It’s yet another big-dollar buyout for the game industry, which has been in an M&A frenzy for about a year, and one of the biggest investments by a Chinese company in an American digital property.

The transaction was first reported by Bloomberg, and Riot confirmed the deal to VentureBeat, though neither outlet has the financial details. Here’s how they break down, according to people familiar with the transaction:

• Tencent, which had already invested in the game maker, will pay “just south” of $400 million to buy out other investors, primarily Benchmark Capital and FirstMark Capital, which along with angels had put approximately $18 million into the company.
• The company’s management team will receive some portion of that buyout themselves, but will also retain an equity stake; some will receive “stay packages.”
• The total investment values the company at $472 million.

The chief appeal of Tencent is Riot’s League of Legends game, which is free to play but encourages players to pay for extra goodies via micro-transactions. (Thanks to readers who educated me about what you can and can’t buy with real-world money in the game.)

In that sense it’s like Zynga’s FarmVille and other popular social games. But it’s a much more sophisticated game, with arcade-style action: Think of World of Warcraft, on steroids and amphetamines.

The deal follows a string of Web-based game deals in the last year. Among the more notable ones: Walt Disney purchased Playdom, Electronic Arts purchased Playfish and DeNA purchased Ngmoco.

According to 2009′s safely-looking-ahead-at-the-year-to-come articles, 2010 was to be “a year of social media convergence.” It was to be a year in which The Cloud “became part of the everyday lexicon of business” and “a year of invention and innovation.” 2010 was to be not just “the year of the tablet,” but also “the year of the smartphone,” “the year of the tweet” and “the year of location.” Above all, 2010 was to be “a year of significant developments” and generally “a busy year for technology.”

And I suppose it was that. But for me, 2010 was a year like any of year–one not to be taken too seriously. Because if you can’t laugh at Eric Schmidt telling critics of Google Street View to “just move,” Apple telling people that their grip–not the iPhone 4′s antenna–is faulty, or Oracle’s samurai CEO Larry Ellison in a kimono, then, really, what’s the point?

It may be true, as my colleague Peter Kafka noted earlier this week, that there’s little point in pretending we know what’s going to happen in the year ahead, but the year about to pass remains good for a laugh.

In an interesting corporate move, the COO of online real-estate site Zillow, Spencer Rascoff (pictured here), has been promoted to CEO, replacing founding CEO Rich Barton.

Barton–who is also venture partner at Benchmark Capital and on the board of Netflix (NFLX)–will remain executive chairman of Zillow.

He co-founded it in 2005 after founding the Expedia travel site in 1994, while an exec at Microsoft (MSFT) and spinning it out in 1999.

After Expedia, Barton moved on to Zillow, also based in Seattle, which has raised $87 million in funding.

“Zillow is in a fantastic spot on many metrics, so it was ready for a new leader for the next phase,” said Barton, who said he would still remain very involved in the company.

One of the reasons Barton said he felt he could move on: Zillow is now profitable on a cash-flow basis via local and national advertising and referral fees. And it had 12.5 million unique users in August, up 41 percent year over year, despite an economic downturn.

Zillow has been focusing a lot on mobile apps, which now represents 15 to 20 percent of Zillow traffic on weekends.

Rascoff said he will focus on further growing reach and revenue on the Web and via mobile. “It’s a priority to grow the size of our audience,” he said.

The overall goal? Unlike a lot of start-up heads who are wary of IPOs, Rascoff said a public offering was the likely path for Zillow.

“I would like us to be public and we intend to be,” he said.

Here is the official Zillow press release:

Zillow Appoints Spencer Rascoff CEO

Co-founder Rich Barton Remains Executive Chairman

SEATTLE–September 14, 2010–Zillow, Inc., which operates leading real estate website Zillow.com®, Zillow® Mortgage Marketplace, and the industry’s largest mobile real estate platform, today announced Spencer Rascoff has been named chief executive officer. Co-founder Rich Barton, who has been the company’s CEO since it was founded in 2005, will continue to be actively involved in Zillow as executive chairman of the board of directors. Fellow co-founder Lloyd Frink will move from president to the new full-time role of chief strategy officer.

Rascoff joined Zillow in 2005 as one of the original executive team members and has been serving as chief operating officer since October 2008. Previously he was chief financial officer and vice president of marketing. As COO, Rascoff has been responsible for the majority of Zillow’s day-to-day operations for the past two years, overseeing marketing, finance, partner relations, legal and human resources as well as the execution of the company’s recent partnership with Yahoo! He is also a frequent housing market commentator on CNBC, CNN, FOX and Bloomberg TV.

“Spencer is an immensely capable and energetic leader who has been a driving force at Zillow from the beginning, helping to grow the company from a spark of an idea into a profitable industry leader. This promotion is well-deserved and reflects the leadership responsibility he’s been carrying for a while,” said Rich Barton, co-founder and executive chairman of Zillow, Inc. “As executive chairman, I look forward to continuing to work with Spencer and the entire team to extend Zillow’s leadership position in online and mobile real estate.”

“Working with Rich, Lloyd and the entire Zillow team has been the most exciting and rewarding period of my career,” said Spencer Rascoff, chief executive officer of Zillow, Inc. “I am extremely proud of our progress to date and even more excited about the opportunities ahead.”

