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Venture investors still have a healthy appetite for early-stage consumer Internet companies, but those startups are having a harder time raising follow-on financing.

Overall the amount invested in consumer information services was off 42% in the first nine months as the difficulties of newly public Internet companies such as Facebook and Zynga cast doubt on the business models and valuations of social media companies.

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Crashlytics, a Cambridge-based startup that helps developers understand how and why their mobile apps crashed, is taking another slug of funding with a $5 million round led by Flybridge and Baseline Ventures. The company’s co-founder Wayne Chang said the company decided to take funding after its $1 million seed round was oversubscribed. (This round was also oversubscribed.)

“We liked the investors that we were working with,” Chang said. “Obviously, we liked the valuation and the terms of this round, too.”

Crashlytics provides developers with an online dashboard that helps explain where mobile app crashes might come from. It details the device’s state at the time of crash (software version, orientation, model, etc.) and even shows developers the exact line of code that the app crashed on.

Chang says that’s a big step up from what Apple provides. Usually if an iOS app crashes, the user deletes the app or leaves a bad review. Chang says that Apple’s own crash reporting system might take a few weeks to reveal what’s going wrong.

The company has some early momentum to show. Chang says that more than 500 organizations are using Crashlytics and that the company’s SDK is on tens of millions of devices.

He touts an enviable list of clients like Path, Hipstamatic, Highlight, Yammer, Box and SoundCloud among dozens of others. A point of pride for Chang is that Crashlytics SDK is very small — think 40 kilobytes. So that should help prevent developers from running up against app size limits in the iOS or Android app stores.

But the big picture isn’t just crash reporting, as you might guess. Crash reporting is a start.

“Our end goal with Crashlytics isn’t do to crash reporting,” Chang said. “We want to be best service for that and then quickly move beyond that to address other developer needs.”

P.S. You may know Crashlytics from controversies such as the debate over how to replace UDIDs on iOS devices. The company came in with its own solution called SecureUDID, that gives developers an identification scheme that won’t violate Apple’s new policies. Apple is deprecating an older identification scheme called UDIDs amid privacy concerns.

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The startups that presented at Y Combinator’s Demo Day last week were remarkable in their own right, but perhaps the most striking thing was the sheer number of them.

With 66 companies and 180 founders in this season’s batch, the auditorium at Mountain View’s Computer History Museum was practically bursting with angel investors and reps from every notable venture firm last week. And that was just the latest class. Since 2005, Y Combinator has since spawned more than a dozen batches of startups including Dropbox and Airbnb. The last two classes alone have created more than 120 companies.

So it raises the question of how Y Combinator has been able to grow in size while sustaining both the quality of startups it churns out and the value it provides for founders.

Essentially, how do you scale a company that creates companies?

The Strategy and Vision

“Our whole approach to scaling Y Combinator is the standard approach to scaling software,” said Paul Graham, Y Combinator’s co-founder.

There are a couple rules, he said. 1) You can’t predict in advance where the bottlenecks will be so you just keep going until you hit the next one and 2) You can always scale a lot more than you originally predicted. ”When you scale things, they often turn into other stuff that you would have never imagined,” he said.

Graham doesn’t have an exact size in mind when accepting companies for a new class. The early-stage venture firm accepts as many companies as the team thinks are worthy. Nor does Graham know how large Y Combinator should ultimately be.

“Imagine if you had asked Mark Zuckerberg that question when Facebook had just two universities,” Graham said. “A lot of what drives us is curiosity about what happens when something like this gets bigger.”

Indeed, some of the other partners liken working at Y Combinator to building a university or a new type of institution that’s never been seen before.

“If you think of YC as a corporation or a company, it has these characteristics that every big company would love to have,” said Harj Taggar, an alum who later became a YC venture partner. “It’s a bunch of smart people working on projects that they love and have upside in. But they are all linked together and get the benefits of being a part of a larger group. YC is effectively inventing a new form of organization.”

Given the scale of Graham’s ambition (which shouldn’t be surprising since he tells founders to have “frighteningly ambitious” startup ideas), we walked through some of the many bottlenecks YC has faced through the years:

Applications:

Y Combinator’s increasing cachet has brought a ballooning number of applications. Last October, Graham said that the firm was seeing about one submission per minute on deadline day for the most recent class.

