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add x feature? Whatever gets you your target growth rate. Judging yourself by weekly growth doesn't mean you can look no more than a week ahead. Once you experience the pain of missing your target one week (it was the only thing that mattered, and you failed at it), you become interested in anything that could spare you such pain in the future. So you'll be willing for example to hire another programmer, who won't contribute to this week's growth but perhaps in a month will have implemented some new feature that will get you more users. But only if (a) the distraction of hiring someone won't make you miss your numbers in the short term, and (b) you're sufficiently worried about whether you can keep hitting your numbers without hiring someone new. It's not that you don't think about the future, just that you think about it no more than necessary. In theory this sort of hill-climbing could get a startup into trouble. They could end up on a local maximum. But in practice that never happens. Having to hit a growth number every week forces founders to act, and acting versus not acting is the high bit of succeeding. Nine times out of ten, sitting around strategizing is just a form of procrastination. Whereas founders' intuitions about which hill to climb are usually better than they realize. Plus the maxima in the space of startup ideas are not spiky and isolated. Most fairly good ideas are adjacent to even better ones. The fascinating thing about optimizing for growth is that it can actually discover startup ideas. You can use the need for growth as a form of evolutionary pressure. If you start out with some initial plan and modify it as necessary to keep hitting, say, 10% weekly growth, you may end up with a quite different company than you meant to start. But anything that grows consistently at 10% a week is almost certainly a better idea than you started with. There's a parallel here to small businesses. Just as the constraint of being located in a particular neighborhood helps define a bar, the constraint of growing at a certain rate can help define a startup. You'll generally do best to follow that constraint wherever it leads rather than being influenced by some initial vision, just as a scientist is better off following the truth wherever it leads rather than being influenced by what he wishes were the case. When Richard Feynman said that the imagination of nature was greater than the imagination of man, he meant that if you just keep following the truth you'll discover cooler things than you could ever have made up. For startups, growth is a constraint much like truth. Every successful startup is at least partly a product of the imagination of growth. **Value** It's hard to find something that grows consistently at several percent a week, but if you do you may have found something surprisingly valuable. If we project forward we see why. weekly| yearly ---|--- 1%| 1.7x 2%| 2.8x 5%| 12.6x 7%| 33.7x 10%| 142.0x A company that grows at 1% a week will |
1.7x a year, whereas a company that grows at 5% a week will grow 12.6x. A company making $1000 a month (a typical number early in YC) and growing at 1% a week will 4 years later be making $7900 a month, which is less than a good programmer makes in salary in Silicon Valley. A startup that grows at 5% a week will in 4 years be making $25 million a month. Our ancestors must rarely have encountered cases of exponential growth, because our intuitions are no guide here. What happens to fast growing startups tends to surprise even the founders. Small variations in growth rate produce qualitatively different outcomes. That's why there's a separate word for startups, and why startups do things that ordinary companies don't, like raising money and getting acquired. And, strangely enough, it's also why they fail so frequently. Considering how valuable a successful startup can become, anyone familiar with the concept of expected value would be surprised if the failure rate weren't high. If a successful startup could make a founder $100 million, then even if the chance of succeeding were only 1%, the expected value of starting one would be $1 million. And the probability of a group of sufficiently smart and determined founders succeeding on that scale might be significantly over 1%. For the right people — e.g. the young Bill Gates — the probability might be 20% or even 50%. So it's not surprising that so many want to take a shot at it. In an efficient market, the number of failed startups should be proportionate to the size of the successes. And since the latter is huge the former should be too. What this means is that at any given time, the great majority of startups will be working on something that's never going to go anywhere, and yet glorifying their doomed efforts with the grandiose title of "startup." This doesn't bother me. It's the same with other high-beta vocations, like being an actor or a novelist. I've long since gotten used to it. But it seems to bother a lot of people, particularly those who've started ordinary businesses. Many are annoyed that these so-called startups get all the attention, when hardly any of them will amount to anything. If they stepped back and looked at the whole picture they might be less indignant. The mistake they're making is that by basing their opinions on anecdotal evidence they're implicitly judging by the median rather than the average. If you judge by the median startup, the whole concept of a startup seems like a fraud. You have to invent a bubble to explain why founders want to start them or investors want to fund them. But it's a mistake to use the median in a domain with so much variation. If you look at the average outcome rather than the median, you can understand why investors like them, and why, if they aren't median people, it's a rational choice for founders to start them. **Deals** Why do investors like startups so much? Why are they so hot to invest in photo-sharing apps, rather than solid money-making |
