Tim Oren writes with a lot of insight about approach for entrepreneurs wanting to build value in software startups, and venture funders requiring both defensibility and eventual liquidity, respond to the rise of open standards, open source, and offshoring. Here he provides an excellent outline of a practical approach that would help stakeholders take decision in terms of funding. Excerpts with edits:
The shape of response is emerging from the fog - perhaps an early indicator of the shape of symbiosis between community and commercial processes - the two stage software startup. Unlike a two-staged rocket, the first stage is light and runs on little fuel, it's the second stage that has the big burn, if it ignites. The first stage of the new model software venture builds a useful product as cheaply as possible. Actual engineering is focused ruthlessly on the unique value and differentiating features. In most cases, open standards are exploited to address as large a market as possible using off-the-shelf APIs and libraries. In many cases, the software is written on top of open source platforms, such as LAMP, to keep down development and initial customer costs. Code is usually written to published interfaces, rather than integrated into the open source itself, to avoid 'contamination' by GPL and other OS licenses. Often, a portion of the development will be sent offshore, particularly if the founders have prior experience or cultural connections with a reliable venue. Build as little as possible, as fast and cheaply as possible, while demonstrating some unique value.
Many of these efforts will result in a product, or even a feature, rather than a sustainable company. But that may be OK for the first stage, because the development time and expense are small enough to be funded by the founders, friends and family, or a few angels. The go-to-market is similarly light. Rather than a sales channel, the venture will buy ad words on Google, promote itself via word of mouth on blogs and via user communities, and penetrate enterprises by pricing low enough to fall within the purchasing power of a department, or even an individual. Being in early and continuous touch with its market, the venture can course correct early and often.The time value of having a functioning product with newly proven value may be sufficient for a quick sale to a larger company which has sales channel synergy, or products in a touching function which can quickly integrate the new functionality. While the sale may result in only a few million dollars, that outcome may be quite profitable to the founders and the individual backers. This may even be true on a risk adjusted basis, and that may be a new thing.
Second stage activities will consume cash in advance of the sales to fund them, as they must occur before imitators arrive. They may include adding functionality to meet customer requests, rebuilding parts of the product for greater efficiency and defensibility, adding the necessary sales force, scalability, and system integration to be able to sell to a higher end market, such as the CXO enterprise level, or carriers. At the point of making the second stage decision, the technology risks have been greatly reduced, and a portion of market risk eliminated. The company has already been learning from the market, though it will undoubtedly need to relearn some things as it shifts focus. Entrepreneurs who choose to enter this stage will receive valuations well above what they would have commanded before achieving a first stage takeoff, though perhaps not as much as they might hope - The PC movement almost followed a similar approach for geting funded several years back.