Every one of the firm’s venture partners used to read every application. Now they don’t. They might read one-third of the applications. It’s the alumni who make the first pass, depending on how much time they have. Some do none while others read as many as 100 applications or more.

“We went back over the years and saw that we had never accepted a company for an interview where the alumni were majority ‘No,’” Taggar said. “This weeds out really bad applications so we can focus on the borderline ones, which take more time.”

But just in case they miss a potentially good company, Y Combinator is starting to use data mining software. They’ve fed a program all of the old Y Combinator applications to find predictors of success and apply them to new submissions, creating a backstop in case they miss something.

“There are two kinds of mistakes: funding a bad startup or missing a good one. Our biggest fear is missing a good startup,” Graham said, adding that Dropbox’s co-founder Drew Houston was actually rejected the first time around. They’ve used the program to generate a top 10 list of factors predicting the probability of acceptance. ”I don’t want to share it, but it was fascinating,” Graham said.

After they pick a cohort of companies to interview, they fly them in. They used to do a single track interview process where every single partner had to be present in the room. Last time, they did two interview tracks with half the partners in one of two rooms that went through half the finalists each. This time, they might do three tracks simultaneously.

Following the interview, the partners decide immediately within the next five minutes about whether they should accept the company or not.

“We have to be very disciplined,” Taggar said. “By the end of the day, when you’ve done twenty-something interviews, you can barely remember what happened in the first one.”

Advising:

Y Combinator’s big initial bottleneck was that there was one Paul Graham, and he only had 24 hours in a day. So the company brought on additional venture partners like Gmail creator Paul Buchheit and alumni like Taggar, Posterous co-founder Garry Tan and Aaron Iba, who successfully sold AppJet to Google. Geoff Ralston, who was chief executive of Lala, the music startup that exited to Apple in 2009, is joining as a partner for this round. Plus there are part-time partners like Loopt co-founder Sam Altman and Justin.tv founders Emmett Shear and Justin Kan. They joined YC’s original partners Jessica Livingston, Trevor Blackwell and Robert Morris.

“It turns out that this is almost perfectly parallelizable,” Graham said. “I know from experience that one partner can deal with 20 startups and if we have 66 startups, we’re at more than 2X over capacity.”

All of the partners are available for office hours and there’s an internal scheduling tool that Y Combinator uses to gauge demand and urgency from founders. Ash Rust, who co-founded SendHub, had an HR issue once. He was able to get office hours within 30 minutes and the right documentation almost immediately after that.

“I know how hard it can be to get help as a founder if you’re not the belle of the ball,” Rust said. “But I’ve never experienced that here.”

If that still sounds a little impersonal for something as unpredictable and idiosyncratic as founding a startup, Buchheit points out that YC’s alumni network is now so large that the firm is starting to have world-class experts on running companies in many areas.

“As YC gets larger, it actually gets better,” Buchheit said, pointing to the firm’s 800 alumni. ”Half the time, I’m sending founders to talk to different alumni. If you’re doing a video startup, then I know the person you really ought to talk to is Justin Kan.”

The firm taps this alumni network when it holds mini-conferences around issues like user acquisition or iOS development.

“There’s this real feeling of appreciation,” Buchheit says. “The founders are very grateful for the experience, so they have a real loyalty and want to help out other companies. There’s a little bit of a pay-it-forward model built into the network.”

Tan even built a private social networking tool for YC founders. Taggar says it’s useful for putting faces to names and that they’ll probably add a section for skills like the ability to code in Python and so on.

Y Combinator’s emerging network effects:

Not only are alumni helping with admissions and advising, they can serve as market-makers for new startups. Many of mobile payment startup Stripe’s customers are part of Y Combinator while Exec is now offering special corporate accounts to run errands for other startups.

“Y Combinator has a built-in economy,” Buchheit says. “We have this tremendous network and another YC company can be your first reference customer when others won’t take the risk.”

