Investment Communities: Innovation Meets Scale


Data-centerLike seemingly half the Pacific Time Zone, I co-founded a software company in 1998. While we were able to bootstrap it for a while -- coding taking place in virtually every room of my San Francisco flat, including my workstation in the hallway -- we had some real costs that forced us to get venture capital before too long.

Computing hardware was part of it, but we also had to get more developers and this meant office space, and this led to legal fees, etc. At one point we had a well-cooled server room filled with racks of production Unix boxes, hot standbys, uninterruptible power supplies, and the like. It was serviced by three full time IT people and I recall one suite of code-management software running about $80,000 per year. Expensive stuff. Our Series A was about $3 million and we ended up raising over subsequent rounds about ten times that amount. 

The evolution of startups and funding

Contrast my experience with that of one of that venture's co-founders, who went on to form a New Media company ten years later. First, no bricks and mortar: none of the company's dozen or so employees shared the same area code, so there was no point in having a centralized office. Second, it was strictly bring your own device (BYOD), so there were no employee-specific IT costs.

Third, they could easily serve over a million unique visitors using Amazon's cloud computing infrastructure, costing about $3K/month. Fourth, they used a ton of free services -- Skype, freeconference.com, Google analytics, Chartbeat, etc. Salaries were far and away their biggest expense, and those could be trimmed, during the early stages, to only what the employees needed to scrape by.  

As a result, they ended up being funded entirely by angel investors. Instead of capital requirements in the tens of millions, it was in the hundreds of thousands.  Admittedly, new media is different than enterprise software, but the basic economics would be roughly the same on a per employee basis.  

There are a lot more investors chasing deals

Going back to 1998, we were cautious of venture capitalists because they took huge equity slices and some would try to add terms like a two-x liquidity preference, or clawback provisions ("I think I'd like my money back now, please").  The alternatives were angel investors -- perhaps a rich uncle, but more likely a wealthy industry veteran with an appetite for new ideas -- and corporate investment.

Each type was considered pretty attractive, although they were hard to find, and you'd hear about them mostly through oblique, whispered tips at the end of meetings. The tips could take you to interesting places. One time, we pitched over dinner to a group of 20 angels who had gathered at Caesar's Palace to follow the NCAA tournament (imagine slot machines ringing in the background while you're describing a patent on ontology-driven information systems).  

The angel investor pool has grown substantially since then, primarily due to the emergence of crowd funding. Crowd funding sites act like exchanges between wealthy (i.e., SEC qualified) investors and entrepreneurs. An investor can sign up with a site like Crowdfunder, shop for deals, and perform due diligence with a service like Crowdcheck. In 2012, crowd funding sourced $2.7 billion in capital with $5.1 billion forecast for 2013 -- the same amount as initial investments by venture capital firms.  

If trying to find an angel in 1998 was like trying to find a mate in colonial America, circa 1640 -- candidates were out there, but few and far between -- then today it's about as easy (and confusing, I suppose) as online dating. Meanwhile, many corporations now have professional in-house venture capital groups. In 2013, these corporate venture arms accounted for more than 10% of total venture capital invested.  (I'm getting VC statistics from the 2014 annual report of the National Venture Capital Association.)  

Traditional venture capital is contracting

The rise of crowdsourcing and corporate venture capital has squeezed traditional venture capital. Capital raised by VCs was down 14% from 2012. Investments continue to be way down from the insane highs surrounding 2000. Most telling, the number of VC principals (VCs who attend board meetings) is down by almost a third from 2007. And these numbers include corporate venture capital, so the hit to traditional venture capital is even higher.

The Wall Street Journal reported last week that venture capital is pretty healthy at early stages, although I suspect that what passes for an early stage company these days looks a lot better than when I was dragging an LCD projector through Caeser's in 1999. Incubators like Y Combinator give young companies practice and polish, and low operating costs let entrepreneurs bootstrap for years, not months.  

The current outlook on funding 

From this former entrepreneur's perspective, the capital markets look good. Corporate investors are easy to identify and professional in their practices. Angels are accessible via crowdsourcing platforms. And traditional VCs have reinvented themselves -- firms like Accel and Bessemer – and are differentiating themselves based on the connections they can bring, their industry expertise, and on dedicated services such as help with identifying talent.  

GE Capital offers a glimpse into the future of value-added capital. Using Salesforce Communities, they built (in just five weeks) a forum, GE Edge, to connect their customers together so they can collaborate, share knowledge, and tap into GE's expertise. The results have been impressive, and substantiate what GE's Ian Forrester said at the time, "we're not just bankers; we're builders." It's hard to think of a stance more resonant with start-ups.  


To learn more on this topic join us at the Salesforce1 World Tour in London for our session "Connected Communities: Drive Business at the Speed of Social."

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