Google, the internet search giant, has agreed to acquire YouTube, the California-based video start-up, for $1.65bn in an all-stock transaction that will turn the company’s 20-something co-founders into instant multi-millionaires.

The deal makes YouTube – which has yet to turn a profit but which has grown into one of the most popular internet destinations with 100m daily video viewings – the first site dedicated to user-generated content to be sold for more than $1bn, setting a new price level for the sector.

“The YouTube team has built an exciting and powerful media platform that complements Google’s mission to organise the world’s information and make it universally accessible and useful,” said Eric Schmidt, Google chief executive. “Our companies share similar values; we both always put our users first and are committed to innovating to improve their experience. Together, we are natural partners to offer a compelling media entertainment service to users, content owners and advertisers.”

Google said the start-up would retain separate offices and all its 67 employees.

In spite of YouTube’s popularity there have been questions about the sustainability of the company in light of the large amount of illegally copied material viewed on the site and limited advertising revenues to date.

However, YouTube has struck deals with big US media companies to legitimately distribute their video content – three were announced on Monday – reducing the threat of copyright lawsuits.

Chad Hurley, YouTube chief executive, said the acquisition would allow the company to “sharpen our focus” in working with content providers to overcome the copyright issue.

In addition, Google’s technical expertise and clout with advertisers could turn YouTube into a highly profitable venture, especially as advertisers increasingly look to target the young audience which is spending less time watching television and more time watching videos on sites such as YouTube.

“Large advertisers are looking to spend more money with Google,” said Ben Schachter, analyst at UBS. “Video is a major focus, and YouTube increases [Google’s] inventory.”

The deal is one of Google’s biggest acquisitions in its eight-year history. It marks a tacit admission by Google that the search group’s own video site has failed to gain the same traction among its audience as YouTube.

“When we looked at the marketplace, there was a clear winner in [the] networking and social networking side of video,” said Mr Schmidt.

The deal follows the acquisition last year by Rupert Murdoch’s News Corp of MySpace.com, the social networking site, for $580m in cash, at the time considered a hefty price for a media start-up but now widely regarded as having been a good investment in order to tap the online youth audience.

Facebook, another social networking site which has also grown hugely in terms of its online audience, has also had talks with media and internet companies about a possible acquisition.

YouTube signed deals on Monday to offer music videos from Vivendi’s Universal Music Group and Sony BMG Music Entertainment, as well as television content from CBS, sharing any related advertising revenue.

YouTube has had acquisition talks with a number of media companies. A deal would make Mr Hurley and Steve Chen, its other co-founder, multi-millionaires.

Chad Hurley has the drawn face and chalky pallor that have become almost a mark of honour for internet entrepreneurs in their early days. If too little sleep is to blame, it would not be surprising.

YouTube, the online video-sharing site he launched in December with Steve Chen, chief technology officer, has hit the sort of popular culture nerve about which most people in his position only dream. Less than a year after its launch, YouTube has become the first site to turn online video into a mass market business, streaming more than 100m short videos a day to an audience of more than 30m in the US alone.

The object of takeover advances from some of the biggest internet companies almost from the moment it was launched, YouTube has recently received a flurry of new bids that could mean it will finally agree to be bought out.

With things moving that fast, who has time to sleep?

What is taking shape in YouTube’s cramped offices above Amici’s pizza restaurant in San Mateo, a suburban wasteland south of San Francisco, has transfixed the television and music industries.

Depending on whom you listen to, this could become the first big new media company to grow out of the web’s Next Big Thing: user-generated video. Alternatively, it could turn out to be the next Napster, an out-of-control network for sharing copyrighted material that draws the legal fire of the established media industry.

Mention of the defunct file-sharing network that opened the gates to mass online piracy draws an instant response from the 29-year-old YouTube chief executive. In an interview late last month, Mr Hurley gave the Napster comparison short shrift. “I think it’s not even a close comparison,” he said. “Napster was a black market for music.”

YouTube, on the other hand, is for teenagers who want to air their angst or show off their talents as home-movie makers. “The more popular users on our site are people who are just telling their stories. It’s almost the ultimate form of reality television,” he said

That is not how Doug Morris, head of Universal Music Group, put it last month. He attacked YouTube and MySpace, the social networking site, as “copyright in-fringers [that] owe us tens of millions of dollars.”

According to this view, YouTube’s users are stuffing its servers with copyrighted music videos, clips of TV shows and other material. Even kids lip-synching to their favourite songs in their bedrooms are distributing music without permission.