Then if one company isn’t quite a home run, its founders and employees will likely be able to find work at another Y Combinator startup. When Jeff and Dan Morin were considering next steps after working on event startup Anyvite for a few years, Graham paired them with another founder, Olga Vidisheva, from the most recent batch. Now they’ve rounded up funding from Greylock Capital, Andreessen Horowitz, SV Angel and Benchmark Capital to bring independent fashion boutiques online at Shoptiques.

The alumni also come back to Demo Day to angel invest in startups from later batches and companies like Parse, Carwoo and Dropbox have raised angel funding from other alums.

Demo Day and Investors:

Maybe the next big bottleneck is the most obvious one: helping investors wade through the dozens of startups it launches every half-year. The firm had to move Demo Day to The Computer History Museum because its offices no longer had space to fit the hundreds of investors. Y Combinator is also reaching the upper limit of how many startups can pitch in a single day.

Getting through 66 pitches is a slog. ”I don’t think we could handle a Demo Week,” Buchheit joked.

Taggar says he’s thinking about how to make it more efficient for investors to set up meetings with the right startups following Demo Day. Right now, the partners just have a mental map of the investor landscape and try to route the right companies to the right investors.

The week after Demo Day is an especially intense one as entrepreneurs and investors try to lock down deals. It’s kind of a weird biannual version of mating season.

With all the investor interest, the founders clearly don’t see Demo Day as the issue.

In fact, Rust had something else on his mind — how to efficiently get food on speaker nights. ”Seriously, the only scaling problem is the enormous dinner line,” he said.

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If you’re unfamiliar with 2tor, this may do the trick. Today, the education startup is announcing that it has closed a $26 million Series D round of financing, led by an affiliate of The Hillman Company, WestRiver Capital, and Silicon Valley Bank Capital, with participation from its existing investors, which include Bessemer Venture Partners, Highland Capital Partners, Redpoint Ventures, Novak Biddle Venture Partners, and City Light Capital. The startup’s significant new infusion of capital brings its total investment to just under $97 million, making it one of the highest-funded education startups in the country — if not the top dog.

So, what is it about the four-year-old 2tor that has attracted this kind of heavy investment? Well, for starters, in spite of growing by leaps and bounds over the last few years, online education is still kind of a joke. Traditionally, it’s been seen as the source of simple (or ineffectual) micro-correspondence courses designed to be supplemental to — not a replacement for — on-campus education. Well aware of the unexceptional quality of many online educational programs, 2tor was founded in 2008 to take the long-view: For online education to become more than just an afterthought, the job would require more than a good idea and some sexy technology.

Rather than point and laugh at higher education, the startup set out to partner with universities to build, administer, and market their own online degree programs, collaborating with institutions to create digital education programs that would not just be equivalent to in-classroom education, but perhaps even better. To do this, 2tor has endeavored to supply universities with the tools, expertise, capital, and global recruiting necessary to lift up online ed by the bootstraps.

Specifically, 2tor has been partnering with graduate-level, degree programs to provide technology platforms that help institutions extend the classroom experience. So far, the startup has partnered with USC’s Rossier School of Education for their online Master of Arts in Teaching degree, as well as the Masters program for Teaching and Social Work, Georgetown’s nursing program, UNC’s MBA program, and today they’ve announced the addition of another program: UNC’s Master of Public Administration. (With plans to go after another eight or so degree programs.)

To give these programs a viable digital educational platform, 2tor developed a web-based infrastructure that enables professors to share materials with their students, provide lectures and interactive lessons, student support service, social interactivity and more. On top of that 2tor has been moving into mobile, releasing an iPad and iPhone app this year that gives students the ability to participate in live, synchronous class sessions via webcam — from anywhere, via 3G or 4G networks. Last month, 2tor added support for Android.

When we last spoke to the startup, it had grown to a staff of more than 370 and had over 3,500 students participating in its first three degree programs, hailing from 30 different countries. And because its mobile and web combo platform gives graduate students access to stuff like an interactive whiteboard, along with the ability to flip through the deck of a slideshow, split off into a break-out session with other students, then hop back into a live webcam class, is a pretty serious upgrade for online education programs.