Prior to Zillow, Rascoff served as vice president of lodging at Expedia, which he joined after InterActiveCorp’s $675 million acquisition of discount travel site Hotwire.com in 2003. Rascoff co-founded Hotwire in 1999 and helped grow the company from an idea to a leading online travel company in just four years. Previously, he was an investment banker in the merger and acquisitions group at Goldman Sachs and held other investment-related positions at TPG Capital, Bear Stearns and Allen & Co. He graduated cum laude from Harvard University, and he serves on Harvard’s Digital Community & Social Networking Advisory Group.

As one of the most-visited real estate sites on the web, Zillow has broken multiple records in operating and financial metrics in the past year and is profitable. In August, 12.5 million unique users visited Zillow.com, up 41 percent year over year. Zillow Mortgage Marketplace logged a record 314,000 loan requests in August, up six-fold from a year ago. National and local advertising sales, including sales through the company’s location-based mobile apps, are also accelerating. Total downloads of Zillow’s mobile apps have surpassed 2 million, making Zillow the most popular real estate app on iPhone®, iPadTM, Android® and Windows® Mobile devices. As previously announced, Zillow recently teamed with Yahoo! Real Estate to create the largest real estate ad network, for which Zillow coordinates sales across the two platforms. Later this fall, Zillow will power all for-sale listings on Yahoo!, bringing more than 4 million home listings to Yahoo! users.

In the interests of political fairness, here is a trailer for a documentary coming out in mid-October that takes aim at President Barack Obama’s economic policies.

Titled “I Want Your Money,” the controversial trailer has already gotten over 1.76 million views on YouTube. (Take that, Michael Moore!)

Here’s the description of the film:

“Set against the backdrop of America’s growing disproval of current economic policies, I WANT YOUR MONEY takes a provocative look at our nation’s deeply depressed economy using the words and actions of Presidents Reagan and Obama. The film exposes the shocking reality of a bloated government while offering alternatives to help steer the United States back towards firm fiscal ground.”

The right-leaning movie–which uses decidedly odd cartoons of Obama and Reagan–features the usual conservative suspects on the topic, such as Newt Gingrich, Mike Huckabee and Steve Forbes. And it makes Speaker of the House Nancy Pelosi look nuts.

In other words, a Tea Party party!

Here’s the trailer:

Cisco Systems is expected to report strong fourth-quarter earnings later today after the markets close, which should be another boost to the tech market.

The Internet computer-networking equipment maker is being buoyed by a return to spending by customers eager to upgrade after recession pullbacks.

Wall Street expects San Jose, Calif.-based Cisco (CSCO) to earn 42 cents per share with $10.9 billion in revenue. In the same quarter a year ago, its net income was 19 cents per share–adjusted earnings were 31 cents–on $8.5 billion in sales.

Either way, that’s a big improvement.

But analysts also expect Cisco to have an even better outlook for 2011, as spending on Internet infrastructure grows. That includes everything from data centers, to routers and switches, to all kinds of networking equipment.

In other words, CEO John Chambers gets to crow a little bit.

Cisco stock, which has been slightly down recently, closed at $24.31, down 1.9 percent, or 46 cents, yesterday.

Since it launched almost exactly a year ago with a $300 million fund, the venture firm of Andreessen Horowitz has cut a rather high-profile path through the Silicon Valley investing community.

And it’s clear the firm has been aiming to make a big splash in the sector–from its involvement in the fractious fight over the spin-off of Skype to its funding of a series of high-profile start-ups (Zynga, Asana, Kno and Rockmelt) to its most recent aggressive moves to finally win the top spot in investing in hot social location site Foursquare.

Now, according to sources and after spending about half its kitty, Andreessen Horowitz is poised to begin another round of fundraising to further bolster its clout.

While it is unclear how much the VC firm will raise, sources expect it to be much more than its first fund.

In its last go-round, the firm had a quick completion of the fund raising, in the midst of a national econalypse. So many assume the next try will be a lot easier, especially given its knack for grabbing hot deals.

A spokeswoman for Andreessen Horowitz declined to comment on future fundraising plans.

The firm is going to need the money as it expands its partners and ambitions to change the venture landscape, as iconic entrepreneur Marc Andreessen noted when he founded the firm with his longtime business partner Ben Horowitz in July of 2009.

Andreessen said then that he was essentially professionalizing the active angel investing that he and Horowitz had been doing.

Over the last several years, either together or apart, the pair have invested in a large variety of innovative start-ups, such as Twitter, Aliph, Digg, LinkedIn and many more.

Andreessen is on the board of Facebook and an adviser to Twitter too.

In an interview with me last year, Andreessen said that unlike many VC firms, Andreessen Horowitz will invest in companies at any stage of life–from early stage to late–and of any size and in any kind of digital sector and will focus on companies led by tech-savvy founders.

He also expressed a disdain for the way the venture business was run.

“For the first time in my life, I am crossing over into the dark side,” said Andreessen at the time, in a joke about VCs being like Darth Vader.

At the time, he also noted that money talked. “It’s important to have more capital,” he said. “Sometimes having a huge checkbook is a great thing.”

Well, we’ll see if Andreessen Horowitz can make that checkbook even larger.