Not only for the obvious reason. The test of any investment is the ratio of return to risk. Startups pass that test because although they're appallingly risky, the returns when they do succeed are so high. But that's not the only reason investors like startups. An ordinary slower-growing business might have just as good a ratio of return to risk, if both were lower. So why are VCs interested only in high-growth companies? The reason is that they get paid by getting their capital back, ideally after the startup IPOs, or failing that when it's acquired. The other way to get returns from an investment is in the form of dividends. Why isn't there a parallel VC industry that invests in ordinary companies in return for a percentage of their profits? Because it's too easy for people who control a private company to funnel its revenues to themselves (e.g. by buying overpriced components from a supplier they control) while making it look like the company is making little profit. Anyone who invested in private companies in return for dividends would have to pay close attention to their books. The reason VCs like to invest in startups is not simply the returns, but also because such investments are so easy to oversee. The founders can't enrich themselves without also enriching the investors. Why do founders want to take the VCs' money? Growth, again. The constraint between good ideas and growth operates in both directions. It's not merely that you need a scalable idea to grow. If you have such an idea and don't grow fast enough, competitors will. Growing too slowly is particularly dangerous in a business with network effects, which the best startups usually have to some degree. Almost every company needs some amount of funding to get started. But startups often raise money even when they are or could be profitable. It might seem foolish to sell stock in a profitable company for less than you think it will later be worth, but it's no more foolish than buying insurance. Fundamentally that's how the most successful startups view fundraising. They could grow the company on its own revenues, but the extra money and help supplied by VCs will let them grow even faster. Raising money lets you _choose_ your growth rate. Money to grow faster is always at the command of the most successful startups, because the VCs need them more than they need the VCs. A profitable startup could if it wanted just grow on its own revenues. Growing slower might be slightly dangerous, but chances are it wouldn't kill them. Whereas VCs need to invest in startups, and in particular the most successful startups, or they'll be out of business. Which means that any sufficiently promising startup will be offered money on terms they'd be crazy to refuse. And yet because of the scale of the successes in the startup business, VCs can still make money from such investments. You'd have to be crazy to believe your company was going to become as valuable as a high growth rate can make it, but some do. |
much every successful startup will get acquisition offers too. Why? What is it about startups that makes other companies want to buy them? Fundamentally the same thing that makes everyone else want the stock of successful startups: a rapidly growing company is valuable. It's a good thing eBay bought Paypal, for example, because Paypal is now responsible for 43% of their sales and probably more of their growth. But acquirers have an additional reason to want startups. A rapidly growing company is not merely valuable, but dangerous. If it keeps expanding, it might expand into the acquirer's own territory. Most product acquisitions have some component of fear. Even if an acquirer isn't threatened by the startup itself, they might be alarmed at the thought of what a competitor could do with it. And because startups are in this sense doubly valuable to acquirers, acquirers will often pay more than an ordinary investor would. **Understand** The combination of founders, investors, and acquirers forms a natural ecosystem. It works so well that those who don't understand it are driven to invent conspiracy theories to explain how neatly things sometimes turn out. Just as our ancestors did to explain the apparently too neat workings of the natural world. But there is no secret cabal making it all work. If you start from the mistaken assumption that Instagram was worthless, you have to invent a secret boss to force Mark Zuckerberg to buy it. To anyone who knows Mark Zuckerberg, that is the reductio ad absurdum of the initial assumption. The reason he bought Instagram was that it was valuable and dangerous, and what made it so was growth. If you want to understand startups, understand growth. Growth drives everything in this world. Growth is why startups usually work on technology — because ideas for fast growing companies are so rare that the best way to find new ones is to discover those recently made viable by change, and technology is the best source of rapid change. Growth is why it's a rational choice economically for so many founders to try starting a startup: growth makes the successful companies so valuable that the expected value is high even though the risk is too. Growth is why VCs want to invest in startups: not just because the returns are high but also because generating returns from capital gains is easier to manage than generating returns from dividends. Growth explains why the most successful startups take VC money even if they don't need to: it lets them choose their growth rate. And growth explains why successful startups almost invariably get acquisition offers. To acquirers a fast-growing company is not merely valuable but dangerous too. It's not just that if you want to succeed in some domain, you have to understand the forces driving it. Understanding growth is what starting a startup _consists_ of. What you're really doing (and to the dismay of some observers, all you're really doing) when you start a startup is committing to solve a |
type of problem than ordinary businesses do. You're committing to search for one of the rare ideas that generates rapid growth. Because these ideas are so valuable, finding one is hard. The startup is the embodiment of your discoveries so far. Starting a startup is thus very much like deciding to be a research scientist: you're not committing to solve any specific problem; you don't know for sure which problems are soluble; but you're committing to try to discover something no one knew before. A startup founder is in effect an economic research scientist. Most don't discover anything that remarkable, but some discover relativity. ** |