Of course, it’s not easy (or cheap) bringing institutions on board, especially with the stigma that’s surrounded online education, and that’s much of the reason why we’ve seen 2tor raise nearly $100 million in funding. As Co-founder Jeremy Johnson told us, 2tor has been investing as much as $10 million in each program it creates. Customizing the platform for each program, working with faculty to get them on board, designing intercampus social networking, and synchronous video capabilities has required significant capital investment.

And so far it’s been working. CEO Chip Paucek and COO Rob Cohen tell us that its first three programs have seen nearly 50 percent adoption of 2tor’s mobile apps, and the online programs are collectively seeing a retention rate of over 80 percent. Obviously, with the amount of capital 2tor puts into these programs, it’s in a sense not a surprise, but these programs are being judged by the same criteria with which one evaluates on-campus, in-classroom education. From class size and student-to-faculty-ratio to retention rate and how, for example, graduates of the USC Teaching program place after completing the program.

This allows the programs to keep the same admissions process they have for on-campus education, applying the same criteria for selection to online degree candidates. That, in and of itself, is largely unheard of in online education. Both Cohen and Paucek said that their wives are participating in 2tor’s programs at these institutions, and report that the digital courses are “hard.” And in that way, the startup is on a mission to create online student experiences that graduates talk about as if they’d been living on campus for two years — even if they were living in Siberia the whole time. Not only that, but ensure that the program is just as rigorous.

2tor has also begun to launch a fleet of microsites intended to become online resources for teachers across the country, regardless of level. Certificationmap.com, for example, is a guide to teacher certifications and lays out the steps necessary to becoming a teacher in each state in the U.S., while Teach.com offers info on teacher salaries, prep work, how to teach abroad, etc.

We’re beginning to see a lot of startups take flipping the classroom more seriously, and from digital textbooks to online education, there’s a lot of exciting stuff happening in the space. 2tor is taking just one approach, and so far, it seems to be working well for them, but higher ed is the low-hanging fruit, next, it will be interesting to see if this formula can be applied to undergraduate degrees, then high school, and on and on. The trick is maintaining the quality, and 2tor may be proving that if startups aren’t willing to take the long-view, and get the necessary capital backing, it’ll be an uphill climb.

For more on 2tor, check ‘em out at home here.

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Editor’s Note: This guest post is written by Doug Pepper, who is a General Partner at InterWest Partners where he invests in SaaS, mobile, consumer Internet and digital media companies. He blogs at dougpepper.blogspot.com.

Everyone expects startups, even successful ones, to undergo a cycle of hype, disappointment and ultimately growth on the way to a sustainable business. But what about new technology markets themselves? Does the growth of a new market follow a similar pattern?

Fred Wilson recently wrote about the twists and turns that startups face (expanding on Paul Graham’s astute “Startup Curve”). I’d like to take those ideas further and describe the “Market Curve” — a similar path that new markets take on the path to sustainability.

The chart below shows the basic pattern. Markets often experience a “Hype Cycle” of overheated expectations followed by a trough — call it “Facing Reality.” If the market ultimately succeeds, the next phase is “Liftoff.” But troughs don’t end until several ingredients are present. First, there must be broad adoption of core underlying technologies that support the market. Second, there needs to be compelling reference applications to drive mainstream adoption. Finally, there must be a pioneering company, typically with a charismatic leader, that leads the market out of the trough. Obviously not all markets are destined to make it out of their trough.

For entrepreneurs and investors the most exciting element of the Market Curve is that, once the trough ends, strong technology markets ultimately prove more valuable than anyone imagined even during the Hype Cycle. Here are a few examples of how different technology markets fit into this curve.

Internet: Broadband Penetration and YouTube

The late ‘90s saw extreme hype surrounding the Internet but the market was simply not yet ready to deliver. With only five million fixed broadband connections in 2000 the underlying technology wasn’t there. Plus there were very few truly compelling applications. The Internet entered its “Facing Reality” trough in the early 2000’s and failed to live up to initial expectations.

But, by 2005, there were 43 million U.S. broadband connections and addictive applications like YouTube and eventually Facebook. That year Jeff Bezos launched Amazon Prime and convinced mainstream consumers that they could conveniently and safely shop for anything online. Since then, the Internet has proven to be more transformative to our civilization and more ingrained into mainstream culture than ever imagined.