Until then, here is a tally of investments that Andreessen Horowitz has made so far, sourced from the firm, split up into categories and size of investment round the firm participated in with other investors. The firm declined to provide the exact amount of their participation in each investment.

It should be noted that Andreessen’s and Horowitz’s previous individual investments in some of these companies are not identified here:

Board

Kno: tablet device for students; $7.5 million
Nicira: cloud infrastructure software; $13 million
Okta: cloud app management; $750,000
Proferi: analytic applications; $2 million
Rockmelt; desktop browser for Facebook; unknown funding
Skype: Web telephony; $50 million

Passive

Apptio: IT cost transparency solutions; $14 million
Asana: enterprise collaboration; $9 million
Boku: mobile online payments; unknown funding
Digg: social media and content; unknown funding
Foursquare: social location; $20 million
Fusion I/O: enterprise I/O solutions; $45 million
Tiny Speck: social gaming; $5 million
Zynga: social gaming; $180 million

Seed

Burbn; social location; $500,000
Canvas Networks: image boards; $625,000
Factual: structured data; $1 million
GoodData: cloud-based collaborative analytics; $2.5 million
Quantifind; enterprise; unknown funding
RethinkDB: database storage; $1.2 million
Mixed Media Labs: photo sharing; $370,000
SnapLogic: open-source enterprise data integration; $2.3 million
TopProspect: social recruiting; unknown funding
Vikkii: user-generated subtitling; unknown funding
Ze Frank Games: online gaming; unknown funding

And here are video interviews BoomTown has done with both Andreessen and Horowitz in the last year on their investing theories:

While there have been politicians running for office in California before who have worked in the tech sector, there’s no doubt that the prospects for two of Silicon Valley’s more prominent execs–Carly Fiorina and Meg Whitman–represent an unusual and interesting situation in the state’s history.

With the tech sector a beacon of hope in a very rough economy and a symbol of health compared with a debt-saddled government, it’s no surprise that both candidates are touting their time as CEOs of two of California’s better known digital giants.

Whitman ran eBay (EBAY) and Fiorina helmed Hewlett-Packard (HPQ).

And, as they both did in their Republican primary races, they’re pushing that business experience very hard.

“Career politicians in Sacramento and Washington, D.C., be warned: You now face your worst nightmare,” said Whitman in her victory speech after winning the GOP primary for governor, referring to herself and Fiorina, who is vying for a Senate seat. “Two businesswomen from the real world who know how to create jobs, balance budgets and get things done.”

But will their narrative of outsider, maverick, high-tech corporate execs versus entrenched career politicians–Democratic candidates Jerry Brown and Sen. Barbara Boxer, who are facing Whitman and Fiorina respectively–play well with voters, and, more importantly, how accurate is their depiction as can-do techies?

That’s something to pay attention to, since a lot will surely be riding on their golden portrayal as business successes in the Golden State versus their opponents’ ability to paint a more cloddish picture of their corporate tenures.

And, just from a quick reading of their Web sites, both Fiorina and Whitman have to tread very carefully.

For example, the bio for Fiorina on her site notes:

“Carly served as the Chairman and Chief Executive Officer of Hewlett-Packard Company from 1999 to 2005, leading the reinvention of the legendary company, successfully steering it through the dot-com bust and the worst technology recession in 25 years. During her tenure, HP’s revenues doubled, from $44 billion to $88 billion, with improved profitability in every product category. Today, HP is the largest technology company in the world.”

That certainly–and not surprisingly–leaves out the layoffs, the myriad controversies over her leadership and, as has been depicted in much press coverage and several books, her none-too-smooth heave-ho from HP with a big fat exit payout to cushion the blow.

In fact, it has been current CEO Mark Hurd who has deservedly gotten a lot of the credit for getting HP moving again.

In addition, while HP is certainly the largest tech company in terms of employees, it is nowhere near the largest in terms of anything else that counts, such as stock market valuation.

HP’s market cap is currently $112 billion, compared with $230 billion for Microsoft (MSFT), $251 billion for Apple (AAPL) and even $168 billion for IBM (IBM).

On her Web site, the tale of Whitman is also rich in wow:

“At eBay, Meg made history. Meg steered eBay through the dot-com rise and fall that saw the vast majority of high-flying start-ups crash and burn, while eBay turned in one quarter of dramatic growth after another. When she joined eBay, the company had just $4.7 million in revenues and 30 employees; when she retired in March of 2008, ten years later, the company had nearly $8 billion in revenues and 15,000 employees worldwide–with millions of users in California alone.”

It’s all pretty much true, and throwing in California auction fans is a nice touch, too.

But it also leaves out a laundry list of problems Whitman left behind, from eBay’s slowness to innovate after its initial success, thereby almost totally missing Web 2.0, to its struggles to reinvigorate its main market business to a series of questionable acquisitions–Skype calling!–made in her decade in charge.

To be fair, any CEO tenure is a mixed bag, and there is not one tech exec who has not presided over a disaster or two.

That said, if both Fiorina and Whitman are selling themselves as Silicon Valley wunderkinds who can fix what’s broke in California, they are going to have to get ready to defend their business records over the next five months just the same as the career pols they are aiming to unseat.

