Disruptive

A PERFECT STORM
^

February 2009 Micro Investment in a Digital Age

As emerging technologies allow developers to do more, faster and

with less resources; our approach to investing should embrace these
changes and evolve to meet their needs.

DRAFT - For discussion purposes only

 DRAFT A Perfect Storm

“The simultaneous occurrence of weather events which, taken individually, would be far less powerful
than the storm resulting of their chance combination. Such occurrences are rare by their very nature,
so that even a slight change in any one event contributing to the perfect storm would lessen its
overall impact.”

The Perfect Storm, Sebastian Junger, 1997

Front page photo: Storm Clouds Threaten! Phil Thirkell (2007)

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THE AUTHOR
Jonathan Bradford trained as an accountant with Arthur Andersen, and subsequently has worked as in
various start-ups and turnarounds. He has worked in London, throughout Europe, Australia and also the
United States. Jonathan has recently joined North East Finance as the Fund Manager for the Design and
Creative Fund.

CONTACT DETAILS
Blog: http://blog.jayeyesea.com
Twitter: @jd

DISCLAIMER
The views expressed in this white paper are those of the author and are not those of his employers or
associated companies unless otherwise stated.
All text and images is © Copyright 2009 the author unless otherwise stated.
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TABLE OF CONTENTS

EXECUTIVE SUMMARY 1
REGIONAL INITIATIVES 3
TECHNOLOGICAL CHANGES 5
ECONOMIC ENVIRONMENT 7
THE PROGRAMME 9
THE IMPACT 11

APPENDICIES
APPENDIX 1 - IS THE CLOUD RIGHT FOR YOU?
APPENDIX 2 - REMEMBER PROFITS EQUAL REVENUES MINUS COSTS
APPENDIX 3 - IPHONE DEVELOPERS GO FROM RAGS TO RICHES
APPENDIX 4 – START-UP IDEAS WE'D LIKE TO FUND
APPENDIX 5 - EARLY STAGE PROGRAMMES
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Disruptive
A Perfect^ Storm
EXECUTIVE SUMMARY

THE OPPORTUNITY
In the current recessionary environment, a combination of emerging and maturing technologies set against
the regional initiatives within the North East of England (“North East”) will create “the Perfect Storm”.
These combined events will create a “once in a generation” opportunity for the digital industry in the North
East. Providing appropriate investment in the right environment will nurture and develop both people and
ideas to create a long term legacy for the region and effect a cultural change in entrepreneurship.

THE PERFECT STORM

The Perfect Storm has been created from a multitude of factors that fall into the following broad
categories. Each in themselves create opportunities for the region, however combined they create a
compelling argument for the creation of a micro investment programme focused on innovative digital start-
ups. The broad categories are:

There are regional initiatives to create of a £125 million “super fund”;

Technological changes allow developers to do more, faster and with less resources; and

Economic factors create an environment where there is a greater propensity to adopt new
disruptive technologies.
To maximise the impact of the programme in the region, it is my belief that it should be created at the
earliest opportunity. I believe that other regions will recognise the potential of such a programme, and
hence “first mover advantage” will be important to attract the “brightest and best” people and ideas to
the North East. Furthermore, it will also demonstrate the importance the region places upon its digital
businesses and innovation.

THE PROGRAMME
The programme I am describing combines micro investments (up to £20,000) supported with intensive
coaching to “seed and accelerate” digital start-ups - typically web based or other software companies.
This approach is similar to Y Combinator based in Silicon Valley.
These might include companies that are focused on the creative industries, gaming, digital media, social
media challenges, social communications and digital media or “Software as a Service” companies that
address a real SME, enterprise or government IT challenge. It might also include mobile platforms,
applications and solutions. Ultimately, the fund should be focused on disruptive technology solutions that
are not capital intensive.
This would be the first such programme in the UK to be supported by a Regional Development Agency
and would complement a number of regional initiatives including Codeworks, Digital City, Northern Film
and Media and Software City.

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EXECUTIVE SUMMARY (CONTINUED)

THE IMPACT
The programme has been designed to increase the number of innovative digital businesses in the North
East. Thereby creating highly skilled jobs and also increasing the quality and number of investment
opportunities for other local investment funds.
I would also anticipate that such a pioneering programme would attract “bright young things” to the
region and also increase the retention rate of graduates from local universities. From this, the region could
“seed” the next generation of entrepreneurs and create a far reaching alumni community.
All of this can be achieved by investing smaller sums with greater focus, supported by intensive coaching in
the right environment.

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REGIONAL INITIATIVES

THE JEREMIE ‘SUPER FUND’

North East Finance (formerly known as NStar) is currently working with One NorthEast, European Regional
Development Fund and the European Investment Bank to create a £125m JEREMIE1 ‘super fund’.

It is widely recognised that in the expanded EU that these monies will be the last substantial tranche of
“venture capital” funding which the North East will be receive from ‘Europe’ and hence the success of the
‘super fund’ will be critical to the future of the region.

How these funds are invested will have a long term impact upon the North East.

PROOF OF CONCEPT FUND

The North East Proof of Concept Fund (“POC”) invests in pre-start, early stage or more mature science and
technology-based companies. Investments are made up to £90,000 and one of the criteria used to
appraise application is the potential to secure a proprietary intellectual property (“IP”) position.

Whilst the POC has been very successful, the investment size may not be necessary for software start-ups
whose success is dependent upon “speed to market” rather than IP. The programme I am describing would
complement POC, which might also act as a follow-on fund for some of these start-ups.

