent of that goes to YouTube. And about 70 percent of the rest is turned over to the video's creators. (Less established talent needing more production and marketing support from Maker get a lesser share.) That leaves the margins for an MCN like Maker relatively thin.

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If Maker is going to be as big a business as, say, Breaking Bad network AMC, it must improve its returns. One way to do this is to increase the RPM rate. That might happen if ad buyers begin to price digital viewership closer to the way they value television eyeballs. Kreiz insists that it only is a matter of time before "parity" is reached, and the company now has 15 ad sales professionals intent on getting better RPM rates on channels like Epic Rap Battles. Maker also is able to negotiate brand-integration deals that don't require any sharing with YouTube. And the RPM economics also could improve as Maker lures its fans away from YouTube onto other distribution networks with more generous ad-sharing arrangements. With that in mind, Maker recently acquired Blip, a web series content platform.

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The other way for Maker to grow its business is to develop ancillary nonadvertising revenue -- using YouTube to test and establish brands but selling audiences merchandise such as hats and T-shirts (which it already does) or extracting licensing fees in the repackaging of content for Roku, Xbox or perhaps cable and satellite television (which it hasn't yet).

And that's where a media veteran like Kreiz can come in handy.

"The type of discussions we're having now are at an entirely different level," says Suster, pointing to the big companies like Canal Plus investing in Maker's C-round of financing. "We are not playing small ball. We're not just building a YouTube network. We believe this is a next-generation studio. We're not looking to sell to DreamWorks. We think we can build something that becomes a lasting part of the entertainment ecosystem."

Adds Greycroft's Dana Settle: "I think this has the opportunity to become the next major media company. That's what the investors certainly believe in. We were really fortunate to be in a situation where the founders brought a guy like Ynon on board to transition."

Still, other MCNs like Machinima reportedly are struggling. And some Maker observers believe there's great risk in being so closely tied to YouTube. For example, a blog post by entrepreneur Jason Calacanis in August predicted that YouTube soon would learn to adopt innovations such as talent collaborations and group sales, cutting out middlemen like Maker. "MCNs are toast," wrote Calacanis.

Despite these issues, the company maintains that its growth trajectory is on target. Although Maker won't provide exact numbers, Suster says that annual revenue is north of $100 million. "We are progressing ahead of track," adds Kreiz. "We have tripled our revenue last year and expect to triple again this year. Many companies that operate on the web don't have revenues at all."

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Watching all of this from the sidelines now is Zappin, who after making a Faustian bargain to give up some control of Maker in return for funding, still is trying to figure out when and how the company got away from him.

On April 16, he sent a resignation letter to the company's board requesting severance of stock vesting and six months of salary. He indicated his willingness to stay on as an adviser. Soon after, the board held a meeting and authorized Zappin's separation agreement, voting Kreiz into the CEO role. In what might be the biggest strike against his lawsuit, Zappin voted in favor of the move.

According to Suster, after the board meeting, Zappin changed his mind and demanded that he be given a senior executive role in order to "save the company." When the request went nowhere, Suster says that Zappin "became hostile."

But, according to Zappin's lawsuit, Kreiz was dissatisfied with merely being a board member and touted a plan to investors to turn the company into a billion-dollar power within three years but needed assurances he couldn't be fired. So Kreiz and the VCs "orchestrated a plan," alleges the suit, to approach Donovan and her brother Ben, another founder with significant stock holdings. In return for lucrative employment agreements, they would authorize the issuance and vesting of stock and an amendment to the board's composition to shift the company from one that favored the founders to one that favored the outside investors. The lawsuit says that had Zappin known the full details of the alleged scheme, he would have taken steps to stop it. (On the other hand, Zappin acknowledges that he was fine with a "succession plan" -- he just doesn't like how it all went down.)

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After the lawsuit was filed June 25, a furious board reconvened for a new vote to take away Zappin's seat. Nearly everyone -- the VCs, Zappin's ex-girlfriend Donovan and even talent who had been given small stakes in the company -- voted to get rid of him. Zappin, who continues to hold about 20 percent of the company's common stock and stands to make quite a bit of money if Maker ever goes public or is bought, was unable to do anything.

Adding a bit of mystery to the case, Zappin hints that something sinister occurred in the weeks following his resignation, but he won't speak specifically about it, promising that more about the "improper actions" will be revealed in his lawsuit. Others at Maker assert that everything that happened was aboveboard, that Zappin knew about the changes and gave them his full backing before having cold feet.

As the litigation plays out and Kreiz works the phones to line up partnerships, licensing and ways to lure advertisers, Zappin has had more time to reflect. He says that after launching the legal war, he withdrew from friends and family to his Venice home, preferring solitude. "I felt devastated," he says. On Oct. 17, he announced that he acquired the digital entertainment news website NewMediaRockstars, which chronicles upstart YouTube players -- companies like Maker Studios.

One day, Zappin is absolutely firm that nothing short of retaking Maker will suffice. The next, he says that "depending on how things go with the litigation, I'll either be going back to Maker or moving on to something else that's new and cool and maybe building something again from the ground up."