As promised, Kara began BoomTown this week with another Steve Jobs blast from the past, this time at D5. It has all been a big countdown to Steve’s upcoming interview live on stage at D8 this coming Tuesday. It’s not just Jobs though. Head on over to the D8 site to see the full roster of tech execs in line for Kara and Walt’s hot seat. Midweek, Kara got a little video time with Keith Lee, CEO of Booyah games, maker of MyTown, the check-in-based social game that, with two million users, dwarfs Foursquare. The start-up just completed a healthy round of funding and apparently used the money to buy a giant Princess Leia doll…watch the video. Kara ended the week on one of her favorite subjects: Who’s departing this week from Yahoo (YHOO)? Looks like Tapan Bhat, head of the Internet giant’s front page, has left the building. Kara got the exclusive skinny.

John was at the Digital Daily ticker the moment the big story hit. Let us mark this down in our calenders as the week Apple exceeded Microsoft (MSFT) in market capitalization. How do you top a story like that? Well, John does it by following the saga of the social network editor that everyone love to hate at the moment. John gave a blow-by-blow of the privacy changes that Facebook founder Mark Zuckerberg laid out for his staff. Verdict? Less bad, maybe. To end the week, John covered some of the expectations around the international release of the iPad. Everyone is watching to see if the tablet outsells the Mac and will then proceed to stump about what that means for Apple (AAPL).

Twitter came in for a landing all over MediaMemo on Monday. Peter opened with a post trying to make sense of its new “ain’t no such thing as a free lunch” profit model. The media shuffle is always in Peter’s crosshairs, and this week’s installment was about Forbes buying up True/Slant. Wait…was that a media company acquiring something? Not selling it off? Peter ended his week with a cautionary tale for all this season’s commencement speakers: Don’t plagiarize your speech. Or, if you do, don’t steal it from YouTube. Nothing is more humiliating than being exposed virally.

Walt stepped out of the writer’s chair for Personal Technology this week and gave Geoffrey Fowler a shot at the keyboard. He turned in an insightful piece on the complicated world of e-bookstores and some useful advice on how to navigate their ins and outs.

The whole AllThingsD crew is feverishly preparing this weekend for D8, and even the lowly Weekend Update crew will be getting on a plane bound for LA. We’re packing plenty of sunscreen and NoDoz. Those shouldn’t interact badly…right?

With much easier comparisons due to a devastating period last year and an upswing in PC sales, Microsoft posted solid third-quarter earnings today after the markets closed.

The Redmond, Wash.-based software giant said it had revenue of $14.5 billion in the quarter ended March 31, a six percent rise from a year ago.

Net income was $4.01 billion, or 45 cents a share.

That’s despite forking over $78 million to Yahoo in the quarter as part of Microsoft’s online search and advertising partnership with the company.

The numbers handily beat Wall Street expectations of $14.4 billion and 42 cents a share.

Microsoft (MSFT) said the results included “the deferral of $305 million of revenue relating to the Microsoft Office 2010 Technology Guarantee program. Adjusting for the revenue deferral, third-quarter revenue totaled $14.81 billion, an increase of eight percent over the prior year period.”

“Windows 7 continues to be a growth engine, but we also saw strong growth in other areas like Bing search, Xbox LIVE and our emerging cloud services,” said CFO Peter Klein in a statement. “Our record third-quarter revenue along with continued rigor on cost management resulted in exceptional EPS growth.”

Was it just a year ago, battered by the econalypse, that Microsoft reported its very first drop in revenue, as well as a disastrous net income?

At the time, then-CFO Chris Liddell noted that the recovery would not happen quickly, but be “slow and gradual.”

That was largely due to weak PC sales, of course. And it led to layoffs and a general mood of gloom over the company.

Last year in the same quarter, Microsoft whiffed big time, reporting revenue of $13.7 billion, down from $14.5 in the third quarter of 2008. Net income was worse, down to $2.98 billion from $4.4 billion the year earlier.

But PC sales are up, which is always good for Microsoft. Its stock has been up because of it–almost four percent just this week.

This year, the company also has sales of the new Windows 7 operating system to goose results.

And the next quarter will also probably look good as Microsoft releases its cash-generating Office 2010 version to businesses and consumers.

The Entertainment and Devices division, which includes Xbox, was up, earning $165 million, from a $41 million loss a year ago.

But the long-suffering Online Services Division–home of the company’s Bing search service–was, more than ever, money-losing. It lost $713 million in the quarter, compared with a loss of $411 million last year.

The red ink was even more so, since Microsoft forked over $78 million to Yahoo (YHOO) in the period, which certainly brightened Yahoo’s bottom line in its report earlier this week.

Here’s the Microsoft press release with tables:

letterheadQ3

The presentation catalyzed a movement. Start-ups everywhere adopted a lean, low-burn, low-investment model. To this day, companies seeking funding at our venture firm, Andreessen Horowitz, proudly proclaim in their pitch decks that they are raising tiny amounts of capital so they can run lean.

On the one hand, it is a fact that capital invested is negatively correlated with returns in the venture capital industry. Pumping too much money into a small start-up is unhealthy for both the company and the investor. On the other hand, Facebook has raised several hundred million dollars and is on track to produce fantastic returns for all of its investors.

