Article from NYTimes.
“What if you threw a $41 million party and nobody came? A start-up company called Color knows how that feels.
In March, Color unveiled its photo-sharing cellphone application — and revealed that it had raised $41 million from investors before the app had a single user. Despite the company’s riches, the app landed with a thud, attracting few users and many complaints from those who did try it.
“It would be pointless even if I managed to understand how it works,” one reviewer wrote in the Apple App Store.
Since then, Color has become a warning sign for investors, entrepreneurs and analysts who fear there is a bubble in start-up investing. They say it shows that venture capitalists, desperate to invest in the next Facebook or LinkedIn, are blindly throwing money at start-ups that have not shown they can build something useful, much less a business that can provide decent returns on investment.
Color, which says it is overhauling its app, is just one of the start-ups that have set tongues wagging about bubbly excess in Silicon Valley. The Melt plans to sell grilled-cheese sandwiches and soup that people can order from their mobile phones. It raised about $15 million from Sequoia Capital, which also invested in Color.
Airbnb, which helps people rent rooms in their homes, is raising venture capital that would value it at a billion dollars. Scoopon, a kind of Groupon for Australians, raised $80 million; Juice in the City, a Groupon for mothers, raised $6 million; and Scvngr, which started a Groupon for gamers, raised $15 million. These could, of course, turn out to be successful businesses. The worry, investors say, is the prices.
They say they have paid two to three times more for their stakes in such start-ups over the past year. According to the National Venture Capital Association, venture capitalists invested $5.9 billion in the first three months of the year, up 14 percent from the period a year earlier, but they invested in 51 fewer companies, indicating they were funneling more money into fewer start-ups.
“The big success stories — Facebook, Zynga and Twitter — are leading to investing in ideas on a napkin, because no one wants to miss out on the next big thing,” said Eric Lefkofsky, a founder of Groupon who also runs Lightbank, a Chicago-based venture fund with a $100 million coffer.
A decade ago, in the first surge of Internet investing, it was not unusual for tech start-ups to raise tens of millions of dollars before they had revenue, a product or users. But venture capitalists became more cautious after the bubble burst and the 2008 recession paralyzed Silicon Valley.
Meanwhile, it now costs less than ever to build a Web site or mobile app. So this time around the general philosophy has been to start small.
“By starting out lean, you have the chance to know if you’re on to something,” said Mark Suster, a managing director at GRP Partners. “If you start fat and the product concept doesn’t work, inherently the company will lose a lot of money.”
Two of Color’s photo-sharing competitors, Instagram and PicPlz, exemplify the lean start-up ethos. They started with $500,000 and $350,000, respectively, and teams of just a few people. As they have introduced successful products and attracted users, they have slowly raised more money and hired engineers.
Color, meanwhile, spent $350,000 to buy the Web address color.com, and an additional $75,000 to buy colour.com. It rents a cavernous office in downtown Palo Alto, where 38 employees work in a space with room for 160, amid beanbag chairs, tents for napping and a hand-built half-pipe skateboard ramp.
Bill Nguyen, Color’s always-smiling founder, has hired a team of expensive engineers, like D. J. Patil, a former chief scientist at LinkedIn.
“If I knew a better way of doing it, I would, but that’s what my cost structure is,” Mr. Nguyen said in an interview last week.
Michael Krupka, a managing director at Bain Capital Ventures and one of Color’s investors, said Color needed to raise a lot of money because it planned to do much more than photo-sharing.”
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