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Summary:

After spending the past few years pouring money into Facebook applications and me-too social networks, venture firms are starting to invest in infrastructure again, with both hardware and software plays tied to the cloud.

When was the last time you bought software that came in a box, an actual CD that you put into your disc drive in order to load it onto your computer? It’s probably been a while, since most applications are now downloaded straight from the Internet. Today a growing number of companies are buying their computing capabilities that way, too. Instead of buying a rack of servers from IBM, Dell or HP, or a dedicated box hosted in a data center, businesses are buying compute power in the form of services from companies like Amazon, GoGrid and Mosso.

Such services are generally referred to as cloud computing, and the game-changing potential of those services has venture firms sitting up and taking notice. Indeed, after spending the past few years pouring money into Facebook applications and me-too social networks, venture firms are starting to invest in infrastructure again, with both hardware and software plays tied to the cloud.

“Clearly there is a renewed interest and investment in infrastructure,” says Bernard Dallé, a partner with Index Ventures. “Twenty-four months ago it was all about the consumer Internet and still a lot of money is going after that, but it has been rebalanced. Now firms see the value that EqualLogic and virtualization has generated, and it’s time to invest.”

So far this year, companies providing cloud services or building services on top of the cloud have raked in more than $70 million. That’s nothing compared to the $14.9 billion that VCs invested during the same six-month period overall, but interest is picking up.

Just this week, 10gen raised a $1.5 million first round from Union Square Ventures to create a platform for programmers to build products on top of the cloud. Appirio, a company trying to help enterprise customers link their data among clouds offered by Google, Salesforce and Amazon raised $5.6 million from Sequoia. And earlier this month, EngineYard raised $15 million from New Enterprise Associates, Amazon and Benchmark Capital to build out a development platform for programs built using Ruby on Rails.

These companies join a growing ecosystem of startups trying to create utility and business models built on top of thousands of servers. If you peel back the fog surrounding cloud computing there are several layers of services. It all starts with a virtualized server running a hypervisor. Between the hypervisor and the operating system — such as Linux or Windows — sits a class of service providers, among them Elastra and Enomaly. They provide tools and services that help an IT manger build out, monitor and manage the virtual hardware inside the cloud.

On top of those are development platforms that can be tailored to a specific cloud, such as Amazon’s, or tied to a programming language, such as Ruby on Rails. Startups here include Bungee Labs, EngineYard and Coghead. Once developers have their programs built on the cloud, they need to monitor and tweak them using tools from the likes of RightScale and Hyperic. With the exception of Enomaly and Coghead, all of these startups have scored venture funding this year.

Coghead raised $8 million last year, and Reuven Cohen, co-founder and CEO of Enomaly, says he’s fielding about 40 calls a week from venture firms that want to invest in his profitable, boot-strapped company. “I’m not in any desperate need to raise funding to keep the business afloat, but we could grow substantially faster,” Cohen says. “We are open to it and from what I can see, there won’t be a better time for valuations.”

Valuations might be on the rise, but VCs are still focused on capital efficiency. For example Sunil Dhaliwal, a general partner with Battery Ventures, says he’s not interested in investing in any cloud provider that wants to build out thousands of servers as there are plenty of companies — among them Google, Amazon and Rackspace — doing that already. In fact, he’s approaching the entire cloud space with caution.

“We’re so early and there’s still plenty of money to be lost — and I underline lost here — and plenty to be made,” Dhaliwal says. “I think there is going to be a lot of trial and error. People are defining and building solutions without people knowing how they really want to consume them.”

He believes the big opportunities will lie with firms that can help corporate customers connect their existing IT networks to the cloud, as well as with those that provide computing as a service to small and medium businesses that don’t want to manage their own IT networks. One way or another, the move to computing delivered as a service is a huge change in the way businesses and even consumers will consume information technology. As far as venture dollars floating amongst the clouds, this is only the beginning.

This was originally published on BusinessWeek.com.

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  1. All the way back in ’98 / ’99, you could pay companies like Exodus to host your web apps (so you wouldn’t have to buy your own servers or dedicated pipes). If you lived in the Bay Area, you couldn’t drive two miles down 101 w/ out seeing at least 10 billboards with an ad slogan containing “five nines” in it. Exodus is out of business, while some hosting co’s have thrived – but here are all these folks now proclaiming “cloud computing” as a brand new computing infrastructure phenomena. But isn’t this precisely what the hosting co’s have been doing for the last 10 years? The idea that this is a new phenomena in IT infrastructure is a strawman argument presented by PR people to make boring IT infrastructure sound sexy. If a cool company like Amazon hadn’t just recently made forays into this arena, and if it didn’t have some bong-hit induced name like “cloud computing” (that makes people feel intellectual when they write about it), the so called “news” around cloud computing would have been DOA two years ago, IMHO. “On Demand” >> “IT Automation” >> “Cloud Computing.” The press has taken all of these marcomm-bation stimuli hook-and-sinker every single time. Just like Charlie Brown and Lucy – at some point you just gotta get wise to the gag, c’mon.

  2. Derek Cheng Friday, July 25, 2008

    When the concept for LongJump’s platform-as-a-service came in the early 90s, our CEO and Founder Pankaj Malviya’s idea was rejected by plenty of VCs who felt it wasn’t going to fly. “No one would buy a platform,” they said. But with some creative bootstrapping and a swell of interest, here we are, doing it without funding.

    VCs are just a means to an end. They’re not always the golden gauge of success.

  3. There’s just a matter of right timing, I guess. It happens not just in the IT industry but more so in the entertainment fields like music and movies as trust and confidence in technologies mature (look at comics adaptation movies now – stories are more or less the same but innovations drive the visual spectre/drawings to moving pics).

    But it till doesn’t prove that VC’s have a nose for top innovations, at the very least, they just want to get a piece of the tasty pie. (And it just hurts that they can afford it and I can’t.)

    Best.
    alain
    mor.ph

  4. HyperLINKS July 25, 2008 | Blogging Hyperic Friday, July 25, 2008

    [...] Higginbotham writes about VC’s increasing interest in the cloud, mentioning Hyperic as an option for [...]

  5. Its a wise decision to be invested in this sector as it will grow exponentially within no time, although it already has grown vast and many users feel it is the easy and best way to have your data in the clouds which is well protected and secure. Sites like eDeskOnline, Thinkfree offer most of the office applications online reducing the burden of carrying your data whereever you go into a hard drive or an USB for that purpose.

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    [...] OM had a thoughtful post the other day about VC’s moving their investments into The Cloud, ie services brought to you and me via the internet. It was interesting for the reason that it [...]

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    [...] Higginbotham writes about VC’s increasing interest in the cloud, mentioning Hyperic as an option for [...]

  8. RightScale Gets $13M To Manage the Cloud – GigaOM Monday, December 8, 2008

    [...] RightScale’s board of directors. The funding is another proof point that venture firms are still investing in cloud computing plays despite the downturn. RightScale, as well as its competitor Elastra, which raised money in August, [...]

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