So what’s a start-up to do? Much of what has been written and said about lean start-ups makes good sense. However, that advice is often incomplete, and some of the things left unsaid are the least intuitive. In this article, I will articulate some of those things left unsaid in arguing the case for the Fat Start-up.

Here is my central argument. There are only two priorities for a start-up:
Winning the market and not running out of cash. Running lean is not an end. For that matter, neither is running fat. Both are tactics that you use to win the market and not run out of cash before you do so. By making “running lean” an end, you may lose your opportunity to win the market, either because you fail to fund the R&D necessary to find product/market fit or you let a competitor out-execute you in taking the market. Sometimes running fat is the right thing to do.

What the hell do I know?

“Al Pacino couldn’t be no gangsta, DeNiro in ‘Casino’ he no gangsta
Wanna be, wanna see, wan’ get a shovel
dig Tookie up n*&%^!, cause he know gangstas”

–The Game

At this point, some of you are asking yourselves, “What the hell does Ben know? If he were really smart, then he’d know that thin is in.” It turns out that I have some experience in managing a fat start-up through the dot-com implosion of the early 2000s. This chart offers a brief summary of equity market history when I was CEO of Loudcloud and Opsware (click to enlarge):

Note that the Nasdaq index is very highly correlated to the start-up funding environment. During the two years I was CEO of Opsware, the Nasdaq fell 80 percent, far more than it has fallen during the current 2008-10 downturn. So the 2000-02 environment was at least as traumatic as this one for Silicon Valley companies–and arguably much worse.

Here is a brief summary of Loudcloud/Opsware’s fund-raising history during that time:

• September 1999: Loudcloud founded
• November 1999: Loudcloud raises $21 million at a $45 million pre-money valuation (Benchmark Capital is the lead investor)
• January 2000: Loudcloud borrows $45 million from Morgan Stanley (MS)
• June 2000: Loudcloud raises $120M at a $700M pre-money valuation
• March 2001: Loudcloud goes public on Nasdaq, raises $160 million and is valued in the public markets at approximately $480 million. Total funds raised to this point: $346 million.
• August 2002: Loudcloud sells the managed services business to EDS (this was the only actual business we had at the time) for $63.5 million and becomes a software company (and changes its name to Opsware).
• September 2002: Opsware trades for 35 cents per share or approximately a $28 million market cap.
• September 2007: Hewlett-Packard (HPQ) acquires Opsware for $1.6 billion

During this period, Loudcloud/Opsware had over 20 direct competitors. Almost all the competitors from the Loudcloud era went bankrupt, including MFN/SiteSmith, Exodus, LogicTier, Williams Communication, Global Crossing, WorldCom/Digex and Storage Networks. Those that survived got bought with valuations of less than $100 million (e.g., Totality) or still have very low valuations (e.g., Navisite).

How did we do it?

“I had a dream I could buy my way to heaven
When I awoke, I spent that on a necklace”

–Kanye West

So how did we navigate through the great dot-com crash, crush the competition, emerge as the No. 1 company in our space and sell the company to HP for $1.6 billion? Did we “cut spending, cut now, and preserve capital?” Did we make cash preservation our No. 1 priority?

No, we didn’t. To underscore the point, here are Loudcloud’s average monthly cash burn figures for the quarters ending in:

• Apr 2001:  $39 million
• Jul 2001:  $35 million
• Oct 2001:  $29 million
• Jan 2002:  $25 million
• Apr 2002:  $22 million
• Jul 2002:  $19.4 million

As you can see, we were aggressively investing in the business throughout 2001 and 2002. While we did reduce our cash burn, we did not make cash preservation our No. 1 priority. As it was, over the course of the transition from Loudcloud to EDS, we sadly laid off 400 employees and transferred another 150 to EDS. However, we didn’t scrimp and save our way to a $1.6 billion acquisition: Instead, it’s what we chose not to cut that ultimately got us there.

Loudcloud was a Web-hosting business. Today, we’d call it a “cloud services” business, but people weren’t quite ready for the “cloud” in 2001. We supercharged our hosting business with software (called Opsware) that automated our Web-hosting operations. The other cloud services businesses of our day also had software investments. However, as the macroeconomic climate changed, they all “cut deep and cut now.” In the end, they ended up putting their software in maintenance mode and stopped building new features.

As we weighed a decision to make the same deep cuts in our own software R&D efforts (a move advocated by the intelligentsia of the day, as well as nearly every MBA we had working in the company), I faced a hard decision: Cut deep and get to cash flow break-even quickly or continue to invest heavily in software?

In the end, I decided to run fat so that we could continue to invest in the Opsware software. At the end of the day, I realized that much larger companies like IBM (IBM) could hire smart people and train them. But without a lasting technology-based advantage, it would be increasingly hard for us to defeat them and build our customer base despite early wins with Ford (F), Fox Sports, and the U.K. government (to name just three of our early customers).

Running fat meant that I laid off zero software engineers so that we could keep on investing in our technology, find our product/market fit, and build a lasting technological advantage.

Still, we had to reduce costs or we would clearly go bankrupt. With this new view of the world, I decided that rather than divesting our intellectual property, I would divest our business. Now, that may sound logical the way I’ve described it, but consider these facts:

• We were generating $65 million/year from the Web-hosting business.
• We were a publicly traded company with a market capitalization of close to $200 million.
• All of our investors (pubic and private) believed in and invested in the Web-hosting business.
• We had close to 500 employees at the time. Nearly all of them were supporting the Web-hosting business.
• We had no other business. We had software, but we did not have a software product and certainly did not have a software business.