CODEWORKS
Codeworks is a centre for digital innovation in the North East of England. They work with technologists,
digital companies, entrepreneurs, university researchers, venture capitalists, economic developers,
rationalists and visionaries in the development and creation of digital companies.

DIGITALCITY
DigitalCity’s mission is to create a vibrant, successful and self-sustaining supercluster in the North East
based on the digital technologies, digital media and creative sectors, being made up of DigitalCity
Business and Institute of Digital Innovation. The former provides both Business Development and High
Growth Support.

Joint European Resources for Micro to Medium Enterprises Initiative

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REGIONAL INITIATIVES (CONTINUED)

NORTHERN FILM & MEDIA

Northern Film & Media is the Regional Screen Agency for the North East of England. It develops the
moving image sector by investing in people and their ideas, focusing their energies and expertise upon
engaging with and developing individuals and companies working in film, television, animation,
commercials, multi-media, and innovative technologies.

SUNDERLAND SOFTWARE CITY

Sunderland Software City (“SSC”) is a major regional project to create a sustainable and globally
competitive software industry in the North East and will enable the development of world class facilities,
initiate new approaches to integrating business and universities and act as a stimulus and catalyst for
growth of existing businesses.

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TECHNOLOGICAL CHANGES

CLOUD COMPUTING
Cloud (or utility) computing will profoundly change the dynamics of the software industry, allowing smaller
start-ups to compete against larger established businesses. This is best described by Nicholas Carr in The
Big Switch (2008):
“A hundred years ago, companies stopped generating their own power with steam engines
and dynamos and plugged into the newly built electric grid. The cheap power pumped out by
electric utilities didn’t just change how businesses operate. It set off a chain reaction of
economic and social transformations that brought the modern world into existence. Today, a
similar revolution is under way. Hooked up to the Internet’s global computing grid, massive
information-processing plants have begun pumping data and software code into our homes
and businesses. This time, it’s computing that’s turning into a utility.”

In this form, cloud computing was first offered by Amazon in 2006 providing end-users a very low cost
“pay as you go” service with no other standing charges. Since then similar forms of cloud computing has
been introduced by Google and Microsoft. Cloud computing may not be the right answer for everyone
(as outlined in a recent article by Joe Weinman - see Appendix 1), but it will become the de facto
platform of choice for start-ups, for the following reasons:

One of the greatest challenges a start-up will face is scaling hardware and its application to
meet demand. The use of a cloud computing platform substantially reduces the hardware risks
(and costs). It provides a highly scalable and resilient platform, allowing start-ups to
concentrate on creating innovative and novel solutions; and

Cloud computing is cost effective avoiding the need to invest in costly hardware when cash is
limited. In addition, costs are directly correlated with demand, reducing “hardware spend” to
a minimum. This reduced “burn” allows start-ups to survive for longer with less cash. Smaller
investment rounds mean that investors can spread their bets across a greater number of start-
ups. Smaller investments also mean better returns – as described by Fred Wilson in “When
Talking About Business Models, Remember That Profits Equal Revenues Minus Costs” (see
Appendix 2).

OPEN SOURCE SOFTWARE

Whilst open source software has been around for over 20 years, it has been much maligned as having
little commercial use. However since the “dot com” boom in 2000, a generation of start-ups has
recognised the value of this software the ability of “standing on the shoulders of giants”.

Open source technology reduces development time and costs. This may be done by adopting
development code previously written or by using development tools which are free.

As open source has matured developers, investors and their lawyers have gained a greater understanding
(and comfort) of its associated intellectual property rights – making its use more common in start-ups.

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TECHNOLOGICAL CHANGES (CONTINUED)

BROWSER & WEB DEVELOPMENT TECHNOLOGIES

During the late 1990s Microsoft and Netscape were locked in a battle to win market share of the browser
market and “the internet” - leading to substantial advancement in browser and web development
technologies. This battle ultimately ended with Netscape's demise and Microsoft being locked in court
rooms around the world for the following 10 years. It did however lead to the birth of the original
“dot com” boom (or Web 1.0 as it has been subsequent dubbed).

Since then Microsoft has encountered a new rival – Google. Where Google has differed from Microsoft is
in the delivery of its products and services through the browser. As a result, it has used a significant
proportion of its “search revenues” to drive innovation of browser and web development technologies - by
sponsoring Firefox, Safari and Opera. Google is also credited with the birth of Web 2.0 when it built
Gmail on Ajax – creating a “near” desktop experience within a browser.
Not being satisfied with how quickly browser technology was evolving Google built its own open source
browser (Chrome), which is arguably faster and more stable than its rivals. In addition, it includes an
offline capability that allows internet applications to be used when there is no internet. Some observers
have started to describe the browser as an “operating system” in its own right.
The browser allows start-ups to deliver solutions which are platform agnostic and avoids the problems
associated with version control and distribution – which is further described below.

DISTRIBUTION CHANNELS
Historically a substantial competitive advantage many large organisations had was their control over the
delivery of services and products to end users. An extremely good example of this is Sage whose
dominance has been, in part, due to its trusted distribution network of accountants.

Whilst the internet may be considered to be the ultimate distribution platform connecting businesses to end
users directly – this “many to many” relationship has had limited success, due to inability of suppliers
and/or end users to find each other.

However, in 2008 this changed with the launch of Apple's Apps Store. This central marketplace provided
a cost effective solution for software developers to deliver their products and for end users to find
solutions. Since its launch the Apps Store has delivered 500 million downloads and has over 15,000
applications – creating a “level playing field” for “bedroom developers” to compete alongside much
larger software businesses. An example of this is the Trism game which made a $250,000 profit in two
months (see Appendix 3).