| | **Want to start a startup?** Get funded by Y Combinator. --- December 2010 Someone we funded is talking to VCs now, and asked me how common it was for a startup's founders to retain control of the board after a series A round. He said VCs told him this almost never happened. Ten years ago that was true. In the past, founders rarely kept control of the board through a series A. The traditional series A board consisted of two founders, two VCs, and one independent member. More recently the recipe is often one founder, one VC, and one independent. In either case the founders lose their majority. But not always. Mark Zuckerberg kept control of Facebook's board through the series A and still has it today. Mark Pincus has kept control of Zynga's too. But are these just outliers? How common is it for founders to keep control after an A round? I'd heard of several cases among the companies we've funded, but I wasn't sure how many there were, so I emailed the ycfounders list. The replies surprised me. In a dozen companies we've funded, the founders still had a majority of the board seats after the series A round. I feel like we're at a tipping point here. A lot of VCs still act as if founders retaining board control after a series A is unheard-of. A lot of them try to make you feel bad if you even ask — as if you're a noob or a control freak for wanting such a thing. But the founders I heard from aren't noobs or control freaks. Or if they are, they are, like Mark Zuckerberg, the kind of noobs and control freaks VCs should be trying to fund more of. Founders retaining control after a series A is clearly heard-of. And barring financial catastrophe, I think in the coming year it will become the norm. Control of a company is a more complicated matter than simply outvoting other parties in board meetings. Investors usually get vetos over certain big decisions, like selling the company, regardless of how many board seats they have. And board votes are rarely split. Matters are decided in the discussion preceding the vote, not in the vote itself, which is usually unanimous. But if opinion is divided in such discussions, the side that knows it would lose in a vote will tend to be less insistent. That's what board control means in practice. You don't simply get to do whatever you want; the board still has to act in the interest of the shareholders; but if you have a majority of board seats, then your opinion about what's in the interest of the shareholders will tend to prevail. So while board control is not total control, it's not imaginary either. There's inevitably a difference in how things feel within the company. Which means if it becomes the norm for founders to retain board control after a series A, that will change the way things feel in the whole startup world. The switch to the new norm may be surprisingly fast, because the startups that can retain control tend to be the best ones. They're the ones that set the trends, both for other startups and for |
A lot of the reason VCs are harsh when negotiating with startups is that they're embarrassed to go back to their partners looking like they got beaten. When they sign a termsheet, they want to be able to brag about the good terms they got. A lot of them don't care that much personally about whether founders keep board control. They just don't want to seem like they had to make concessions. Which means if letting the founders keep control stops being perceived as a concession, it will rapidly become much more common. Like a lot of changes that have been forced on VCs, this change won't turn out to be as big a problem as they might think. VCs will still be able to convince; they just won't be able to compel. And the startups where they have to resort to compulsion are not the ones that matter anyway. VCs make most of their money from a few big hits, and those aren't them. Knowing that founders will keep control of the board may even help VCs pick better. If they know they can't fire the founders, they'll have to choose founders they can trust. And that's who they should have been choosing all along. **Thanks** to Sam Altman, John Bautista, Trevor Blackwell, Paul Buchheit, Brian Chesky, Bill Clerico, Patrick Collison, Adam Goldstein, James Lindenbaum, Jessica Livingston, and Fred Wilson for reading drafts of this. * * * --- |
| _Note: The strategy described at the end of this essay didn't work. It would work for a while, and then I'd gradually find myself using the Internet on my work computer. I'm trying other strategies now, but I think this time I'll wait till I'm sure they work before writing about them._ May 2008 Procrastination feeds on distractions. Most people find it uncomfortable just to sit and do nothing; you avoid work by doing something else. So one way to beat procrastination is to starve it of distractions. But that's not as straightforward as it sounds, because there are people working hard to distract you. Distraction is not a static obstacle that you avoid like you might avoid a rock in the road. Distraction seeks you out. Chesterfield described dirt as matter out of place. Distracting is, similarly, desirable at the wrong time. And technology is continually being refined to produce more and more desirable things. Which means that as we learn to avoid one class of distractions, new ones constantly appear, like drug-resistant bacteria. Television, for example, has after 50 years of refinement reached the point where it's like visual crack. I realized when I was 13 that TV was addictive, so I stopped watching it. But I read recently that the average American watches 4 hours of TV a day. A quarter of their life. TV is in decline now, but only because people have found even more addictive ways of wasting time. And what's especially dangerous is that many happen at your computer. This is no accident. An ever larger percentage of office workers sit in front of computers connected to the Internet, and distractions always evolve toward the procrastinators. I remember when computers were, for me at least, exclusively for work. I might occasionally dial up a server to get mail or ftp files, but most of the time I was offline. All I could do was write and program. Now I