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The Business of Startups Is Business

As the economy slumps, many entrepreneurs are looking past consumer Web sites to focus on products and services for companies

As far as entrepreneur Dries Buytaert is concerned, a startup with smart ideas and driven people has a good chance of surviving, whatever the economic climate. "Make sure you have a solid business plan and you've done your homework and are passionate about what you are doing, and people will recognize your potential," says Buytaert, who in 2001 came up with a new way for people to collaborate online and publish Web content. His idea turned into Drupal, a project that draws together software developers from around the world who collectively tinker with and add features to the content management system made available for free.

Seven years on, as he tries to turn his idea into a successful business, Buytaert isn't taking any chances. He and fellow entrepreneur Jay Batson co-founded Acquia and have raised $7 million to help them in their quest to widen the use of Drupal. More than 700 contributors now work on some 2,000 features for the so-called open-source software, which is used by Sony BMG Music, Warner Music Group (WMG), Forbes, The Onion, Harvard University, Time Warner's (TWX) AOL, Amnesty International, and more than 250,000 other companies to manage their Web sites.

Buytaert is among a handful of innovators who are building businesses and products aimed at other companies and who were identified in a survey of venture capitalists and BusinessWeek editors and readers as some of this year's most promising young technology entrepreneurs. Many of these 30-and-under innovators buck the trend that has lured scores of entrepreneurs to green technology and consumer-focused online services, such as social networks and so-called widgets that let Web users append games, videos, and the like to personal profiles.

"Natural Evolution"

To be sure, venture capitalists are still eagerly funding startups specializing in green tech and the class of consumer-facing online businesses grouped under the Web 2.0 heading. Clean-tech companies garnered $2.52 billion in funding last year, a 79% increase from 2006, according to Dow Jones VentureSource. Web 2.0 businesses raised $1.34 billion, an 87% increase from 2006. By contrast, startups focused on information technology for enterprises raised $1.98 billion, an 18% decline from 2006.

Still, some of the most promising startups are eschewing products that have a faddish, me-too look and feel, attempting to form companies they hope will have a more lasting business model, say venture capitalists. "You are starting to see the Internet and small business become an interesting area," says Jeff Fagnan, partner at Atlas Venture, which this year plans to "fund multiple investments" in companies that cater to businesses. "As certain areas of consumer Internet are becoming saturated, it's the natural evolution."

In the second half of 2008, Acquia will release a new, souped-up version of Drupal software and make it available to companies for free. Buytaert will try to make money through sales of related support services. In December, Acquia raised its funding from North Bridge Venture Partners, Sigma Partners, and O'Reilly AlphaTech Ventures. "For a while, people were not focusing on infrastructure and applications for the Internet, but now it's popular again because there's real pain and real need there," says Michael Skok of North Bridge Venture Partners.

Business Networks

Some startups and their funders are focusing on business-focused ventures to hedge against economic travails that could damp demand for green tech or consumer-specific services. "No one sector is leading the way as they did in the 1990s," says Alan Spoon of Polaris Venture Partners. Inspired by a resurgence in crafting and a desire to sell his own handmade furniture, Robert Kalin in July, 2005, launched Etsy and built it into the world's largest online marketplace for sellers of handmade crafts (, 7/23/07). The company boasts more than 73,000 active sellers who last year sold almost 2 million items worth $26.5 million. In January, Etsy raised $27 million from Jim Breyer at Accel Partners, Union Square Ventures, and Hubert Burda Media.

OpenDNS caters to larger companies. Headed by David Ulevitch, 26, OpenDNS helps more than 4 million consumers and organizations, including 10,000 schools, block inappropriate Web sites and protect their computers from spam and phishing schemes. OpenDNS identifies "bad" sites using a database, EveryDNS, which Ulevitch created in 2001 and made open to developers who in turn submit and verify names of harmful or malicious Web sites. OpenDNS makes its service available for free but generates revenue through a partnership with Yahoo! (YHOO) to show ads to users. Amid the housing and credit crises, "free is certainly the right price," Ulevitch says, with good reason. The less than two-year-old company is profitable.

Ad Revenue

The OpenDNS business model underscores another theme unifying some of the most successful innovators: generating revenue through ads. Online advertising is expected to rise 22.7%, to $25.9 billion, in 2008, according to market research firm eMarketer. "Advertising is where most of [today's Web entrepreneurs] plan to make money," says Tracy Lefteroff, global managing partner of venture capital and private equity at PricewaterhouseCoopers.

Founded in 2005, New York's Phreesia developed a handheld tablet that helps health-care providers collect and manage patient information. Co-founders Chaim Indig and Evan Roberts make the device available to doctors at no charge. Physicians use the tablets in place of traditional clipboards for patient check-in. Phreesia makes money by selling ad space to such companies as pharmaceuticals makers that want to reach those patients via the digital tablet. Phreesia, which raised a total of $13.25 million in funding from HLM Venture Partners, Long River, Polaris Venture Partners, and Village Ventures, supports more than 1,000 doctors and is adding 300 to 400 new doctors a month, Indig says. The company expects to record more than $10 million in ad revenue this year.

As the economy slows, companies like Phreesia that are generating sales and cobbling together a workable business model may very well continue to attract the attention of increasingly selective venture capitalists and the customers—be they consumers or companies—they so desperately crave. Says Fagnan of Atlas, "A lot of the best technology companies were actually built in an economic downturn."

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