The incredible success of this marketplace is widely recognised and is being replicated by Nokia,
Blackberry, Google (Android) and Microsoft (Windows Mobile). In addition, there are already rumours
that Apple will expand the Apps Store’s functionality for its other products. Microsoft may also create a
marketplace for Windows 7 when is launched later in 2009.

Clearly this marketplace model is here to stay.

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ECONOMIC ENVIRONMENT

TECHNOLOGICAL CHANGE
As at January 2009, it is accepted that the UK and all major economies are in recession. Whilst its size
and length cannot be ascertained at this stage, it is recognised that it is much more significant that just a
slow down.

Anecdotal evidence suggests that technological changes do not follow economic cycles and that the
greatest technological progress occurs during times of need and is counter-cyclical to the economic
conditions.

ADOPTION OF NEW IDEAS

Another side effect of the downturn is the increased appetite of businesses to adopt new (disruptive)
technologies where cost savings or greater efficiencies can be achieved. During “good times” it can be
very difficult to persuade businesses to change their working practices due to the risks of failure.

This is best put by Sergey Brin (co-founder of Google), "Scarcity creates clarity. In my interpretation also
in the sense that certain business ideas will thrive in a rather downturn economy as they help companies
consolidate their act through cost savings when management attention is not just obsessively concerned with
hyper-growth.”

REDUCED COMPETITION IN CAPITAL MARKETS

The venture capital market has been relatively robust over the last few years, particularly in technology.
Some have even argued that there has been a Web 2.0 bubble where unsustainable business models
have received funding.

Whilst this sharp downturn will cause many of these businesses to close, venture capitalists will be more
likely to use their funds to protect their current investments through “follow on” rounds rather than invest in
new start-ups. This will have the overall effect of reducing funds available for start-ups and also reducing
the overall competition in the early stage capital market.

Less competition will have a twofold effect – it will create greater opportunities for start-up investments
funds, however it will also reduce the number of new opportunities for larger investment funds such as the
North Star Co-Investment Fund.

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ECONOMIC ENVIRONMENT (CONTINUED)

REDUCED COMPETITION IN LABOUR MARKETS

The downturn will also reduce competition in the labour markets for graduates who will have few
employment opportunities. In addition, average graduate salary should also fall.

Similarly this will have a twofold effect. Firstly, fewer graduate employment opportunities should increase
the number of graduates (or near graduates) who will consider starting a business with the appropriate
support. Secondly, lower graduate salaries reduce the opportunity cost of starting a business versus
entering employment.

REDUCED ANGEL INVESTORS PARTICIPATION

Historically angel investors have been a significant source of capital for software starts-ups.

However the turbulent capital markets have either caused them to withdraw from investing in early stage
businesses or invest in businesses which are a little more mature with less risk. The latter example would
include start-ups which have a substantial proportion of their development completed (through financial
bootstrapping) and are looking to launch and scale their product/service.

To ensure that the supply of new digital businesses does not “dry up” it is essential to replace these
investors with an alternative source of funds.

CHANGING VENTURE CAPITAL MODELS

As technology has evolved, it has become clear that start-ups can achieve more with less money, and
hence venture capitalists have had to evolve to meet their requirements.

The first example of this new approach to seed-stage funding was Y Combinator which started in 2005. It
provides seed money, advice, and connections at two 3-month programmes per year. Y Combinator
provides very little money, based upon the firm’s philosophy that between free software, dynamic
languages, the web, and Moore's Law, the cost of founding a start-up has greatly decreased. Since its
inception, Y Combinator has funded over 80 start-ups – many of which have gone on to be successful.

To illustrate the types of start-ups Y Combinator was keen to invest in, they published a list of “Start-up
ideas we’d like to fund” (see Appendix 4).

Since then, a number of other firms have successfully replicated this model, of which only one is based in
the UK – Seedcamp - which accepts applicants from across Europe. A full list of these seed capital
programmes may be found in Appendix 5.

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THE PROGRAMME

OVERVIEW
It is recognised that sometimes money is not enough to make a start-up successful. The programme I have
suggested places equally as much value upon the monies invested and as the intensive coaching which runs
in parallel.
For the programme to be effective, I have suggested that the investment criteria to be narrow –
specifically digital industry start-ups focused on disruptive technology that is not capital intensive.
The key objective of the programme is to support, nurture and accelerate “people and ideas” to create an
early stage release of the product/service and a viable business proposition.

Outlined below are my suggested key elements to the programme.

FUNDING

The seed fund would invest up to £20,000, in two tranches. The first £10,000 would be invested
at the commencement of the programme, and the second £10,000 would be released upon
successful completion of the programme – this might include the demonstration of a prototype,
preparation of a viable business plan and attendance of the coaching sessions.

The investment would be made as a convertible loan - similar to the structure used by “Proof of
Concept”.

APPLICANTS

Each application is based upon a team of individuals (“founders”) and their idea.

The application process would be online, and would not require the preparation of a business
plan. The selection process may include an interview/presentation.

Applications would be assessed upon the strength of the team, idea and the ability to deliver a
prototype within the limited funds.

Founders would be expected to have a technical background and would typically be less than 30
years of age. There would ordinarily be two or three founders.

TIMING

The programme would be 16 weeks long and would have two intakes – subject to the quality of
the applications.

It would be anticipated that each intake would have up to 10 teams. This would create significant
critical mass to potentially attract follow on investors to the programme.

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THE PROGRAMME (CONTINUED)

ENVIRONMENT & LOCATION

The accommodation should be open plan with breakout rooms and accommodate up to 30 people.

