Tech Startups Go Lean as Software, Storage Costs Drop

To start their company and get its first product out the door, the founders of software maker 280 North Inc. needed little more than a half-dozen computers and a roof overhead.

Francisco Tolmasky, Ross Boucher and Tom Robinson kept costs in check by using code available free on the Web and renting storage on the cheap from Amazon.com Inc. Expenses are about $4,500 a month, and the San Francisco company -- two years after getting off the ground -- is close to making a profit.

From Silicon Valley to New York, technology startups are tapping individual investors, friends and their own savings to fund operations and product development. That helps owners keep greater control of their companies and more of the equity. After only raising about $100,000, 280 North says it has plenty of cash to get another product to market.

“The biggest line item in these companies now is rent and food,” said Chris Sacca, a former Google Inc. executive who has invested in 280 North and other early-stage startups. A decade ago, “I don’t think you could write a line of code for less than $1 million,” he said.

That means there’s less demand for big venture investments. The size of the average venture round has shrunk by half to $6.3 million since the dot-com bubble in 2000, according to the National Venture Capital Association in Arlington, Virginia. The figures don’t include smaller financings, known as angel investments, that often aren’t made public.

Cheap Technology

Startups are getting by on less because they don’t need to pay for software from Microsoft Corp. and Oracle Corp. -- free programs are available from Google and the open-source community. And instead of using servers and storage from International Business Machines Corp. and Hewlett-Packard Co., they can pay much less for Web-based services from Amazon.com and Rackspace Hosting Inc.

Foursquare Labs Inc., a New York startup that lets people share their whereabouts via mobile phones, has parlayed an angel investment into a business with more than 1 million users. And San Francisco’s Flowtown Inc., a maker of software for businesses, used money from friends and family to establish a customer base of 7,000.

The large venture capital firms typically don’t make those kinds of investments, since they’re aiming for bigger bets and bigger returns. Firms such as New Enterprise Associates, Norwest Venture Partners and Khosla Ventures have raised billion-dollar funds in the past year.

Smaller Checks

Sacca took a different approach when he started his firm, Truckee, California-based Lowercase Capital. He realized that if Web companies only need him to write checks of $25,000 to $100,000, a much smaller fund made sense. So he raised a pool of less than $10 million.

SV Angel, a firm run by Ron Conway, follows a similar philosophy. It raised a $20 million fund. Another early-stage investor, Mike Maples, says that for startups “$500,000 is the new $5 million.”

The bootstrapping trend is depriving large venture funds of some of the most promising potential investments, says Steve Blank, an eight-time entrepreneur who teaches classes at Stanford University and the University of California at Berkeley.

“If you’ve got a billion-dollar fund, there’s no way the math works for you to put half a million dollars to work,” Blank said. “The most exciting and profitable areas the past couple years have been Internet startups, which structurally, the big guys with the billion-dollar funds can’t attack.”

Apartment Rental

280 North began with a $20,000 investment from Y Combinator, a startup incubator that runs three-month programs to help its companies meet people in the industry. After going through the program in early 2008, the company’s founders rented an apartment together in San Francisco’s Haight-Ashbury district.

The founders, all in their mid-20s, studied engineering together at the University of Southern California in Los Angeles, where they built a program for developers to create Web applications. The free software, called Cappuccino, has been downloaded more than 100,000 times.

In December, 280 North started selling a test version of a product called Atlas that lets programmers quickly build graphical Web apps without needing to write code. The company plans to release the next version of Atlas this year and generate enough revenue to be profitable.

“Given the technology, it’s clear to us that this is not something that needs big venture capital,” said Tolmasky, who worked with Boucher at Apple for two years before starting 280 North. “We don’t need any sort of sophisticated hardware.”

Facebook, Twitter

Not all Silicon Valley startups are shying away from large investment rounds. Facebook Inc. has raised over $700 million in the past five years. And Twitter Inc., Zynga Game Network Inc. and Chegg Inc. have each raised more than $100 million.

Still, to get into startups when prices are cheap, investors have to write smaller checks than in the past, says Geoff Yang, a founding partner at Menlo Park, California-based Redpoint Ventures. The amount his firm expects to invest in a typical Internet or software company has declined by 60 percent over the past decade, he says.

“An increasing trend is big funds like ours banding with angels and writing small checks just to try and get a foot in the door,” said Yang, whose previous investments include MySpace and TiVo Inc.

Twitter Offices

On about $100,000, Flowtown has rented space in Twitter’s San Francisco office building and created a product for small businesses and nonprofits. Flowtown’s software helps companies communicate with customers by using data from social networks like Facebook.

While Flowtown reached profitability last year, founder Ethan Bloch says the three-person company is still searching for its business model and using customer feedback to find glitches and improve features. Rather than raise money now to expand, Bloch wants to have a clearer sense of where the company is going. He’s in no rush.

“It was extremely cheap to get this first iteration of Flowtown up,” said Bloch, 24. “We want to get to a point where we really feel confident that we’ve found the model. That would be better for Flowtown and our potential investors.”

To contact the reporter on this story: Ari Levy in San Francisco at alevy5@bloomberg.net

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