How the cloud is cutting dependence on venture capital investment

A decade ago, investors funded projects. Today, venture capital funds are scaling up already successful companies. This shift isn't just because VCs have become more rational in their investments. Plenty of startups just don't go looking for cash. The main reason startups can postpone or turn down VC money is cloud computing and SaaS.

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Back in the autumn of 2000, the buzz at the Internet World conference centred 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 (£282 million).

With VC money left to burn before the acquisition closed, Bluestone threw a huge party, renting out the entire USS 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 to investors. Then the real money comes 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 forego 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.

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