The location would be easily accessible both locally and nationally – to increase the probability of
attracting applicants, investors and advisors to the programme.

It should be close to other centres of technical excellence, but remain independent of any
academic institution – for example, DigitalCity Business or Sunderland Software City.

COACHING

Coaching sessions should be compulsory and requirement for attracting further funding.

Coaching should be regularised at a predefined time each week.

Coaching should include all of the following:
o Interpersonal skills,
o Technical training,
o Business advice, and
o Legal & financial training.

Weekly dinners should be held with a guest speaker.
Note, a substantial number of elements described above are included within DigitalCity Business’s
successful Business Growth Workshop System. This would significantly reduce the time required to prepare
the coaching programme.

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THE IMPACT

The programme has a significant number of benefits for the start-ups and also the region.

Create new businesses. This approach would immediately create new businesses for
technically skilled graduate employment in the region.

Attract and retain “bright young things”. The region already attracts many “bright young
things” who attend local universities. At the end of their course a significant proportion leave
the region in search of employment. This programme would help retain some of the best and
the brightest and also attract “bright young things” from out of the region including Europe.

Increase the probability of follow-on investment. The programme has been designed to
improve the chances that the start-ups will be best prepared to raise further funds – by
providing an environment conducive to developing a product/service in a very limited time
scale and also improve their all round business acumen.

Complement other regional initiatives. The Regional Development Agency has spent
significant funds on other regional digital and software industry initiatives. This programme
would complement these initiatives – with either early stage ideas being accelerated through
the programme, or these newly formed businesses finding a home after the programme.

Improve deal flow and quality of funding applications. As angel investors have withdrawn
from the capital market, the number of potential start-ups will therefore be reduced. This
initiative would generate a new source of potential businesses which the “Proof of Concept”,
“Design and Creative Fund” and “Co- Investment Equity Fund” could fund at later stages.

Attract investors and professional advisors to the region. A biannual programme with up to
10 businesses would create sufficient critical mass to attract investors and professional advisors
to the region with a potential spin-off benefit to other local investment funds and businesses.

Up skill technical staff. There are many talented technical graduates in the region. This
programme would accelerate the learning curve of starting a new business – which would
ultimately benefit the software industry throughout the region.

More “bang for your buck”. Since this programme only invests relatively small sums of
money – with the ability to withdraw the second tranche, the investment funds exposure to any
particular idea is very limited. You invest less but potential impact to the region is significant.

Creating the next generation of entrepreneurs. Central to this programme is instilling a “can
do attitude” and encouraging the founders to chase their dreams. Nurturing this spirit at an
early age can have a profound impact upon the rest of their working lives.

Create an alumni community. Finally, with so many founders working in close proximity to
each other, it is important that the programme develops a programme alumnus. This will in the
longer term create a community upon which the programme and region can benefit.

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“You're going to reap just what you sow”

Perfect Day, Lou Reed, 1972

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APPENDICIES
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APPENDIX 1
IS THE CLOUD RIGHT FOR YOU?

Outlined below is an excerpt from the article “Is the Cloud Right for You? Ask Yourself These 5 Questions”
by Joe Weinman (13 August 2008) which illustrates when it is advantageous to use a data centre versus a
cloud computing platform.

Key Question Enterprise Data Centre Cloud Services Key Cloud Benefit
Better Better

1) Is demand constant? Constant Variable Scalable and On-

Demand
2) Is growth predictable? Predictable Unpredictable

3) Can demand be shaped? Shapeable Not shapeable

4) Where are the users? Concentrated Dispersed Globally Dispersed to

Reduce Latency
5) Is the application interactive? Batch Highly interactive
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APPENDIX 2
REMEMBER PROFITS EQUAL REVENUES MINUS COSTS

“When Talking About Business Models, Remember That Profits Equal Revenues Minus Costs” appeared on
Fred Wilson’s blog – A VC (January 31, 2009)

There is no shortage of discussion about Internet business models these days. And they almost always focus on revenues. But revenues are only
half of the value creation equation. The other half is costs.

Let me explain. Businesses are worth the net present value of future cash flows. Cash flows means profits basically (capital expenditures are
important but I'm going to leave them out of the discussion on this post). So a business is worth the sum of all of its future profits, discounted back
to a net present value. For those who don't want a lesson in finance, you can simplify this theory even more by using a cash flow multiple as a
proxy for a net present value. I like to use a 10x multiple for cash flow as a simplistic proxy for net present value.

So with that simplification, the value of a business is approximated by 10 x (revenues - costs). You can focus on creating value by driving revenues
or you can focus on creating value by driving profits. And they are not the same. Because costs don't have to grow linearly with revenues.

Chris Andersen wrote a very good piece in today's WSJ called The Economics Of Giving It Away. In that essay, Chris wrote:

Meanwhile YouTube is still struggling to match it s popularity with revenues and Facebook is selling
commodit y ads for pennies after it s effort t o charge for int rusive advertising led t o a user backlash. And
news-sharing site Digg, for all its millions of users, st ill doesn't make a dime. A year ago, that hardly
mattered: The business model was "build to a lucrative exit, preferably in cash." But now t he exit doors
are closed and cash flow is king.

Chris goes on to suggest that Internet entrepreneurs are going to have to get people to step up and pay for something instead of just giving
everything away for free because advertising isn't going to foot the bill for every company. That may well be true and we are certainly thinking that
way for most, if not all, of our portfolio companies. But Chris's examples, particularly Facebook and Digg, are examples of companies that might
benefit from looking at the cost side of the profit equation at some point (maybe not yet).

