Investors Check In With Big Bucks for Location-Based Deals

It's nearly impossible to keep a secret in Silicon Valley -- especially when it comes to new fundings of hot companies. This was definitely the case with Andreessen Horowitz taking part in a $20 million venture round for Foursquare.

Oh, and there was buzz that Facebook and Yahoo (YHOO) tried to buy the scrappy startup. But why sell too soon?

Simply put, Foursquare operates a mobile service that allows you to check in to a place, such as a restaurant, store or nightclub. It combines the power of social networking with the growth in smartphones.

While it may seem somewhat silly, the market for location-based services (LBS) is likely to be enormous. And investors are opening their wallets to get a piece of the action, which will escalate valuations. The rumor is that Foursquare's round came at a post-money valuation of $115 million.

That's impressive for a company that got its start in March 2009 and has only 1.8 million users. However, it's gaining 15,00 new users every day, which is apparently faster than Twitter's pace in its formative stages.

What's the Point of All This?

The LBS market isn't new. The early adopters were enterprise customers, such as UPS (UPS) and FedEx (FDX), which needed to find cost-effective ways to track things like parcels or inventory. It wasn't until the late 1990s that LBS came to consumers through the Palm "personal digital assistants." Since then, adoption has been fairly slow, and the market remains a niche.

But this may be on the verge of changing, especially with the surge in demand for smartphones and the popularity of Apple's (AAPL) iPhone.

As a result, a variety of startups are trying to capitalize on the market. Besides Foursquare, other players include Loopt, Gowalla, Booyah and BrightKite. Even Twitter and Google (GOOG) have their own offerings. And Facebook is planning to launch its own version.

To build user engagement, LBS applications often leverage gaming techniques. For example, if you frequent a gym, you'll earn a badge. Or, in the case of Foursquare, you may become the location's "mayor" if you have the most check-ins. Next, LBS providers will may also offer incentives, such as free products or discounts. Companies like Starbucks (SBUX) and Ben & Jerry's have already participated in these kinds of promotional campaigns.

A Growth Gusher?

According to Borrell Associates, local business spend over $60 billion in advertising. The estimate is that by 2011, about $15.9 billion will be local online advertising, up from $8.7 billion in 2007. Of course, a big beneficiary of this market has been Google.

But LBS offerings could be another growth gusher. Smartphone apps allow for a scalable way to connect customers with businesses -- creating highly valuable databases. These systems can then provide targeted advertising. In fact, the business model could prove much more lucrative then traditional social media.

However, LBS has a big problem: privacy. Do you really want hundreds or even thousands of people to know where you are? Suppose you're out-of-town and your house is empty. Could it be burglarized? Or if someone knows you're alone, could you be stalked?

As LBS offerings grow, these issues will only get more complicated. Ultimately, it may mean that users will be much more circumspect about who they allow in their network, which could stunt growth. At the same time, politicians and regulators could step in as well. Social networks have been able to deal with privacy problems (but not without controversy -- just ask Facebook). But LBS may test the ultimate limits.