Despite all of this, we sold the Loudcloud hosting business to EDS and became Opsware the software company. It was not clear that this was a good idea at the time. In fact, the market thought it was a terrible idea: Our stock promptly lost 80 percent of its value, putting our market cap at about $28 million. It’s worth pointing out that this was about $40 million less than the cash that we had in the bank.

During the transition, we shrank our payroll from 450 employees to fewer than 100. Even with this massive reduction in expenses, it would take another three quarters to reach cash-flow break-even, a milestone we finally reached in Q2 of 2003.

One could argue–and many did–that we should have cut a lot deeper than we did given that we only had one customer. Although EDS was a very large customer (it generated $20 million/year in revenue), a brand new software company doesn’t need 100 people. We could have taken steps to reach cash-flow break-even immediately (clearly, that might have helped us get above 35 cents per share). In other words, we could have “gone lean” by cutting deep, cutting now, and preserving capital.

But rather than do what seemed obvious, I decided to keep on investing. Here’s why: In an economic boom, cash is great, but not necessarily a meaningful competitive advantage. If every company is well funded, being super-well funded doesn’t help you win. In fact, being super-well funded can actually screw you.

But in a bust (like the one we were in), having a lot of cash can be a huge competitive advantage because you can use that cash to put enormous pressure on your underfunded competitors. And that’s what we did.

We spent aggressively to match our best competitor’s product, feature for feature. And we used our public currency to acquire important adjacent functionality (network, process and storage management) that our competitors did not have and couldn’t acquire because they didn’t have the cash (or the equity).

In doing so, we were able to beat a really high-quality start-up (Bladelogic) that did not have the massive technical and cultural baggage that came from exiting the managed services business. Bladelogic was eventually sold to BMC (BMC) for $800 million. But I’m firmly convinced that had we not spent the money, Bladelogic would have emerged as the No. 1 company in the space and gotten the $1.6 billion exit instead of Opsware.

In the end, by continuing to invest aggressively in our technological advantage despite a hellacious funding environment, we were able to turn a doomed business into a winning one.

That is the very short version of how we won the market during the great tech recession of the early 2000s.

So did we learn?

“Hegel was right when he said that we learn from history that man can never learn anything from history.”

–George Bernard Shaw (1856-1950)

Every start-up is in a furious race against time. The start-up must find the product-market fit that leads to a great business and substantially take the market before running out of cash. As a result, the top two priorities are always to:

1. Find the product that 1,000 enterprise or 50 million consumers want to buy and grab those customers before your competitors do.
2. Raise enough cash and spend it intelligently so that you don’t go broke along the way.

Clearly, you can’t succeed if you don’t achieve both priority No. 1 and priority No. 2. So why is taking the market more important than not running out of cash? Because the only thing worse for an entrepreneur than start-up hell (bankruptcy) is start-up purgatory.

What is start-up purgatory, you ask? Start-up purgatory occurs when you don’t go bankrupt, but you fail to build the No. 1 product in the space. You have enough money with your conservative burn rate to last for many years. You may even be cash-flow positive. However, you have zero chance of becoming a high-growth company. You have zero chance of being anything but a very small technology business (see Navisite). From the entrepreneur’s point of view, this can be worse than start-up hell since you are stuck with the small company.

You recruited all the employees, you raised all the money and you made all the promises. You either see it through or leave–without your good reputation. No one wants to work for an entrepreneur who quits his or her own company. This is start-up purgatory, where you work just as hard, reap none of the rewards, and watch all your best people leave you. It sucks to be you.

The Bottom Line

Spending a little or spending a lot is a means, not an end. Choose the right strategy to win the market or you may end up going straight to purgatory.

As you listen to the virtues of the lean start-up–lightweight sales, light engineering, and so on–keep the following in mind:

• If you are a high-tech start-up, your value is in your intellectual property. Don’t stare at your spreadsheets so long that you get confused about that.
• You cannot save your way to winning the market.
• The best companies can raise money even in this market. If you are one of those, you should consider raising enough to wipe out your competition.

Thin is in, but sometimes you gotta eat.

Ben Horowitz is co-founder and general partner of Andreessen Horowitz. He co-founded Loudcloud, later renamed Opsware Inc., in 1999 and served as CEO of the company before it was acquired in 2007 by Hewlett-Packard. He was most recently vice president and general manager of Hewlett-Packard’s Business Technology Organization Unit.

John got to cover the outset of an epic conflict this week. It has all the marks of a mega-hit. It’s about property, philosophy and most important, resources that both parties need in order to survive. It’s a shame the Oscar deadline has already passed, because the coming battle between Apple and HTC might have challenged a particular blue blockbuster in the category “best use of technology in a screenplay.” They do seem to share the same basic plot structure, anyway. Shortly after reporting on Apple’s (AAPL) opening salvo at HTC, John stepped back to offer some perspective on the conflict and guessed that maybe, just maybe, Apple was really firing at Google (GOOG), as the Android based devices are the subject of Apple’s legal scrum with HTC. Who doesn’t love a good proxy war? It was an Apple-a-day this week at Digital Daily, as John rounded things out with a post about the on-again-off-again release date for iPad. The iPad certainly cometh, but the confusion as to when led to some serious chatter in the blogosphere. Read John’s post. He’s got it all figured out.