Let's look at Craiglist. I've heard people estimate that they are doing close to $100mm in annual revenues at this point. Many say, "they could be
doing so much more". But the Craigslist profit equation is interesting. They apparently have less than 30 employees. That's about $4mm/year in
employee costs. Let's assume that they spend another $6mm per year on hosting and bandwidth costs and other costs. So it's very possible that
Craigslist's annual costs are around $10mm/year. Their value equation then is 10 x (100-10) = $900mm. That's almost a billion dollars in value for
a company with only 30 employees.

The web can do that in more than one company. Last month, I read on Techcrunch that Digg's annual revenues were around $8.5mm last year.
Everyone was saying how bad that was. And maybe it is, but I don't know. It wasn't the revenues that shocked me. It was the costs. Apparently
Digg's costs for 2008 were about $14mm and they have over 70 employees and are planning on growing that number to 150 in 2009. Digg is
entirely peer produced. It could take a Craigslist approach to its business and keep its headcount to around 30. Then it might be close to breakeven
and could grow over time to a business with $30mm to $50mm in revenue and $10mm in costs and $20mm to $40mm in profits. Apparently Digg
has been looking for an exit in the neighbourhood of $300mm. They could get there with a lean cost structure possibly more easily than investing
heavily in new stuff.

Facebook also comes to mind. Last winter, Kara Swisher reported that Facebook was planning on generating revenues of $300mm to $350mm in
2008 and that it would have profits of $50mm, meaning its costs would be $300mm in 2008. She also reported that Facebook would take its
headcount to about 1000 by the end of 2008. As Chris said in his WSJ piece, Facebook has been widely derided for the low CPMs it generates
(pennies in Chris' words). But instead of deriding the revenues that Facebook is generating, maybe we should be in awe of a $350mm revenue
stream coming from a company that produces no content of its own. Why does Facebook need 1000 employees? Why does it need to spend
$300mm per year? There may be good reasons. International expansion can be expensive and so is building out a large sales organization. But of
course, none of that has to happen. Could Facebook instead cut is headcount back to 500ish and become incredibly profitable and still grow like a
weed? I don't know that much about what is going on inside of Facebook and I am not trying to be critical of any one company. I am just trying to
make a larger point.

Let's talk about the biggest and most valuable Internet company of them all, Google. Google has one incredibly amazing business - keyword
advertising. It relies on its own search service and deals with other search services and content partners for the audience that drives the keyword
business. If you stripped that business out of Google, you'd probably have a business that has gross revenues of $20bn, net revenues of $13bn,
and operating profits of $8bn to $10bn. That business is worth the approximately $100bn of market value that Google has right now. Everything
else is valued at zero because it has a lot of costs and no revenue. Could Google unlock a lot of value by giving up on everything else they are
doing? Maybe not, but they probably wouldn't lose much value either. I am not suggesting they do that, by the way. But again, I just want to make
a point.
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APPENDIX 2
REMEMBER PROFITS EQUAL REVENUES MINUS COSTS (CONTINUED)

The web can create incredibly high operating margin businesses. Craigslist has an operating margin of 90%. Google's keyword business has an
operating margin north of 60% (based on net revenues) and possibly higher. Could Facebook and Digg copy those models and create a lot of value
on revenue numbers that many think are pitifully small? I think so.

We have a bunch of companies in our portfolio that have done a lot with very little. For example, Tumblr has less than 10 employees, Disqus has 5,
Twitter has around 20, Boxee has around 10. These companies are reaching large audiences and creating scale that can be monetized in many
ways. We didn't tell these companies to stay small. They told us they could do a lot with a little. And watching them do just that has taught me a
lot. Yes, they will all grow this year, most of our companies will. But if they continue to do a lot with a little, their business models will be built on
operating margins that are very high and can create a lot of value without a lot of revenue.

I think that's an important part of the economics of the web that are left out of most discussions of Internet business models. Yes, we are turning
analog dollars into digital pennies in many cases. But we are also doing the same thing on the cost side, maybe even more so. And I think that
"operating leverage" is going to create a lot of value.
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APPENDIX 3
IPHONE DEVELOPERS GO FROM RAGS TO RICHES

“iPhone Developers Go From Rags to Riches” appeared on Wired (September 19, 2008)
The iPhone is a revolutionary handset. But it is also the key to a virtual gold mine -- the iTunes App Store, where independent developers can
become multimillionaires in just a year.

Since its launch in July, the App Store has grown to become an indie developer's dream come true. Steve Demeter, developer of the vastly popular
$5 iPhone game Trism, announced he made $250,000 in profit in just two months. His team? Himself, mainly, with a little bit of help from a friend
and a contracted designer (whom he paid $500). If his profits continue at this rate, Demeter will earn nearly $2 million by July 2009.

"I really didn't think about the money," Demeter said in a phone interview with Wired.com. "I got an e-mail from a lady who's like, a 50-year-old
woman who says, 'I do not play games, but I love Trism.' That's what I did it for."

What's more, Demeter initially released Trism as a free native application in the Jailbreak community -- meaning it was a game that users could
play only if they hacked their iPhones. The prospects of making money were uncertain, but Demeter had a vision: He knew iPhone apps would get
big once Apple released a software developer kit to allow third-party apps on the handset, and he wanted to get in on the platform early.

Though Demeter's success was fortuitous, he said he expects other applications to see similar numbers. He said the factors that made Trism stand
out were unique gameplay (Trism is essentially a version of Bejeweled using the iPhone's accelerometer), high replay value and an online
leaderboard that creates community. He said applications with great content will sell themselves, and that's ultimately what other developers need
to focus on, too.