Mr Hurley has certainly shown none of the hubris that turned Napster and a generation of peer-to-peer networks into mortal enemies of the entertainment industry. He controls his words carefully, always staying “on message” – that YouTube is trying to become a partner of the media giants, and could become a massive new marketplace for entertainment companies to reach their audience.

The YouTube founders have already seen first-hand the sort of internet killing they could look forward to if they play their cards right. They both got their first taste of it at PayPal, the online payments service that was later bought by eBay. (Mr Hurley was the 15th employee and the first de-signer hired by PayPal.)

Like both of those internet companies, he now claims that YouTube is the beneficiary of “network effects” that mean the bigger the site’s audience becomes the more success will feed off itself. The exhibitionists who post their home videos on YouTube are drawn by its large audience, and the content then serves to draw even more viewers.

The question now for Mr Hurley and Mr Chen is whether they emulate PayPal in one other respect: by selling out to a larger internet company. Barely two weeks ago, the YouTube chief said his company had not been involved in any acquisition talks and seemed adamant about staying independent. “We’re just going to continue to build the business on our own,” he said.

YouTube’s choice of its venture capital backers – Sequoia Capital, the same firm behind PayPal (as well as one of those behind Google and Yahoo) – reflected that desire not to sell out too early, he said. “That’s why we went with Sequoia . . . They’re not a VC that builds small companies.”

Since he spoke those words, though, YouTube has been on the receiving end of fresh acquisition overtures from Google and others. With offers said to be in the region of $1.5bn-$1.6bn, Mr Hurley’s independent streak will be severely tested.

Meanwhile, YouTube still needs to prove that there actually is a business to be built from the odds and ends of video that turn up on its site.

It must also convince entertainment companies that this can be a mutually beneficial endeavour.

In recent weeks, the video site has started the process of trying to find a formula for making money from its burgeoning audience – not least because the costs associated with distributing its videos are also rising fast – though Mr Hurley, while not giving details, insists that the company is at least financially “stable”. One example: a video promoting a new CD from Paris Hilton on a sponsored “brand channel” – a specially designed YouTube page that allows users to view branded content.

Mr Hurley is adamant that the company does not intend to resort to “pre-rolled” ads, the short commercial messages that some sites force their users to watch before seeing a video.

He also says that YouTube is not going to turn to a company such as Google, as MySpace recently did, to deliver ads to its site. Such deals have become a popular way for fast-growing websites to cash in on their new audiences.

“We have an opportunity to develop our own ad system,” says Mr Hurley. “We’d love to move forward on that and not let an easy ad deal distract us.”

It is still unclear what advertising on YouTube will look like or what ways the site will find to let advertisers engage with its audience. But, with its own online advertising network, Mr Hurley says YouTube will also be in a better position to meet the requirements of mainstream consumer advertisers. “Google has a great product. They’ve built a great business but it’s a different world when you’re truly, truly dealing with brand advertising.”

For now, some media companies at least appear willing to give Mr Hurley and Mr Chen a chance to prove their case.

In a breakthrough for the company, Warner Music signed a deal with YouTube last month that potentially lets both companies share revenue from advertising generated by the music group’s content posted on the website.

YouTube claims to have developed software that can identify copyrighted music in the videos submitted by its users. Warner will be offered the choice of having the material removed from YouTube or sharing in any income the company can generate from the video.

Ultimately, this points to the bargain that Mr Hurley hopes to strike with the entertainment industry. “We’re preparing them to stay relevant in this new market, with this new wave of content that’s going to be coming online,” he says. “There are different technologies that we’re building that help them identify their content. But it does require them to work with us.”

As the different stances struck in recent weeks by Universal Music and Warner Music show, it is too early to tell whether that is a message the entertain-ment world is ready yet to accept.

Politicians have yet to wake up to the impact of the internet, which will expose them to online “truth predictor” tests and affect the outcome of general elections, the head of Google said on Tuesday.

In an interview with the Financial Times, Eric Schmidt, the chairman and chief executive of the most popular internet search engine, said his speech to the conference of the UK’s Conservative Party on Tuesday was part of a global mission to educate political leaders.

“Many of the politicians don’t actually understand the phenomenon of the internet very well. It’s partly because of their age ... often what they learn about the internet they learn from their staffs and their children,” Mr Schmidt said.