Amazon has surfed the wave of the Internet’s Market Curve almost from the very beginning. Their stock price clearly follows this pattern.

Mobile: The iPhone and App Store

Between 2000 and 2005, nearly every VC firm had Mobile as a core investment sector. And, with few exceptions, those investments were unsuccessful. During that time, mobile networks were slow and unreliable (remember the CDPD network?), devices were clunky and carriers thwarted innovation. Clearly, that all changed when Steve Jobs launched the iPhone in 2007 and replaced the carrier decks with the App Store. And, with more than one billion mobile broadband subscribers globally, the post-PC mobile computing industry is in a “Liftoff” phase that is accelerating beyond wildest expectations.

SaaS: Salesforce.com and Successfactors

When I first joined my VC firm, InterWest Partners, in September 2000, the Application Service Provider (ASP) concept was all the rage. These ASPs offered off-the-shelf software to enterprises delivered over the Internet. However, between 2001 and 2007, adoption was slow because enterprises were more concerned with security risks than the benefits of hosted software.

Over time, Internet security and reliability improved and several pioneering companies, including Marc Benioff’s Salesforce.com and Lars Daalgard’s Successfactors, emerged with proprietary software applications that proved the benefits of SaaS delivery. Today, this market has broadened into a larger paradigm called Cloud Computing with corporations shifting nearly every aspect of their IT infrastructure into the Cloud. This could not have been imagined during the Hype Cycle of this market.

Market Failures: Troughs That Never End

Of course, not every market recovers from its trough. For example, while there are certainly specific nano technologies that are fundamental to many products, a broader nanotechnology market hasn’t emerged. It’s not clear that it ever will. And, in my opinion, Cleantech currently sits at the bottom of the trough. Because of extreme capital intensity, long sales cycles and wavering enterprise and consumer interest in “Green,” this market has become challenged. The question is whether Cleantech will ever emerge from the depths of the trough where it sits today and become the powerful market that John Doerr, Vinod Khosla and many others had hoped.

In the chart below, I show where a number of current technology Markets sit along the Market Curve.

Takeway: Have Conviction During the Trough

The best investors recognize and take advantage of these troughs and the best entrepreneurs lead Markets out of the trough. When SaaS was in the trough, Marc Benioff built Salesforce.com and Dave Strohm invested in Lars Daalgard at Successfactors. When the Internet was in the trough, Jeff Bezos built Amazon.com and Roelof Botha invested in YouTube. In the case of Steve Jobs, he invented a product and pioneered a business model that altered the Mobile market and led it out of the trough. The key is to have conviction about a Market and, as an investor, look for the technologies, products and leaders that will end the trough. Or, as an entrepreneur, launch market leading products and business models to end it yourself.

Marketo is an example of an investment my firm, InterWest, made during a trough. During the late 1990′s, there was a peak of excitement around Marketing Automation with companies like Annuncio, Rubric, Marketfirst and ePiphany. But, the market was not ready. Marketers were not adopting Internet techniques for acquiring customers and they didn’t have sufficient budgets to adopt and implement enterprise software.

By 2006 when InterWest invested in Marketo, the company’s founders believed, and my colleague Bruce Cleveland and I agreed, that the market had progressed along the Market Curve. Marketers had begun consistently utilizing search engine marketing, landing pages, email marketing, and online content marketing … all the activities that are harnessed and optimized by Marketing Automation and Lead Nurturing products. And, the SaaS delivery and business model meant that marketers could quickly see ROI without big budgets or IT resources.

We had conviction that that the Marketo team would create the compelling products needed to lead the Marketing Automation market out of the trough. Today it seems clear that this market will be larger than expected even during the initial Hype Cycle.

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Editor’s Note: Alexander Haislip is a marketing executive with cloud-based server automation startup ScaleXtreme and the author of Essentials of Venture Capital. Follow him on Twitter @ahaislip.