In a sense, the App Store, despite its corporate ties, has created an open market where developers can strike it rich with minimal resources -- even
out of a garage -- so long as they possess the talent and the time.

Bart Decrem, CEO of Tapulous, would agree. His company's free application Tap Tap Revenge, a music-rhythm game that utilizes the iPhone's touch
screen and accelerometer, hit a milestone of 1,000,000 downloads just two weeks after its launch. As of this writing there are 1.75 million users
who have downloaded Tap Tap Revenge, according to Decrem, and the company expects that number to grow to 2,000,000 by next week. As
for profits, Tapulous just recently began inserting advertisements in the game, and the company also has plans to release a premium version that
will cost money.

Decrem was mum to disclose profit numbers, but Demeter estimates that any top iPhone app is making its company roughly $5,000 to $10,000 a
day.

Decrem's recipe for success with Tap Tap is similar to Trism's: Paying attention to detail; keeping the app engaging and alive with various forms
of gameplay; and relying on those two factors to spread popularity with an old-fashioned marketing method -- word of mouth. Similar to Trism,
Tap Tap Revenge was also an app that initially emerged in the Jailbreak community, and it spawned a loyal following there before breaking out
into the broader market with the launch of the App Store.

Decrem, whose initial team was only four people including himself, said he views the App Store as an exciting new landscape, as opposed to today's
overcrowded world of dot-coms.

"I think it's a very interesting space, and it's very reminiscent of the early days of the web in terms of the amount of green fields and opportunity,"
Decrem said in a phone interview. "You really don't need a huge amount of capital. You need attention to detail and product, and that's going to
keep increasing."

Not all App Store success stories started out with the iPhone in mind.Design by a Knife CEO Austin Sarner's story is a bit different from Demeter's
and Decrem's. Sarner built his reputation as a coder who had developed popular Mac applications in the past: App Zapper and Disco. He didn't even
think about developing an iPhone app until much later in the game, he says.

Good thing he did: Sarner's $3 application, Pennies, a budgeting tool, was the 12th most popular in the App Store at one point.

Sarner echoes the idea that great content -- not marketing -- is what drives App Store success.

"You can come up with a generic idea, but implement it properly and you really are going to stand out," Sarner said in a phone interview. "Basically
everybody's on the same level once they submit an iPhone app. Unlike traditional marketing, there's no ad campaign: A user just sees what he sees
in the iPhone store, and the applications kind of have to sell themselves to some extent."

All three of these developers -- big fish in a small pond, if you will -- have plans for future iPhone applications as well.

"I have a sense of a bigger picture," Demeter said. "The community that has spread within Trism -- the amount of people that use forum
accounts and create a sense of community -- I want to keep making great games, games people want to play."

Updated: 11 a.m., Sept. 23: Demeter provided document ation to Wired.com confirming his earnings.
 DRAFT
APPENDIX 4
START-UP IDEAS WE'D LIKE TO FUND

“Start-up Ideas We'd Like To Fund” appeared on Y Combinator (July 2008)