The current “TV generation” of political leaders had learned to “switch on” and perform in front of the cameras and most were now aware of the internet’s importance, he said. But he argued they had yet to grasp the technology’s implications, not least in terms of the power it hands to voters, posing the question: “If television created this generation of politicians, what will the internet do to the next generation of politicians?”

“The internet has largely filled a role of funding for politicians ... but it has not yet affected elections. It clearly will,” he forecast. This electoral impact would manifest itself relatively quickly in Britain, where, he said, the internet was “exploding”. He added: “Given the take-up rate of broadband and the number of people online – it will happen here.”

He forecast that, within five years, “truth predictor” software would “hold politicians to account”. Voters would be able to check the probability that apparently factual statements by politicians were actually correct, using programmes that automatically compared claims with historic data, he said.

Politicians “don’t in general understand the implications” of the internet, Mr Schmidt argued. “One of my messages to them is to think about having every one of your voters online all the time, then inputting ‘is this true or false?’ We [at Google] are not in charge of truth but we might be able to give a probability.”

Mr Schmidt hailed George Osborne, shadow chancellor, as the “voice of the new generation” – an accolade that will be seen as adding to the coup the Tories scored by persuading the Google boss to address their conference.

Google is an apolitical company and Mr Schmidt’s address to the Conservatives’ seaside gathering was not an endorsement of the party, he stressed. Mr Schmidt pointed out he also enjoyed a “very nice meeting with Tony [Blair]” in Downing Street on Monday during what was literally a flying visit to the UK – Mr Schmidt piloted his own Gulfstream jet to Bournemouth.

The Silicon Valley leader’s praise for the section of Mr Osborne’s address that contrasted the Tories’ youthful leadership with the older Labour cabinet gilded a rhetorical point that the shadow chancellor had already made to delegates. Citing the prime minister’s reference last week to the “Google generation”, Mr Osborne boasted: “This week, the Google generation got the guy who runs the company to come and speak to us.”

Mr Schmidt declined to be drawn further into commenting on domestic politics. He was asked by the FT about the technological awareness displayed by John Prescott this summer when the deputy prime minister said: “I think it’s called the internet or something – blogs is it? – I don’t know, I’ve only just got used to letters.” The Google boss was diplomacy personified, stating: “Not knowing him, it sounds like a great opportunity for us to go visit him.”

Mr Schmidt had earlier won thunderous applause from delegates, injecting some much-needed excitement into the conference by portraying Google as being “built around wow moments” – a dynamic the Tories would love to replicate.

Google is suddenly a two-product company. Its $1.6bn (£880m) acquisition of YouTube, which makes it a major force in video networking as well as searching, provides a number of interesting lessons.

The first is how difficult it has proved for even the most successful dot.com companies to do the same trick twice - to replicate their initial success by developing another company organically in a different growth zone.

Google has spawned lots of interesting services, some of which I am a huge fan - such as Google Mail, Google Earth, video, blog-search spreadheets. But none has achieved the critical mass that Google itself has with searching, where it has more than 50% of the market. (Incidentally, I notice that the spell checker in the newly revamped Writely word processor - now owned by Google - doesn't recognise the words "blog" or "Google" in its dictionary.)

Google's move mirrors that of Yahoo!, which is gobbling up other companies such as the photosharing website Flickr.com. Yahoo!'s own photo site, though much larger than others a year or two ago, could not go the extra distance faced with competition from upstarts such as Photobucket and, on a lesser scale, Flickr.

The moral? If you want to use the leverage of your market position to create other success stories, make sure - like Microsoft, with Word and Excel - that you have an unassailable monopoly first.

The flipside of this argument is how wonderful it is that in the new age of dot.com giants it is still possible for two guys in a garage to beat them at their own game. It happened with Photobucket and Flickr, it happened with MySpace (and all the other social networking sites) and it has happened with YouTube. A year ago, Yahoo! was reckoned by Hitwise to have over 80% of the video download market. Now YouTube has almost 50%. Not bad for a year's work.

YouTube is a particularly interesting phenomenon. Viewed in isolation, it looks ridiculously overvalued as it doesn't make any money to speak of and only has a recently nurtured "community" side to keep punters locked in. Google has discovered a brilliant way of printing money by planting discreet adverts on our web pages. Now it has 100 million video views a day to aim at. It is a good each-way bet. If it succeeds it will make pots of money. And if it fails and eye-loose YouTubers migrate elsewhere, then Google has only used overvalued shares to pay for the site while also preventing it from getting into the hands of a rival such as Yahoo!.

