Thursday, Apr. 09, 2009

The New Internet Start-Up Boom: Get Rich Slow

By Josh Quittner

It's time to stop whining. The economy might be melting down like a pat of butter on a hot Hummer roof, but for some people — you, maybe? — this could be a very good thing.

Here's why. At no other time in recent history has it been easier or cheaper to start a new kind of company. Possibly a very profitable company. Let's call these start-ups LILOs, for "a little in, a lot out." These are Web-based businesses that cost almost nothing to get off the ground yet can turn into great moneymakers (if you work hard and are patient, but we'll get to that part of the story).

How do you get started? All that's required is a great idea for a product that will fill a need in the 21st century. These days you'd do best if your idea either makes people money or saves them money.

And launching now will make your company stronger later — you'll learn to survive on fumes until the economy improves. (See how companies have survived bankruptcy.)

That's what John Tayman is doing. He's an author (The Colony, about a former leper colony near Maui) who lives in San Francisco, where I met him; he wrote reviews for a business magazine I edited. Tayman knew little about technology and even less about business. And yet he dreamed of a website that would summarize car reviews from other sources and rank every model of new car. "It'll be like RottenTomatoes.com meets Kelley Blue Book," he explained to me during lunch one day last June.

Tayman said he intended to build the site on the side while continuing to write for a living. He'd work on his new company only at night and on weekends. Oh, yes, and he had only about $10,000. "Good luck with that!" I thought. Ideas are much easier to hatch than they are to execute.

Tayman went to work with nothing more than his PowerBook laptop. A hyperorganized fellow, he quickly discovered a trove of freebies online — instructional manuals and sites aimed at bootstrappers — that walk you through the process from start to finish.

On a website called 37signals.com he learned about the virtues of lightweight programming languages like Ruby on Rails, which are ideal for the project he envisioned. He visited RentACoder.com and Elance.com sites where you can find software developers. He picked up the jargon he needed to describe his project so he could put it out for a bid, and he found his first programmer — in the Ukraine — who agreed to start building the digital scaffolding for the site. Within months, Tayman had a virtual staff of 20 employees working for him in five different countries. "In fact, I didn't even meet the guy who built most of the site until the launch party," he says.

That guy, by the way, as well as a top-flight designer, liked Tayman's idea so much he agreed to take less than his usual fee for equity in the company. See how launching in a downturn works? (See the 25 best blogs of 2009.)

MotorMouths.com went live in January. Tayman figures he has worked about 10 hours a week on it and hasn't spent a cent on marketing or advertising. Growth is modest but steady: nearly 10,000 people visit each week, he says, all of whom get there by word of mouth and via a software "bot" that lets users of Twitter, the popular micromessaging service, request reviews. (See the top 10 celebrity Twitter feeds.)

The cost to Tayman? "Almost $9,800, all in," he said. As for revenue, he just sold his first display ad, for, well, the low three figures. But it's a start: "We've already reached ramen profitability." His math: he spends about $75 a month on server fees and other expenses.

Noodleconomics
The term ramen profitable was coined by Paul Graham, a Silicon Valley start-up investor, essayist and muse to LILO entrepreneurs. It means that your start-up is self-sustaining and can eke out enough profit to keep you alive on instant noodles while your business gains traction.

"At this point, it would be hard for companies to get any cheaper," Graham said. Since everyone already has an Internet-connected computer, "it's gotten to the point that you can't detect the cost of a company when added to a person's living expenses. A company is no more expensive than a hobby these days."

Graham is a partner in Y Combinator, a Mountain View, Calif., company that invests small sums of money in LILO-style start-ups and advises them during their ramen days. The difference between a start-up and a small business, by the way, is that a "start-up is designed to grow — it's scalable," said Graham. Compare a hair salon with Facebook. "Hair salons scale linearly," he explained. "You have to do twice as much work to get twice as much revenue." But once Facebook was built? It grew exponentially.

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Graham said that the recession notwithstanding, he's seeing as many people starting companies now as he did a year ago. That's because over the past five years, as broadband connections to the Net became as commonplace as electricity, the model for launching a Web company changed.