When we read Y Combinator applications there are always ideas we're hoping to see. In the past we've never said publicly what they are. If we say
we're looking for x, we'll get applications proposing x, certainly. But then it actually becomes harder to judge them: is this group proposing x
because they were already thinking about it, or because they know that's what we want to hear?
We don't like to sit on these ideas, though, because we really want people to work on them. So we're trying something new: we're going to list
some of the ideas we've been waiting to see, but only describe them in general terms. It may be that recipes for ideas are the most useful form
anyway, because imaginative people will take them in directions we didn't anticipate.
Please don't feel that if you want to apply to Y Combinator, you have to work on one of these types of ideas. If we've learned nothing else from
doing YC, it's how little we know. Many of the best start-ups we've funded, like Loopt, proposed things we'd never considered.
1. A cure for the disease of which the RIAA is a symptom. Something is broken when Sony and Universal are suing children. Actually, at least
two things are broken: the software that file sharers use, and the record labels' business model. The current situation can't be the final answer. And
what happened with music is now happening with movies. When the dust settles in 20 years, what will this world look like? What components of it
could you start building now?
The answer may be far afield. The answer for the music industry, for example, is probably to give up insisting on payment for recorded music and
focus on licensing and live shows. But what happens to movies? Do they morph into games?
2. Simplified browsing. There are a lot of cases where you'd trade some of the power of a web browser for greater simplicity. Grandparents and
small children don't want the full web; they want to communicate and share pictures and look things up. What viable ideas lie undiscovered in the
space between a digital photo frame and a computer running Firefox? If you built one now, who else would use it besides grandparents and small
children?
3. New news. As Marc Andreessen points out, newspapers are in trouble. The problem is not merely that they've been slow to adapt to the web.
It's more serious than that: their problems are due to deep structural flaws that are exposed now that they have competitors. When the only
sources of news were the wire services and a few big papers, it was enough to keep writing stories about how the president met with someone and
they each said conventional things written in advance by their staffs. Readers were never that interested, but they were willing to consider this
news when there were no alternatives.
News will morph significantly in the more competitive environment of the web. So called "blogs" (because the old media call everything published
online a "blog") like PerezHilton and TechCrunch are one sign of the future. News sites like Reddit and Digg are another. But these are just the
beginning.
4. Outsourced IT. In most companies the IT department is an expensive bottleneck. Getting them to make you a simple web form could take
months. Enter Wufoo. Now if the marketing department wants to put a form on the web, they can do it themselves in 5 minutes. You can take
practically anything users still depend on IT departments for and base a start-up on it, and you will have the enormous force of their present
dissatisfaction pushing you forward.
5. Enterprise software 2.0. Enterprise software companies sell bad software for huge amounts of money. They get away with it for a variety of
reasons that link together to form a sort of protective wall. But the software world is changing. I suspect that if you study different parts of the
enterprise software business (not just what the software does, but more importantly, how it's sold) you'll find parts that could be picked off by
start-ups.
One way to start is to make things for smaller companies, because they can't afford the overpriced stuff made for big ones. They're also easier to
sell to.
6. More variants of CRM. This is a form of enterprise software, but I'm mentioning it explicitly because it seems like this area has such potential.
CRM ("Customer Relationship Management") means all sorts of different things, but a lot of the current embodiments don't seem much more than
mailing list managers. It should be possible to make interactions with customers much higher-res.
7. Something your company needs that doesn't exist. Many of the best start-ups happened when someone needed something in their work,
found it didn't exist, and quit to build it. This is vaguer than most of the other recipes here, but it may be the most valuable. You're working on
something you know customers want, because you were the customer. And if it was something you needed at work, other people will too, and
they'll be willing to pay for it.
So if you're working for a big company and you want to strike out on your own, here's a recipe for an idea. Start this sentence: "We'd pay a lot if
someone would just build a ..." Whatever you say next is probably a good product idea.
8. Dating. Current dating sites are not the last word. Better ones will appear. But anyone who wants to start a dating start-up has to answer two
questions: in addition to the usual question about how you're going to approach dating differently, you have to answer the even more important
question of how to overcome the huge chicken and egg problem every dating site faces. A site like Reddit is interesting when there are only 20
users. But no one wants to use a dating site with only 20 users—which of course becomes a self-perpetuating problem. So if you want to do a
dating start-up, don't focus on the novel take on dating that you're going to offer. That's the easy half. Focus on novel ways to get around the
chicken and egg problem.
9. Photo/video sharing services. A lot of the most popular sites on the web are for photo sharing. But the sites classified as social networks are
also largely about photo sharing. As much as people like to share words (IM and email and blogging are "word sharing" apps), they probably like to
share pictures more. It's less work and the results are usually more interesting. I think there is huge growth still to come. There may ultimately be
30 different subtypes of image/video sharing service, half of which remain to be discovered.
10. Auctions. Online auctions have more potential than most people currently realize. Auctions seem boring now because EBay is doing a bad job,
but is still powerful enough that they have a de facto monopoly. Result: stagnation. But I suspect EBay could now be attacked on its home territory,
and that this territory would, in the hands of a successful invader, turn out to be more valuable than it currently appears. As with dating, however,
a start-up that wants to do this has to expend more effort on their strategy for cracking the monopoly than on how their auction site will work.
11. Web Office apps. We're interested in funding anyone competing with Microsoft desktop software. Obviously this is a rich market, considering
how much Microsoft makes from it. A start-up that made a tenth as much would be very happy. And a start-up that takes on such a project will be
helped along by Microsoft itself, who between their increasingly bureaucratic culture and their desire to protect existing desktop revenues will
probably do a bad job of building web-based Office variants themselves. Before you try to start a start-up doing this, however, you should be
prepared to explain why existing web-based Office alternatives haven't taken the world by storm, and how you're going to beat that.
12. Fix advertising. Advertising could be made much better if it tried to please its audience, instead of treating them like victims who deserve x
amount of abuse in return for whatever free site they're getting. It doesn't work anyway; audiences learn to tune out boring ads, no matter how
loud they shout.
 DRAFT
APPENDIX 4
START-UP IDEAS WE'D LIKE TO FUND (CONTINUED)

