Startups Cater to Startups as Funding Rebounds to 2008 Level

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Pedestrians walk past the headquarters building of Facebook Inc. in Palo Alto, California, U.S., on Wednesday, Jan. 19, 2011.

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Photographer: Tony Avelar/Bloomberg

Pedestrians walk past the headquarters building of Facebook Inc. in Palo Alto, California, U.S., on Wednesday, Jan. 19, 2011. Close

Pedestrians walk past the headquarters building of Facebook Inc. in Palo Alto, California, U.S., on Wednesday, Jan. 19, 2011.

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Co-founder and CEO Solomon Hykes of DotCloud at his South of Market Street offices, in San Francisco. Close

Co-founder and CEO Solomon Hykes of DotCloud at his South of Market Street offices, in San Francisco.

Photographer: Michael Macor/San Francisco Chronicle via Bloomberg

Co-founder and CEO Solomon Hykes, of DotCloud at his South of Market Street offices, in San Francisco. Close

Co-founder and CEO Solomon Hykes, of DotCloud at his South of Market Street offices, in San Francisco.

Photographer: Michael Macor/San Francisco Chronicle via Bloomberg

Co-founder and CEO Solomon Hykes, of DotCloud at his South of Market Street offices, in San Francisco. Close

Co-founder and CEO Solomon Hykes, of DotCloud at his South of Market Street offices, in San Francisco.

Silicon Valley’s Internet boom has gotten so big it needs startups to cater to the startups.

Stack Exchange Inc., for instance, helps Web companies hire Java software experts and get answers to programming questions. DotCloud Inc. simplifies application development, and New Relic Inc.’s engineers help make apps run better.

They’re benefiting from a resurgence in funding for startups, giving them seed money to work with -- and plenty of potential customers. Enticed by the success of Twitter Inc. and Facebook Inc., investors poured $1.19 billion into U.S. Web startups last quarter, with $254 million for first-round financings, the most since 2008, according to the National Venture Capital Association.

Startups are helping fellow Internet developers distribute applications, spruce up their software and take advantage of soaring sales of smartphones and tablets.

“There’s an explosion of services catering to developers,” said Solomon Hykes, who co-founded San Francisco- based DotCloud last year with Sebastien Pahl.

Startups helping other new companies are getting an added boost from technology that makes it easy to deliver software and data over the Internet. The availability of cloud computing lets businesses more swiftly deliver services unhampered by older computer systems or bureaucracy. That means apps can be constantly updated and customers can provide instant feedback, so startups can improve their products before going after larger corporate customers -- the so-called enterprise market.

Real Businesses

“For companies building these technologies, it’s more efficient for them to start out by selling to other startups rather than into the enterprise,” said Dan Scholnick, a general partner at Trinity Ventures in Menlo Park, California. He’s an investor in DotCloud and New Relic. “Our ultimate goal is for these companies to turn into real businesses.”

The risk of serving startups is customers can disappear overnight, and most new businesses fail eventually. The flood of funding also is reminiscent of the 1990s Internet bubble, which ended with startups across the country going out of business.

Today’s startups have an advantage over the original dot- coms: It takes less money to get off the ground. Cloud computing has freed them from having to buy and maintain their own servers. They also want to spend less time focused on technical challenges in general, Hykes says, which is where companies like DotCloud come in.

Its software automatically lets applications written in different languages work together, saving Web developers the trouble.

Free to Focus

“They’re free to focus 100 percent of the time on what actually matters,” said Hykes, whose company is also backed by Yahoo! Inc. co-founder Jerry Yang. “They want to focus on building an application.”

Scholnick co-led a $10 million investment last month in DotCloud along with Peter Fenton of Benchmark Capital in Menlo Park. They’re also both investors in New Relic, which has raised $19.5 million since being formed three years ago, including $10 million in October.

DotCloud was first backed by Y Combinator, the Mountain View, California-based incubator founded by Paul Graham. Since 2005, more than 250 companies have received funding from Y Combinator and been part of the firm’s three-month startup school. In July 2008, Graham wrote a blog post on 30 ideas he’d like to fund, the last of which was “startups for startups.”

Attracting Suitors

Some of Y Combinator’s startup-oriented startups have already been acquired by larger companies. Heroku Inc. was purchased in January by Salesforce.com Inc. (CRM) for about $212 million, and 280 North Inc. was bought last year by Motorola Inc. for about $20 million.

Rackspace Hosting Inc. (RAX), a Web hosting service that got its start serving small technology companies, bought Y Combinator- backed Cloudkick Inc. in December, gaining a tool that helps manage cloud servers. Rackspace, founded in 1998, is now valued at more than $5 billion and winning bigger customers.

And some new companies that begin by targeting their peers graduate into serving a broader, bigger customer base. New Relic, a three-year-old Web company in San Francisco, is now working its way up after focusing on startups.

The company helps customers monitor the performance of their websites and apps, letting them quickly find and solve problems. Its software, which costs as much as $150 per server per month, is used by more than 9,000 companies, including online-game developer Zynga Inc., business-networking site LinkedIn Corp., and the daily-deal sites Groupon Inc. and LivingSocial.

‘Unencumbered’

“Companies like Zynga, Groupon and LivingSocial are very often new adopters of technology because they’re unencumbered by the past,” said Lewis Cirne, New Relic’s founder and chief executive officer, who sold his previous company, Wily Technology Inc., to CA Inc. (CA) “They’re able to adopt new systems.”

Now that it’s serving more-established companies, such as Motorola, CBS Interactive and AT&T Interactive, New Relic is better insulated against a slump in Web startups, he said.

“It’s a mistake for a company to bet their business on only servicing startups in the long term,” Cirne said. He cited a “graveyard of companies” that tried that strategy before collapsing when the bubble burst.

In New York, Joel Spolsky and Jeff Atwood have turned Stack Exchange into the go-to site for developers to get their programming questions answered. Founded in 2008, the company has amassed an audience of more than 19 million users to its 48 forum sites. More than half its traffic goes to Stack Overflow, its main site for programmers.

“It’s a highly targeted and pretty valuable demographic,” said Neil Rimer, a partner at Index Ventures in Geneva, which led a $12 million funding round in Stack Exchange last month. “That’s worth something to an advertiser or recruiter.”

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

To contact the editor responsible for this story: Tom Giles at tgiles5@bloomberg.net

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