The success of YouTube underlines the importance of critical mass over a mere business model. There are other sites, such as Revver, that are much better than YouTube for the consumer as they give the person who uploaded the video a 50% share of any advertising revenue generated when a viewer clicks on an advert at the end of a video. Despite not giving users any such financial return, YouTube powered ahead to the stage where growth simply fed on itself.

But for how much longer? The fact is that the YouTube assets that Google has purchased consist of zillions of amateur videos uploaded by you and me, plus others ripped off from television and films. Without these community-owned assets, YouTube would be nothing. We hear a lot about user-generated content, but not enough about user-owned content. If I were Google I would do something about that pretty quickly.

A couple of weeks ago, Mavericks owner Mark Cuban said that only a 'moron' would purchase YouTube. Google's leadership has proven to be anything but, as the company has grown to become a multi-billion dollar Internet landmark. Not a bad gig for its very young founders, Larry Page and Sergey Brin.

The reason Mark Cuban labeled the purchase in such harsh terms has largely to do with the potential legal liability that permeates YouTube. Although much of YouTube's content is mind-numbing antics performed by teenagers with considerable time at their disposal, an extensive portion is copyrighted material. YouTube recently found itself in marginal trouble with NBC Studios for hosting the Saturday Night Live skit 'The Chronic of Narnia.'

But that trouble passed when NBC simply asked YouTube to remove the infringing material. The video downloading website complied, and within days the event was a mere memory. However any YouTube aficionado knows the extent of copyright material, if we consider every instance regardless of length, is comparable to many online communities accused of copyright infringement. Content holders with an axe to grind may be itching for the opportunity to strike at Google.

In Mark Cuban's blog, he points out the potential legal problems stems from a technicality on YouTubes part – the site isn't truly a streaming site. Rather, it's a 'progressive downloading' website. With enough marginal computer skills, any YouTube fan can easily download scores of TV show clips and distribute them as he or she wishes.

“Its obvious what Youtube is trying to do. They are trying to push the obligation of licensing rights out on the rights holders by hiding behind the Safe Harbor rules of the DMCA. Make the rights holders find the copyrighted materials out of 60k uploads a day rather than make Youtube find the copyright owners of the materials uploaded. “

“As I have said many times, that 5h!t aint gonna fly. I don't think so, and neither does a long, long list of copyright owners. We aren't just talking big media companies. We are talking fake a lawsuit companies.”

Mr. Cuban is quite confident that Google's YouTube venture is heading for deep trouble. Yet that hasn't happened, and the speculation that it might happen just because Google has poured 1.65 billion into YouTube remains just speculation. Perhaps YouTube has avoided the wrath shared by commercial P2P operators considering the site is not currently a money making enterprise. But Google plans to change all that.

YouTube will likely have the same look and feel once Google takes over. Their corporate offices will remain in San Bruno, California, and no one will be laid off. However Google will begin incorporating advertisements into YouTube – the typical non-intrusive ads that Google has been known for.

“With Google's technology, advertiser relationships and global reach, YouTube will continue to build on its success as one of the world's most popular services for video entertainment.” Google stated in a press release.

How much does Google's video aspect grow? According to comScore, it's quite substantial, yet not quite the blockbuster some are making it out to be.

“While one research company has touted market share of visits to a few online video sites as a key metric with which to evaluate the transaction (reporting that YouTube has a 40 percent market share), comScore considers this to be misleading, especially when evaluating the impact of Google's acquisition. Analyzing the transaction using share of visits suggests that all visits to video sites are equally valuable - but how can that be true? For example, one visit might result in only one video stream being viewed, while another visit can result in 20 video streams being viewed. With the potential to insert an ad in every stream, clearly all visits are not of equal value when considering the advertising potential of any site that offers streaming video. The problem is compounded if market share is measured only within a few select sites and not across the entire Web.”

Self-glorifying intentions aside, comScore brings up an interesting point. In other words, it may be true that YouTube draws in a significant amount of traffic, but what good is that traffic if a small proportion actually downloads videos? According to comScore, the following chart represents the breakdown of the top video website market share:



As we see from the chart, YouTube is the #3 site in terms of traffic. However the share of those who download is actually smaller than Yahoo! and MySpace. The incorporation of Google however will, by comScore's calculation, increase Google's presence by 'ten fold.'

Google isn't run by morons, and the risk of potential lawsuits had no doubt been calculated and recalculated immeasurably. Google's biggest risk may not be potential lawsuits, but whether their advertising campaign will be successful.