What Cloud Computing Means for Startup Financing

October 3, 2014
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Guest post from Andy Barkett, CTO for the Republican National Committee and the CEO of Getexp, Inc.

Before Instagram became Facebook’s golden child, it was a small startup, raising only $500,000 in its first seed round. The company operated with 16 employees at its largest, yet managed to create a product that attracted and served 30 million people before it was acquired for a staggering $1 billion.

Although the price tag was astonishing at the time, the story of Instagram’s wild success isn’t the anomaly it seems. Instead, Instagram serves as a sterling example of the new opportunities cloud computing has presented for entrepreneurs to start big businesses with small piles of cash.

 

Make the Cloud Shift, and Reduce Upfront Costs

Instagram was a great idea; there’s no question about that. But it would have remained just that if Kevin Systrom hadn’t been able to afford to get it off the ground.

Instagram cut out the need for costly server installation, administration, maintenance, and more by enlisting Amazon Web Services rather than paying for expensive servers at the beginning. By “renting” servers and equipment from cloud providers, startups pay small monthly fees, get the resources they need based on demand and user growth, and respond to customer demand in real time.

Accessing pay-as-you-go SaaS solutions for email, CRM software, project management and tracking, customer support, phone systems, accounting software, and even HR also lessens this initial burden. Cloud computing has allowed pipe dreams to become realities by cutting the human and financial capital needed to start a new venture by millions of dollars.

But relying on cloud solutions offers more than a cheaper price tag. Startups can stay lean and dispense with the administrators and maintenance teams required to keep servers up and running. More importantly, you can scale right along with your customers.

Instead of anticipating future needs, you can use only the funding necessary to meet your short-term business needs. These systems have been vetted many times over, which reduces the likelihood that potential hiccups occur and makes scaling a seamless process rather than a stressful one.

Cloud computing has broken down barriers and helped many entrepreneurs bring their ideas to fruition. This “pay as you go” mentality has also opened up new, less risky possibilities for raising funds throughout the process.

 

Adopt This Mindset to Secure Venture Capitalist Funding

Even with reduced costs thanks to cloud services, running a company is an expensive venture, and you’ll need capital for research and development to get started. But now you can spread that funding out. You take less in the beginning, and when the company grows, you’ll have market validation that will make your company an attractive investment opportunity to VCs.

So what are the costs when starting out? Let’s start a company together to put them in perspective.

Let’s say we’re opening an online business to make better use of photo assets in commercial companies. For example, home repair companies could use these photos to showcase their completed work. It could be an Angie’s List-meets-Instagram service.

Using Amazon Web Services or a similar provider, we could build a site, do a little guerilla marketing, build a prototype, and get a handful of companies using it for around $50,000. At this stage, we wouldn’t even need VC funding.

Once the product reaches a certain level of stability, we can estimate how many servers we need per user, how many marketing dollars we spend per user acquired, and how much development work is left to create a finished product. This is where VCs would come in.

With an unproven product still in its infancy, securing funding can be difficult the first time around. But because we have fewer upfront costs, we’re not stuck asking for more than we need. Instead, we can seek funding in two phases: development and marketing.

You can’t skimp on hiring the right people — or the budget that coincides with securing top talent. A project like this would require about $1 million for six software engineers in the first year. Although this number may be fluid, it’s important to remember that no one will want to work for a startup that only has a couple months’ worth of expenses in the bank.

On top of that, the company would need about $200,000 for additional expenses during the development phase, reaching a grand total of $1.2 million.

In a traditional funding setting, you would ask for an additional $2 million for marketing and scaling. But in this fundraising process, there’s no reason to ask for $3.2 million at the outset. You wouldn’t want to, either, because it’s much riskier to back software development work than a marketing campaign.

The software work is all or nothing; it’s difficult to see intermediate progress and prove what the end cost will be. The marketing plan, on the other hand, is entirely cloud-based and requires no upfront cash commitment. If we got $1.2 million from the VCs to fund the development, and it works, the next $2 million should come on much better terms. And that means we keep more of the value we generate.

This is the direction we’re headed. Rather than borrowing millions at the beginning, startups can curtail the financial risk and ask for a year’s worth of employee salaries and the minimal development costs on top of that. It presents new avenues for lean, mean startups to scale and creates job security for startup employees.

Essentially, you’re only asking for a type of unemployment insurance for the employees taking a risk on your company in these early stages.

Outsourcing infrastructure will allow startups to concentrate on R&D efforts and innovation. Cloud computing is creating a chain reaction that benefits not only entrepreneurs and investors, but also consumers. More awesome ideas are seeing the light of day, which creates more job opportunities. Advances in cloud computing mean that the next Instagram success is just around the corner — at a fraction of the cost.

 

Andy Barkett is the CTO for the Republican National Committee and the CEO of Getexp, Inc. He is a managing partner at startup advisory firm Davis Innovators, which seeks promising ventures at early stages and offers a variety of services, from fundraising to talent planning. Andy has more than a decade of experience working in strategy and engineering at companies like Facebook, Livescribe, NVIDIA, and Google. Connect with Andy on Twitter!

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Like all of you entrepreneurs and investors out there, Aaron has been in the trenches. He is the founder of an influential online media and PR company. From oil wildcatters to mining prospectors, tech gurus to medical doctors, and even celebrities, Aaron has helped market and expand brand awareness for a diverse range of publicly traded companies ran by entrepreneurs from all walks of life.

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