How Instagram Built a $1 Billion App in Two Years?

Silicon Valley is one of the few places where a 27-year-old Web entrepreneur can parlay a photo- sharing application with no known source of revenue into $1 billion — in two years.

Evidence of that came yesterday, when Facebook Inc. (FB) announced plans to buy Instagram, a startup co-founded in 2010 by Kevin Systrom, a Stanford University graduate and former Google Inc. employee.

The Instagram app, owned by Burbn Inc., fetched $1 billion in cash and stock after building an audience of more than 30 million people, mostly users of Apple Inc. (AAPL)’s iPhone. That kind of growth was enabled by the spread of social networking and smartphones, and the plummeting costs required to build an Internet company. Instagram has just 13 employees, up from four a year ago, when the app was used by 4 million consumers.

“It’s a massive accomplishment,” said Shervin Pishevar, a managing director at Menlo Ventures in Menlo Park, California. Pishevar backs social-media companies, though he didn’t invest in Instagram. “This is an indicator of what great teams and great products with amazing execution can accomplish in historic amounts of time,” he said.

While the deal may raise concerns about another technology bubble, the price tag is only about 1 percent of Facebook’s projected valuation when the world’s largest social-networking site sells shares to the public. And Chief Executive Officer Mark Zuckerberg, who founded the company in a Harvard University dormitory, understands the model of establishing an audience before generating sales. That’s how he built Facebook.

Bigger Deal

Prior to the Instagram deal, Zuckerberg had only purchased smaller companies, including e-book publisher Push Pop Press Inc. and mobile-messaging app Beluga Inc. Nothing came close in size to Instagram, an app used by smartphone owners to upload photos, color them with vintage effects and other filters, and then share them with friends.

“This is an important milestone for Facebook, because it’s the first time we’ve ever acquired a product and company with so many users,” Zuckerberg said in a statement yesterday.

Unlike Zuckerberg, who dropped out of Harvard after starting Facebook in 2004, Instagram CEO Systrom finished college. He graduated from Stanford in 2006 with a degree in management science and engineering and was part of the school’s Mayfield Fellows Program, a nine-month course for future entrepreneurs.

Early Projects

Systrom also was in the Sigma Nu Fraternity, where he was routinely showing off his design skills, said Tommy Leep, one of Systrom’s fraternity brothers. Systrom produced a video for the frat and worked on a college marketplace that worked like Craigslist, said Leep, who now works at venture firm Floodgate in Palo Alto, California.

“Kevin was a constant tinkerer, always working on interesting technology products,” Leep said. “He was one of those guys that it would just make sense to put a bet on.”

Systrom didn’t respond to a request for comment.

After Stanford, Systrom worked as an intern at podcasting startup Odeo, whose early team included Evan Williams, Biz Stone and Jack Dorsey, the trio who later started Twitter Inc.

He then worked at Mountain View, California-based Google (GOOG) on the Gmail and Google Reader products, as well as in the company’s corporate-development unit. In early 2010, he teamed up with Mike Krieger, a fellow Stanford grad who would become his Instagram partner.

Andreessen Horowitz

Right off the bat, they raised a $500,000 seed investment from Andreessen Horowitz and Baseline Ventures. They introduced the Instagram application seven months later in October and had almost 200,000 users within the first week, according to a New York Times report at the time.

Bloomberg LP, the parent of Bloomberg News is an investor in Andreessen Horowitz.

By February 2011, membership had soared to 1.75 million, with users uploading 290,000 photos a day. That growth attracted a $7 million investment from Benchmark Capital and prominent angel investors, including Twitter’s Dorsey, Chris Sacca and Quora Inc.’s Adam D’Angelo.

In the next three months, the user base more than doubled to 4 million, all while the company still employed only four people. Systrom said in a May 2011 interview on “Bloomberg West” that “we have many late nights.”

Since then, the number of Instagram users has jumped more than sevenfold. Last week, the app became available for phones running Google’s Android operating system, expanding on its inroads with the iPhone.

‘Dopamine Effect’

After a week in the Android store, Instagram is the top- ranked free app not made by Google and No. 3 overall, behind Google voice search and maps. Facebook is eighth.

The app’s success stems in part from how many users give feedback on Instagram photos, Sacca said. A large percentage of pictures get “liked” by other users, he said.

“That engagement creates the dopamine effect that leaves users feeling fantastic and coming back for more,” Sacca said.

Investors, meanwhile, have been lining up to get in the door. That culminated last week in a $60 million financing round, led by Sequoia Capital, which valued the company at $500 million, according to people with knowledge of the funding.

That means Systrom built Instagram’s valuation from zero to $500 million in two years, then doubled it to $1 billion in a week. Despite the odds, Systrom and Krieger always knew they would reach this point, Sacca said.

“They never once doubted that they were building a billion-dollar company,” he said.