BoomTown wasted no time getting back in the groove after returning from meeting all the Mexi-geeks in Monterrey. Upon arriving back in soggy San Francisco, she descended upon the AAAA. This year’s advertising agency confab was all about the social, Kara reported. Weekend Update wonders if Kara was forced to watch preroll video ads about Lipitor and Kiva before she was allowed to change interviewees. That’s the ultimate social advertising. Midweek, Kara posted about a viral video that gets the distinction of being the only Oprah product ever consumed willingly by Weekend Updaters. The short piece on Roger Ebert getting his own voice back seems like the best possible application of technology to better a life, and it’s just darn cool. Kara finished the week with a post about Google’s purchase of DocVerse. The move represents a shot right at the heart of Microsoft’s (MSFT) flagship software package, and is just another weapon in the arms race for what may be a coming war in the cloud.

MediaMemo was on the case of the missing comedy this week, when Peter reported that Stephen Colbert and Jon Stewart had left the Hulu lineup. Their shows represent only a small fraction of the total Hulu content monster. A small, hilarious viewer-drawing, ad-selling fraction. Peter moved on to a quick update on the semi-empire that is the Huffington Post. Arianna is doing well, with somewhere in the neighborhood of 28 million unique visitors in January according to comScore (SCOR). The “get huge” model may work for start-ups out here in Silicon Valley, but everyone in the media world is waiting to see if she can monetize that monster. Toward the end of the week, Peter talked with Jeff Smith of Smule about why he won’t be developing mobile games for Android anytime soon. Maybe Google has more to fight with than just Apple.

The Mossberg contingent was in overdrive this week and treated us all not only to the normal triad of great posts but to a Mossblog as well. Personal Technology pushed into a new frontier, as Walt wrote about the emerging market for wireless computer-to-TV video transfer. He tested two separate systems, Wi-Di and PlayOn which both aim to put video from your computer on to an enabled TV. Both worked as advertised, though each has drawbacks, in either technology or content limitations. Walt tells it like it is, and Weekend Update has a feeling that he’ll be telling us more about these technologies as they mature in the consumer space. The Mossblog this week has some informative video of Walt discussing Internet video displayed on TV. He appeared on the WSJ’s Digits show to talk about wireless display technology, but said we hadn’t reached a tipping point yet, partly because we hadn’t reached the necessary market penetration. Mossberg’s Mailbox had even more questions in it about Quicken for Mac this week, and the news was much the same as in last week’s column: The new Quicken for Mac isn’t up to par with the version, so think hard before you buy. Katie offered analysis of yet another 3-D device that may be coming to a lap near you. She reviewed two laptops, one from Asus and one from Acer, both with 3-D display technology. She had good things to say about the devices as solid laptops in their own right, but she’s still not sold on the glasses.

Get your popcorn ready, throw on your 3-D glasses, and wait for the lights to dim. The new week is about to start.

Kara was full-tilt geek this week with an early post from TED’s viral video division. It seems Bill Gates told the assembled geekerati his one true wish. Wanna know what it is? We guess you’ll have to watch the video to find out. Kara then gave us some perspective on Yahoo (YHOO) playing social catch-up with its recent Twitter deal. Everyone may be muttering “too little, too late,” but it could be worse. The Internet giant could have tried to release its own social network. Kara then jetted off to sunny Mexico to give a keynote at SISCTI, Mexico’s major infotech conference. We’re hoping she brings us back a sombrero.

Everyone is chattering about Web-delivered video this week, but Peter brought some real perspective to all the racket. It looks like Walmart (WMT) is coughing up $100 million for Vudu in its theoretical bid to compete with the iTunes store. That’s a way bigger ticket than had been expected, but it looks like the world’s largest retailer is getting some serious skin in the game. Midweek, Peter brought us a story of triumph from the world of newspapers. It seems that the financial situation at the Washington Post (WPO) was “less bad” last quarter. The bleeding has slowed, but the patient is still in the ICU. Peter rounded things out with a dose of reality for Apple’s (AAPL) otherwise magical rhetoric. Billions of songs, billions of apps and download volume that leaps every quarter do not equal impressive profits, apparently. Don’t feel too bad for Steve though. We all know songs and apps are just fuel for the iFire.

Digital Daily started off the week all aflutter with news that Twitter is pumping out 600 tweets per second. That means if all those tweets are paced end to end, multiplied by 60 seconds in a minute, 60 minutes in an hour and 24 hours in a day, Twitter still isn’t making any money. After a slew of posts early in the week, John tied up Palm coverage with some thoughts on “Project Jumpstart.” It seems Palm (PALM) should be thinking about a different sort of project, maybe one that involves getting bought. Finally, in everyone’s favorite category, John covered some more Apple speculation in the iPad afterglow. It looks like analysts are expecting a refreshed iPhone that will cost less and potentially have some new gesture-based features.

