Open Source, Cloud Computing and Ecosystems Changing VC Investments

The world of investing is changing as startup costs are plummeting for companies who are able to use open-source software and cloud computing tools while in many cases piggybacking on existing product ecosystems as they grow. As Bloomberg reports in an article I found through GigaOm, tech startups need much less money because they aren’t using the expensive computers their “ancestors” used.

Hosted storage, hosted software, open-source and the lower price of office rental space means there can be many more startups per dollar. The downside for VC funds is you can’t put a billion dollars to work $500,000 at a time.

For founders, this means potentially more available capital and the ability to keep a larger share of their companies.

The downsides are in an age of open-source and cloud-based solutions, margins have fallen meaning those mega high-priced startups have a tougher time recouping their initial expenses.

Here is an excerpt worth sharing from the Bloomberg story:

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.

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