“Portfolio” is a word that Silicon Valley loves. Venture firms have portfolios of startups, web designers have portfolios of their work and even public relations agencies have a portfolio of clients. Now chief information officers and IT architects have portfolios of computing power made up of physical servers, virtual machines and public cloud instances at multiple providers.

For most people, a portfolio is little more than an accumulation of individual decisions over time. Look in a typical VC’s portfolio, and you’ll see a storage locker stuffed with buzzword bingo startups slouching toward an orderly shutdown. A web designer’s portfolio? A collection of unrelated commissions.

CIOs don’t have the same luxury to be so haphazard. They have to have a little more foresight when it comes to putting together a compute portfolio. They’re juggling functionality, availability, security and cost and can’t afford to drop anything. And they’re stealing concepts from the world of high finance to make it work.

Finance became a true science when Harry Markowitz invented Modern Portfolio Theory. His simple insight was this: each asset has a risk/reward tradeoff and there’s a single collection of assets—an optimal portfolio—that maximizes reward and minimizes risk. Then Markowitz did a lot of math to show how an investor could get to that optimal portfolio.

Today the most cutting edge IT professionals are starting to discover the idea themselves. For them, the tradeoff isn’t between risk and reward, it’s between functionality and cost. Functionality encompasses a range of variables, from availability to security to sheer processing power. Cost, on the other hand, has never really been that clear until now.

NAKED COST

Cloud computing exposes the naked cost of processing cycles. It strips away the long amortization of under-utilized physical hardware and confusing vendor contracts. It eliminates the abstraction of virtualization efficiency. It clarifies the ambiguous costs of IT employees. Public cloud vendors focus on a single metric: Cents per hour.

The naked cost of computing, once exposed, re-orients your thinking. You’re constantly appraising whether a given job would be cheaper to run on Rackspace or internally.

CIOs are thinking harder than ever before about the tradeoffs they make. They’ve got options now that they didn’t have before. They’re no longer stuck in a monogamous relationship with hardware vendors, so they’re thinking about the features that matter most and what they’re willing to pay for them. It’s clear that credit card data should run only on hardened machines optimized for security, but what about player data in a virtual world? The public cloud may be perfect when you launch a new online video game, but it may make sense to build your own private cloud when demand levels off.

The compute infrastructure has to fit the workload and the cost has to fit the budget.

OPTIMAL COMBINATION

The good news is that there’s an optimal portfolio of computing capacity—just like Markowitz laid out for stock and bond investors. Given a company’s functional requirements and its budget, there’s a perfect combination of physical servers, virtual machines and public cloud instances that maximizes the benefits and minimizes the cost.

Getting to that optimal combination of compute resources isn’t easy. IT Professionals need visibility their existing IT assets and the ability to reorient their resources. It also requires forethought, a truly rare commodity.

It’s often stunning to see how little systems architects know about their own systems. We’ve all heard about rogue IT and the BYOD movement, and some confusion about those devices might be understandable. But not know the basics of what servers you have, what they’re running, how close they are to capacity and how much they cost you is shocking. As Peter Drucker once opined: If you can’t measure something, you can’t manage it. Visibility is the first step to control.

Better information is necessary for creating an optimal compute portfolio but it isn’t sufficient. You also have to have the ability to swap one type of compute infrastructure for another. In finance, this corresponds to the concept of liquidity, or your ability to buy and sell assets on the open market. Getting liquidity in compute infrastructure is more complicated.

It’s long been possible to swap one machine out for newer one, or to re-provision a workload. Virtualization makes it easier to move processing around, but you’re still locked in to your underlying hardware and the operating systems you’ve loaded. Moving between cloud providers can be extremely tricky if you’ve not architected your instances with templates.

Most importantly, getting to an optimal compute portfolio requires forethought. You have to think carefully about the mix of functionality you’ll need and your willingness to pay for it. Not just now, but also in the future. You have to plan for the time when you’ll need to re-balance your compute portfolio. That means architecting your systems for portability from the outset.

Finance, when it’s done right, is a disciplined way of balancing tradeoffs and planning—that’s a rigor IT departments need to adopt as they build modern computing infrastructure.

Let’s just hope they don’t take it too far and start issuing compute default swaps.

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