What we have now is basically print and TV advertising translated to the web. The right answer will probably look very different. It might not even
seem like advertising, by current standards. So the way to approach this problem is probably to start over from scratch: to think what the goal of
advertising is, and ask how to do that using the new ingredients technology gives us. Probably the new answers exist already, in some early form
that will only later be recognized as the replacement for traditional advertising.
Bonus points if you can invent new forms of advertising whose effects are measurable, above all in sales.
13. Online learning. US schools are often bad. A lot of parents realize it, and would be interested in ways for their kids to learn more. Till recently,
schools, like newspapers, had geographical monopolies. But the web changes that. How can you teach kids now that you can reach them through
the web? The possible answers are a lot more interesting than just putting books online.
One route would be to start with test prep services, for which there's already demand, and then expand into teaching kids more than just how to
score high on tests. Another would be to start with games and gradually make them more thoughtful. Another, particularly for younger kids, would
be to let them learn by watching one another (anonymously) solve problems.
14. Tools for measurement. Now that so much happens on computers connected to networks, it's possible to measure things we may not have
realized we could. And there are some big problems that may be soluble if we can measure more. The most important of all is the defining flaw of
large organizations: you can't tell who the most productive people are. A small company is measured directly by the market. But once an
organization gets big enough that people on in the interior are protected from market forces, politics starts to rule, instead of performance. An
improvement of even a few percent in the ability to measure what actually happens in large organizations would have a huge impact on the world
economy, and a start-up that enabled it would be entitled to a cut.
15. Off the shelf security. Services like ADT charge a fortune. Now that houses and their owners are both connected to networks practically all
the time, a start-up could stitch together alternatives out of cheap, existing hardware and services.
16. A form of search that depends on design. Google doesn't have a lot of weaknesses. One of the biggest is that they have no sense of
design. They do the next best thing, which is to keep things sparse. But if there were a kind of search that depended a lot on design, a start-up
might actually be able to beat Google at search. I don't know if there is, but if you do, we'd love to hear from you.
17. New payment methods. There are almost certainly things whose growth is held back because there's no way to charge for them. And the
people who could implement solutions don't realize how much demand there would be, precisely because this growth has been held back. So pretty
much any new way of paying for things that's easier for some class of situations will turn out to have a bigger market than its inventors expected.
Look at PayPal. (Warning: Regulated industry.)
18. The WebOS. It probably won't be a literal translation of a client OS shifted to servers. But as applications migrate to servers, it seems possible
there will be something that plays a central role like an OS does. We've already funded several start-ups that could be candidates. But this is a big
prize, and there will probably be multiple winners.
19. Application and/or data hosting. This is related to the preceding idea, but not identical. And again, while we've already funded several
start-ups in this area, it's probably going to be big enough that it contains several rich markets.
It may turn out that 4, 18, and 19 all have the same answer. Or rather, that there will be things that answer all three. But the way to find such a
grand, overarching solution is probably not to approach it directly, but to start by solving smaller, specific problems, then gradually expand your
scope. Start by writing Basic for the Altair.
20. Shopping guides. Like news, shopping used to be constrained by geography. You went to your local store and chose from what they had. Now
the space of possibilities is bewilderingly large, and people need help navigating it. If you already know what you want, Bountii can find you the
best price. But how do you decide what you want? Hint: One answer is related to number 3.
21. Finance software for individuals and small businesses. Intuit seems ripe for picking off. The difficulty is that they've got data connections
with all the banks. That's hard for a small start-up to match. But if you can start in a neighbouring area and gradually expand into their territory,
you could displace them.
22. A web-based Excel/database hybrid. People often use Excel as a lightweight database. I suspect there's an opportunity to create the
program such users wish existed, and that there are new things you could do if it were web-based. Like make it easier to get data into it, through
forms or scraping.
Don't make it feel like a database. That frightens people. The question to ask is: how much can I let people do without defining structure? You want
the database equivalent of a language that makes it easy to keep data in linked lists. (Which means you probably want to write it in one.)
23. More open alternatives to Wikipedia. Deletionists rule Wikipedia. Ironically, they're constrained by print-era thinking. What harm does it do
if an online reference has a long tail of articles that are only interesting to a few people, so long as everyone can still find whatever they're looking
for? There is room to do to Wikipedia what Wikipedia did to Britannica.
24. A buffer against bad customer service. A lot of companies (to say nothing of government agencies) have appalling customer service.
"Please stay on the line. Your call is important to us." Doesn't it make you cringe just to read that? Sometimes the UIs presented to customers are
even deliberately difficult; some airlines deliberately make it hard to buy tickets using miles, for example. Maybe if you built a more user-friendly
wrapper around common bad customer service experiences, people would pay to use it. Passport expediters are an encouraging example.
25. A Craigslist competitor. Craiglist is ambivalent about being a business. This is both a strength and a weakness. If you focus on the areas
where it's a weakness, you may find there are better ways to solve some of the problems Craigslist solves.
26. Better video chat. Skype and Tokbox are just the beginning. There's going to be a lot of evolution in this area, especially on mobile devices.
27. Hardware/software hybrids. Most hackers find hardware projects alarming. You have to deal with messy, expensive physical stuff.
But Meraki shows what you can do if you're willing to venture even a little way into hardware. There's a lot of low-hanging fruit in hardware; you
can often do dramatically new things by making comparatively small tweaks to existing stuff.
Hardware is already mostly software. What I mean by a hardware/software hybrid is one in which software plays a very visible role. If you work on
an idea of this type you'll tend to have the field to yourself, because most hackers are afraid of hardware, and most hardware companies can't write
good software. (One reason your iPod isn't made by Sony is that Sony can't write iTunes.)
28. Fixing email overload. A lot of people, including me, feel they get too much email. A solution would find a ready market. But the best solution
may not be anything as obvious as a new mail reader.
Related problem: Using your inbox as a to-do list. The solution is probably to acknowledge this rather than prevent it.
29. Easy site builders for specific markets. Weebly is a good, general-purpose site builder. But there are a lot of markets that could use more
specialized tools. What's the best way to make a web site if you're a real estate agent, or a restaurant, or a lawyer? There still don't seem to be
canonical answers.
Obviously the way to build this is to write a flexible site builder, then write layers on top to produce different variants. Hint: The key to making a
site builder for end-users is to make software that lets people with no design ability produce things that look good—or at least professional.
30. Start-ups for start-ups. The increasing number of start-ups is itself an opportunity for start-ups. We're one; TechCrunch is another. What
other new things can you do?
 DRAFT
APPENDIX 5
EARLY STAGE PROGRAMMES

Name Location Amount Intake Programme Length Comment

Y Combinator Silicon Valley $5,000 + $5,000 per 19 Companies 12 weeks The original “seed money
founder (Summer 2007) and mentorship” approach

TechStars Boulder, Colorado $6,000 per founder (max 10 Companies 13 weeks -

$18,000)

Dream IT Ventures Philadelphia $15,000- $30,000 Not known 12 weeks -

LaunchBox Digital Washington DC Up to $20,000 9 Companies 12 weeks -

Seedcamp London, receives applicants €50,000 5 Companies 12 weeks The only European early
from across Europe stage programme

Innovate!Europe Europe wide Not known 1 Winner 6 month programme at “Talent Search” to
accelerator located in accelerate pre-existing
Silicon Valley start-ups