In the old days, start-ups tended to get funded before they launched. Think of the dotcom archetype, Amazon. Only after getting a $300,000 check from his parents did Jeff Bezos set to work building his site. That was typical: entrepreneurs first put their energy into writing business plans — a map that spelled out what they hoped to build. After the money was in hand, they got to work.

There were two drawbacks to that model, both related to the risk of investment. The first was that founders frequently ended up owning a tiny percentage of their company as their ownership got diluted each time they brought in a new round of investment. The second was that there's often no correlation between the assumptions in a theoretical business plan and reality. Many great business plans turned into lousy start-ups — one reason for the last dotcom crash.

But with LILOs, business plans are an afterthought because you can try your idea first at minimal expense, without persuading others to buy in. Or, as Joi Ito, another well-known tech investor, told me recently, "the cost of mapping it is almost higher than the cost of trying it."

Riding the Downturn
That's certainly true for Joe Gebbia and Brian Chesky. Classmates at the Rhode Island School of Design (RISD), they moved to San Francisco a few years ago with the vague intention of starting a business. Their eureka moment occurred in October 2007 when a huge design conference decimated the supply of hotel rooms in the city. They decided to try their idea without mapping it out. (See which businesses are bucking the recession.)

"We thought, Why not host people in our own apartment?" Gebbia said. "It was a way to make a few extra bucks to offset our already expensive rent." The guys had an extra bed, a sofa and an air mattress and decided to offer, via the conference's website, ad hoc bed-and-breakfast accommodations. Thus was born AirBnB.com They made $1,000 that week and were shocked to find that their customers weren't teenage slackers but were instead older folks, including a 45-year-old father of three. Said Gebbia: "It completely blew away our assumptions."

Since they had no money, they quickly enlisted as their partner a former roommate, Nathan Blecharczyk, who had some technical skills. He built the website — which was initially aimed at cities with big conference calendars — and made it easy for hosts to offer low-rent lodging to visitors. AirBnB.com handled the financial transaction between guests and hosts and took 10% from the guests and 3% from the hosts.

Traffic grew. Along the way, the guys listened to their customers, tweaked the site and got free press by arriving at high-profile events, like the 2008 Democratic Convention, that were suddenly short of hotel space. Tapping their RISD backgrounds, they designed fanciful Obama O's and Cap'n McCain's cereal boxes and sold $30,000 worth as collector's items, which kept them going. With their guerrilla lodging site and their cereal boxes, they got on CNN, on many local newscasts and in the New York Times and the Wall Street Journal. And their site grew — enough to garner $20,000 from Y Combinator, the venture firm. (See pictures of the best Obama Inaugural merchandise.)

Today AirBnB.com has nearly 12,000 registered users, with more than 3,000 properties nationwide, Gebbia said. "As the economy gets worse, our business gets better." Again, this is a get-rich-slowly scheme: the business generates enough money to house and feed its three founders, who live together in an apartment that doubles as their workplace.

Will it be the next Facebook? The next Blogger, Digg or Twitter? Who knows? It almost goes without saying that many more start-ups fail than succeed. Reid Hoffman, founder and CEO of the job-networking site LinkedIn and an angel investor in many start-ups (including Facebook), says, "The biggest problem facing any website is distribution." In a world where it's so easy to start a company, how will anyone find yours?

But here again, a bad economy is the LILOpreneur's friend. Ito likes to say, "The cost of failure is cheap. It's so low, you can swing the bat way more times." In a bad economy, no one really notices or cares about more failure. That creates a better environment for risk-taking, which is the only way innovation occurs.

At the same time, launching in a bad economy imposes a kind of discipline, forcing entrepreneurs to keep costs low and be smart about marketing and distribution.

The common wisdom would suggest that Tayman couldn't have picked a worse time to start a company that depends on automotive advertising. But he knew that going in. "I wanted to launch into the dip so that by the time advertising improves, MotorMouths will be sitting pretty," he told me a few days ago. He said he was optimistic, based on recent figures that show auto ads are on the upswing. "If our current growth trends hold and the ad trends hold, MotorMouths could be a $250,000-revenue company within 18 months."

Then again, the economy could get worse and worse. If that happens? Tayman's already working on his next idea.

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