Walt’s column was of particular interest this week, especially if you’ve got finances to deal with or a certain gray-bearded uncle to pay in mid-April. Walt gave the rundown on the latest Mac version of Quicken. The Mac-Quicken relationship has always been tricky, and people (Weekend Updaters included) have used some tricky workarounds to keep using the Windows version of Intuit’s (INTU) popular finance program. Sadly, the latest version for Mac doesn’t really close the gap, and Walt wasn’t too up on making the switch. Mossberg’s Mailbox was full of magicJack mail this week–sort of like the leftovers from last week’s wild VOIParty. It turns out that it’s not the best idea to try to fax over the magicJack, even if it does sort of work for some people some of the time. That settles it. Weekend Update is gonna get one and hook it up to our Clapper-activated file-server.

Finally, Katie brought the cloud down to ground level this week with a review of Pogoplug, a device that lets you host and stream your files from a home hard drive over the Internet to your devices. You can be your own cloud, sort of, and Katie said she liked it just fine. Low-level clouds…maybe we can get the term fog computing to catch on.

Stay safe, be well, and have a look at the some of the stuff coming out of Chile this weekend. This time it was Santiago, but AllThingsD HQ sits on the ring of fire too.

The music label’s suit made it very difficult for Veoh to climb out of the deep hole it found itself in last year. But it was the Web video start-up, not Universal, that dug that pit.

First, some housekeeping. CEO Dmitry Shapiro now confirms his company’s impending shutdown and Chapter 7 bankruptcy filing.

Plans to either sell or refinance the company came “close, in both cases,” he told me late this afternoon. “But we were unable to secure either option.”

Shapiro didn’t offer any details about the future of the Web site or the videos users have uploaded there over the years. I gather that’s because he doesn’t know himself.

He did, however, sketch out a brief picture of the company’s demise. Like others, Shapiro points out the problems caused by Universal’s copyright suit, which is broadly similar to the one Viacom (VIA) is still fighting with Google’s (GOOG) YouTube.

“Clearly the UMG lawsuit was a tremendous weight on the company. It was both financially draining and distracting, and it choked off the ability for any significant strategic deals, because everybody we talked to was terrified of getting sued immediately,” he said. “And we know that potential investors were thinking that, too.”

But the UMG lawsuit didn’t burn through $70 million of investors’ money. At most, sources say, the company spent something in the $6 million to $8 million range on legal fees.

Where did the rest of the money to go?

To fund Veoh’s YouTube-sized ambitions, apparently. Sources familiar with the company tell me that during its go-go days, it was spending as much as $4 million a month on a bloated staff and infrastructure.

But Veoh only generated something like $12 million in sales over its five-year life, and most of that was in the past couple years, sources said.

Veoh’s burn rate was cut back significantly after the economy crashed. And it shrank even more last April, when Shapiro returned to the company he founded and replaced then-CEO Steve Mitgang.

Could Veoh have raised more money at that point? It’s hard to see how, even if the Universal lawsuit wasn’t hanging over it. It was difficult to raise money for any online advertising venture in the spring of 2009, let alone a money-burning Web video site.

And it’s worth noting that Joost, another well-funded Web video start-up, more or less shut down a few months after Veoh’s restructuring.

On the other hand, France’s DailyMotion managed to raise another $25 million last October. So there are still people out there betting on Web video, and Shapiro says they’re right. But his company was too early, and it grew too fast–and ultimately, not fast enough.

“We were pioneers, and we were there in the first few years when there was no advertising market to speak of,” he says. “Over the next couple years, do I think that more and more brand advertisers are going to move into online video? Absolutely. Online video is going to be a success.”

An ugly forecast, especially considering today’s financial report from the company: A loss of $13.3 million, or 11 cents a share, on revenue of $145.5 million–down five percent year-over-year.

“The severe recession in 2009 hurt both our revenue and profitability for the year,” Bob Kimball, president and acting CEO of RealNetworks, said in an earnings news release. “While we don’t expect that overall trend to change in the first quarter, we are aggressively moving to transform RealNetworks into a more simple and focused company that delivers value to its shareholders. The first step in Real’s simplification was announced this week with the separation of our Rhapsody music business into an independent company.”

The fine folks at comScore have graciously allowed BoomTown to embed a very good report they released this week about the digital landscape.

Titled “The 2009 U.S. Digital Year in Review: A Recap of the Year in Digital Marketing,” it’s chock-a-block full of all kinds of interesting information, from declining growth rates for e-commerce to core search market share to social networking trends to display advertising innovations to the big issues in video and mobile.

I also like all the pretty charts and unusual factoids–such as the fact that the heaviest individual spending day of the year was Tuesday, Dec. 15 with $913 million in consumer buying and that “long-tail” videos on small sites make up more than 50 percent of the viewing.

There’s this and more in the report, which covers most of the Internet bigs, such as Google (GOOG), Facebook, Microsoft (MSFT), Yahoo (YHOO), Twitter and MySpace.

Noted the comScore (SCOR) report:

“2009 represented a critical year in the relatively brief history of digital media; a year that was marred by the overhang of a global economic recession that had a particularly negative impact on the U.S. advertising and e-commerce markets. But it was also a year in which digital consumer activity soared, new innovations grabbed hold in the marketplace and businesses got more serious about navigating the digital landscape.”

Click on through and you can read all about it here (and download your own version here):

comScore 2009 US Digital Year in Review –