Monday, October 31, 2005

The End Of The Sand Hill Road

Sand Hill Road is the Palo Alto home to the big beasts of venture capital. They've belatedly realized that their business model for Internet startups is broken and are scrabbling to avoid ending up on the scrapheap. Isn't capitalism wonderful?

The WSJ reports (subscription):

Internet start-ups and venture capitalists are back in vogue in Silicon Valley. But now the two don't necessarily go together.

Consider Flickr, the innovative online-photo service launched by a small Canadian company early last year. Like many Web start-ups today, it was built on a dime: Husband-and-wife founders Stewart Butterfield and Caterina Fake used cheap software to construct the Flickr site, eschewing pricey computers. Some gear, such as computer storage, was "about 100 times cheaper" than it would have been even five years ago, says Mr. Butterfield. It cost only about $200,000 to pay salaries and get the site up and running, he says.

By last year, several top venture-capital firms were clamoring to invest in Flickr through its parent company, Ludicorp Research & Development Ltd. In December, Mr. Butterfield had a funding offer from Accel Partners of Palo Alto, Calif. But the entrepreneur decided instead to sell to Internet giant Yahoo Inc. for what people familiar with the matter say was about $25 million, significantly higher than the value Accel had put on the company and Accel's proposed investment.

It's a scenario playing out all over Silicon Valley -- and one with potentially big ramifications for venture capitalists. A new generation of Internet companies -- many offering online photo and blogging services or downloadable software for businesses -- have been built for a fraction of the cost just a few years ago

It's amazing the VCs missed this - together with other the entrepreneurs, I moved from VCs to self-funded businesses 8 years ago, here's why.

Trying to get VC funding eats up huge amounts of your time when you should be signing up Beta customers and building product. And in return for funding you, they make you to swap your stock with options (they take the stock), they take a board majority, and often invest in several of your competitors. Then if after 12 -24 months they decide your company lost the race, they pull the plug.

But, starting around 1997, you haven't actually needed a lot of cash to build a profitable software business.

You don't need offices or any of the overheads that go with them - you can inexpensively outsource payroll and accountants. PCs, servers and bandwidth are cheap, and one or two first rate developers working from home with modern software and components can build almost anything.

If you to concentrate on delivering real value to real customers, they then pay you! You don't need cash to ramp sales and support as the business takes off - instead you partner with one of the galaxy of burned out tech business that have sales and support in abundance, but lack product. They'll do this for margin.

Then you exit by a trade sale, like the Flickr folk (great job!).

No stock options - they don't work anyway thanks to Sarbanes-Oxley, no control-freak MBAs cluttering up the board - in fact, no board meetings! Just you and the developers working together like crazy to make your first customers ecstatic.

This trend is moving at warp speed and if you ride it, you'll get rich. Just sign up a pre-launch customer first, partner with a great developer, put all your cash in the business, and work 100 hour weeks for two years.