The new internet independents

For most internet entrepreneurs, trying to explain why an idea deserves an injection of cold, hard cash from a Silicon Valley venture capitalist is an accepted and even exhilarating part of the start-up process.

Not for Stewart Butterfield and Caterina Fake, the husband-and-wife team behind Flickr, the photo-sharing service that was sold last year to Yahoo for a rumoured $30m (£17m). They shunned VC investment and pull no punches when explaining why.

“I saw a lot of companies come to grief in the early 2000s that had taken [VC] money,” says Ms Fake, who lived in San Francisco during the dotcom bubble. “I had seen so many companies crash and burn and I had also seen a lot of start-ups that had grown too fast. There was something really perverse [in the idea] that we would take money and then have to find ways to spend it.”

For Flickr’s co-founders, the benefits of staying small were clear. The company was at break-even point when they agreed to sell it to Yahoo. Rather than dilute their stakes in return for VC cash they did not need, Mr Butterfield and Ms Fake decided to sell with the vast majority of their equity intact.

Flickr’s story reflects a growing preference among young internet companies for going it alone. A few years ago, the independent route would have been all but impossible. In the late 1990s, high fixed costs for servers, storage and software meant that most start-ups had no choice but to turn to VCs to get their operations off the ground.

But while some parts of the tech sector, such as semiconductors and mobile technologies, will always rely on outside investment, self-funded start-ups are exploiting broader changes in technology and business that lower the barriers to entry for aspiring entrepreneurs.

First, falling hardware costs mean that many internet companies “don’t need start-up capital any more, they need scaling capital”, says Ms Fake. By turning to venture capitalists, she says, young companies risk being forced to find ways to spend it on things that they may not need – a trend that led many companies to grief during the bubble.

In Flickr’s case, a single investment round with friends and family and a handful of well-known Silicon Valley angel investors was enough to help the company manage its growing capital expenses.

“We would have needed a couple of million if we had started a few years earlier,” says Mr Butterfield.

Five years ago, he says, a server with a few hundred gigabytes of storage – one of many needed to handle uploads of member photographs – would have cost Flickr about $250,000. Today, Mr Butterfield says, “you can get a terabyte of storage for about $5,000”.

Second, entrepreneurs have learnt lessons from the dotcom boom and bust. Sascha Lewis, the co-founder of Flavorpill, a weekly on-line events magazine, says he and his co-founder Mark Mangan were happy to think small from the start.

“From our previous experiences in the heyday, all the attention to growth and expanding market share, and the pressure to grow exponentially – I think it was the downfall of the space,” he says.

Today, the company that started as a two-man project to catalogue interesting happenings in New York six years ago manages publications in five cities and on two continents – and employs a full-time staff of just eight people.

“We wanted to stay focused. We knew we had a good product and a brand that we wanted to build,” Mr Lewis says. With few overheads and none of the obligations to outside board members that would have come with VC money, Flavorpill’s founders were able to develop the site at their own pace. They spent a year and a half refining Flavorpill’s look and building its audience before they approached advertisers.

Their patience paid off. Today, Flavorpill’s publications reach about 300,000 people around the world each week. DailyCandy, a rival events site with a similar geographic reach, recently put itself on the market with a rumoured price tag of $100m.

Third, the spread of open-source web building blocks, such as MySQL and PHP, makes it easier for entrepreneurs to create sophisticated sites and services.

Andy Baio was still working in his day job at a financial firm in Southern California when Yahoo bought Upcoming.org, a social networking and event-planning site he had developed in his spare time using free, open-source web tools. “Free software makes hobbyist tinkering simple,” he says, “At the end of the day, the only thing you’ve spent is your free time.”

Mr Baio did not start Upcoming with the intention of turning it into a business, so it came as a surprise when the company started to get attention from venture capitalists at a conference in San Francisco last year. “We started getting a lot of attention and some press coverage but venture capitalists want to take a big piece,” says Mr Baio. “I was doing this on the side for fun so that was an unappealing option for me.”

Paul Graham, a software engineer and founder of YCombinator, a company that provides seed funding to tech start-ups, says that a trend towards quicker exits is also pushing companies to go it alone. “For a lot of these guys, the choice is to get bought or take VC money,” he says.

For many companies, the latter option is still attractive. “From where I sit, deal flow is about like it always is,” says Steve Domenik, a partner at Sevin Rosen Funds, a VC specialising in early-stage investments.

But Mr Butterfield of Flickr points out the risks in trying to grow large through the VC route. “There could be another September 11, or someone like Google or Yahoo or AOL could realise their photo product should be just as good as Flickr.”

Last, the independent model has received a boost from the internet community. In the years since the dotcom bubble, entrepreneurial ideas have been
discussed, assessed and promoted by a close-knit
community of influential bloggers.

Individual bloggers, web aggregators such as Digg and del.icio.us, and influential community blogs such as Slashdot and Metafilter offer a platform for the spread of good ideas – in contrast to the costly billboards and stadium sponsorship deals of the dotcom bubble.

“There is this idea that if you do something cool, if it is truly an interesting, innovative and exciting idea, then it will find an audience,” says Mr Baio.

Companies such as Flickr have been shaped by the ethos of the blogging world. Ms Fake says Flickr’s shoestring budget forced it to develop as many blog-friendly features as possible.

“We started with the philosophy that constraints are very productive,” she says. “The less money you have, the more creative you have to be.”

FIVE FORCES BEHIND THE RISE OF A NEW KIND OF INTERNET ENTREPRENEUR

Lessons of Web 1.0

Entrepreneurs whose paper fortunes turned to dust following the dotcom boom and bust have adopted a more hard-nosed approach to business and a healthy scepticism towards outside investment.

Low-cost web tools

Free open-source web development tools, such as MySQL and PHP, have lowered barriers to entry for aspiring web entrepreneurs.

The ascent of blogs and aggregators

With the rise of blogs or online diaries, the internet has become a highly efficient system for the dissemination of “cool” ideas – an effect that start-ups can use to create a buzz around their sites or services. One rave review from a prominent blogger is sometimes all it takes for an idea to explode into the mainstream. Popular community blogs include Slashdot and Metafilter. Link aggregators such as Digg, a technology news website, and del.icio.us, a social web tagging site, are combed by users searching for the next big thing.

New exit routes

Fall-out from Enron and other corporate scandals has made initial public offerings less appealing to founding teams. Meanwhile, recent buying sprees by companies such as Google, Yahoo and News Corp have put pressure on competitors to keep up. As a result, the latest generation of internet entrepreneurs have plenty of exit options available.

Falling hardware prices

Plummeting hardware prices, particularly for servers and storage, mean that start-ups do not need to break the bank to create an IT infrastructure. Low-end servers capable of servicing a modest start-up’s need can fit into a shoestring budget. Web design and programming can be outsourced to developers in India or eastern Europe.