Back in the fall of 2000, the buzz at the Internet World conference centered on two things: the NASDAQ meltdown and a number of acquisitions. One of the big acquisitions announced at the show was HP's deal to purchase Bluestone Software for $450 million. With VC money left to burn before the acquisition closed, Bluestone threw a huge party, renting out the entire U.S.S. Intrepid museum, hiring several popular bands to play below decks in the massive aircraft carrier, and inviting anyone and everyone at the conference to the blow-out party.
A move like that would be unheard of today. Not just because that kind of reckless spending is now frowned upon, but also because few startups will have raised excess VC money that is burning a hole in their corporate pockets.
The 2000s, despite the dotcom crash, was a decade of big VC investments. The blueprint for startups went like this: Come up with an idea that involves the Internet, raise a significant amount of VC money, work in secret for a year or two to develop a beta product and then begin raising serious money in the expansion round, a funding round used to get a working product out of the lab and into the market.
Venture Capital Today
Fast forward to today. VC money isn't drying up, but few companies are getting those big expansion-stage investments of 10 years ago. Today, big money flows in after a product has been developed, not before. When money pours in to an early stage social media company like Quora (whose founders are Facebook alums), the company has an actual product or service, not just a concept, to pitch investors. Then, the real money come in later, to established startups like Twitter or DropBox, which don't just have fully formed services, but which have also already attracted hordes of loyal users.
In the early 2000s, investors funded science projects. Today, VCs fund the scaling up of already successful companies. Any fliers are made on early stage startups, but even many of them are considered fairly safe bets.
This shift isn't just because VCs have become more rational in their investments; it's also because plenty of startups don't go looking for money until they are already pretty far along in the product development cycle.
Andy Yang calls this the "barbell effect." Yang was formerly a VC with BlackBerry Partners fund, and he is now the managing director and "chief innovation hunter" for Extreme Startups, a tech accelerator. "Startups have more options today," Yang said. "There are more angels, accelerators, incubators and even micro-VCs. Startups are scaling more from angel funding and delaying taking on big rounds until much, much later. Some have been able to forgo funding all together."
Cloud Computing Empowers Startups
The main reason startups can postpone or turn down VC money is cloud computing. With SaaS and the cloud, startups no longer have to make big capex investments to develop a product. Instead, money is spent on two things: talent and opex. Startups pay for what they use and nothing more.
"It's easier, cheaper and faster to start a company today," said Deborah Farrington, general partner at StarVest Partners. "Overhead costs are much lower, and for certain consumer-facing startups, especially in social media, viral adoption becomes almost part of the business case. These companies don't even seek funding until they have a large base of dedicated users."
Amazon Web Services, Google Apps, Salesforce.com, Radian6, LinkedIn and a slew of other cloud-based services have given anyone who has an idea for a startup the tools to launch it on the cheap.
A good then vs. now comparison is to look at supercomputing. A few years back, grid computing startups attracted major VC investments. Univa was founded in 2004 and took on an $8 million round of Series A funding in 2005 to get its product out the door. Around the same time, Jason Stowe was in the process of founding the high-performance computing startup, Cycle Computing . Cloud computing had not yet become an overhyped buzzword, but Stowe knew that the technology landscape was changing. Stowe decided to see if he could skip VC funding altogether.
He launched Cycle Computing not with $8 million, but with $8,000 of his own money. The low development costs translated into lower costs to end users, which, in turn, made the process of acquiring customers that much easier. "Last summer, we spun up a 30,000-core supercomputer cluster [using Amazon EC2] for a pharmaceutical client. We ran it for eight hours, using it for drug discovery, and then shut it down. The bill to the client was $8,500," Stowe said. "Today, any biotech startup can access something that would have cost $10-15 million to build yourself just a few years ago."
Zohar Alon, CEO and co-founder of cloud security startup Dome9 tells a similar story. "When launching my first startup in 2006, equipment was required and it was expensive. Servers in the office and, of course, hosted long-term leased servers were needed. We had to operate a lot of the systems ourselves Â source control, help desk applications and a corporate Wiki Â and it's not just the increased upfront cost that hurts you, but the energy wasted on managing, maintaining and securing these systems."
Alon contrasted that experience with the founding of Dome9. "We relied on cloud and hosted services for everything we could. We used [co-founder Roy Feintuch 's] living room as our base for the first nine months, until a friend volunteered a 20'x20' space where we stayed until we got funding," he said. "The distributed nature of SaaS services allowed that to happen, and many of the tools we used when we started the company are the same ones we're using today."
Alon provided a long list of cloud and SaaS services that helped him start his company on a tiny budget. These include Rackspace for testing and development, Pingdom for service monitoring, Loggly for app monitoring and hosted repositories, MailChimp for customer newsletters, and Uservoice for support and help desk services.
In other words, tools critical to the entire business cycle, from development to testing to sales and marketing and on through to customer support, can now be consumed on-demand as services.
Outsourcing Means You Don't Have to Be Technical
When lawyers Tom Zuber and Olivier Taillieu founded LawLoop.com, not only did they take advantage of the cloud, but they also outsourced much of the software development to overseas coders. "I doubt we could have done this 10 years ago," Taillieu said. "We're entirely self-funded. With the cloud and outsourcing, startups can take advantage of huge economies of scale, while also having the ability to work without borders. Through the cloud, enormous processing power is now in the hands of people all over the world."
All of this adds up to a much more level playing field for potential entrepreneurs. If you see a problem and think you know how to solve it, you can sign up for some cloud services, hire some cheap overseas coders and be on your way in no time. "People think about entrepreneurship at a much younger age today," VC Farrington said. "There are more role models and they aren't as remote as past success stories."
The democratization of entrepreneurship doesn't mean VCs should start looking for other work. At the early stages, VC networks can be instrumental in finding and attracting talent. Later, the cash infusions are necessary to build out sales and marketing.
"With barriers falling everywhere, it's harder to differentiate yourself," Farrington said. "It still takes money to break through the clutter, scale up sales and marketing and demonstrate to the market that you are substantially different from competitors."
Most successful startups will still take on VC money at some point. What's different today is that they have more options, can put it off longer, and often don't need it until they've already achieved a degree of success. That's a good thing all around. For startups, they get better valuations. For VCs, the odds that their investments will pay off are better. And for everyone else, the cloud is ushering in a golden age of innovation.
Jeff Vance is a Los Angeles-based freelance writer who focuses on next-generation technology trends. Follow him on Twitter @ JWVance.
Read more about software as a service (saas) in CIO's Software as a Service (SaaS) Drilldown.