feel as if someone snuck a television onto my desk. Terribly addictive things are just a click away. Run into an obstacle in what you're working on? Hmm, I wonder what's new online. Better check. After years of carefully avoiding classic time sinks like TV, games, and Usenet, I still managed to fall prey to distraction, because I didn't realize that it evolves. Something that used to be safe, using the Internet, gradually became more and more dangerous. Some days I'd wake up, get a cup of tea and check the news, then check email, then check the news again, then answer a few emails, then suddenly notice it was almost lunchtime and I hadn't gotten any real work done. And this started to happen more and more often. It took me surprisingly long to realize how distracting the Internet had become, because the problem was intermittent. I ignored it the way you let yourself ignore a bug that only appears intermittently. When I was in the middle of a project, distractions weren't really a problem. It was when I'd finished one project and was deciding what to do next that they always bit me. Another reason |
was hard to notice the danger of this new type of distraction was that social customs hadn't yet caught up with it. If I'd spent a whole morning sitting on a sofa watching TV, I'd have noticed very quickly. That's a known danger sign, like drinking alone. But using the Internet still looked and felt a lot like work. Eventually, though, it became clear that the Internet had become so much more distracting that I had to start treating it differently. Basically, I had to add a new application to my list of known time sinks: Firefox. * * * The problem is a hard one to solve because most people still need the Internet for some things. If you drink too much, you can solve that problem by stopping entirely. But you can't solve the problem of overeating by stopping eating. I couldn't simply avoid the Internet entirely, as I'd done with previous time sinks. At first I tried rules. For example, I'd tell myself I was only going to use the Internet twice a day. But these schemes never worked for long. Eventually something would come up that required me to use it more than that. And then I'd gradually slip back into my old ways. Addictive things have to be treated as if they were sentient adversaries—as if there were a little man in your head always cooking up the most plausible arguments for doing whatever you're trying to stop doing. If you leave a path to it, he'll find it. The key seems to be visibility. The biggest ingredient in most bad habits is denial. So you have to make it so that you can't merely _slip_ into doing the thing you're trying to avoid. It has to set off alarms. Maybe in the long term the right answer for dealing with Internet distractions will be software that watches and controls them. But in the meantime I've found a more drastic solution that definitely works: to set up a separate computer for using the Internet. I now leave wifi turned off on my main computer except when I need to transfer a file or edit a web page, and I have a separate laptop on the other side of the room that I use to check mail or browse the web. (Irony of ironies, it's the computer Steve Huffman wrote Reddit on. When Steve and Alexis auctioned off their old laptops for charity, I bought them for the Y Combinator museum.) My rule is that I can spend as much time online as I want, as long as I do it on that computer. And this turns out to be enough. When I have to sit on the other side of the room to check email or browse the web, I become much more aware of it. Sufficiently aware, in my case at least, that it's hard to spend more than about an hour a day online. And my main computer is now freed for work. If you try this trick, you'll probably be struck by how different it feels when your computer is disconnected from the Internet. It was alarming to me how foreign it felt to sit in front of a computer that could only be used for work, because that showed how much time I must have been wasting. _Wow. All I can do at this computer is work. Ok, I better work then._ |
the good part. Your old bad habits now help you to work. You're used to sitting in front of that computer for hours at a time. But you can't browse the web or check email now. What are you going to do? You can't just sit there. So you start working. --- --- Good and Bad Procrastination | | Spanish Translation Arabic Translation | | Catalan Translation Russian Translation | | Spanish Translation * * * --- |
| | **Want to start a startup?** Get funded by Y Combinator. --- November 2009 I don't think Apple realizes how badly the App Store approval process is broken. Or rather, I don't think they realize how much it matters that it's broken. The way Apple runs the App Store has harmed their reputation with programmers more than anything else they've ever done. Their reputation with programmers used to be great. It used to be the most common complaint you heard about Apple was that their fans admired them too uncritically. The App Store has changed that. Now a lot of programmers have started to see Apple as evil. How much of the goodwill Apple once had with programmers have they lost over the App Store? A third? Half? And that's just so far. The App Store is an ongoing karma leak. * * * How did Apple get into this mess? Their fundamental problem is that they don't understand software. They treat iPhone apps the way they treat the music they sell through iTunes. Apple is the channel; they own the user; if you want to reach users, you do it on their terms. The record labels agreed, reluctantly. But this model doesn't work for software. It doesn't work for an intermediary to own the user. The software business learned that in the early 1980s, when companies like VisiCorp showed that although the words "software" and "publisher" fit together, the underlying concepts don't. Software isn't like music or books. It's too complicated for a third party to act as an intermediary between developer and user. And yet that's what Apple is trying to be with the App Store: a software publisher. And a particularly overreaching one at that, with fussy tastes and a rigidly enforced house style. If software publishing didn't work in 1980, it works even less now that software development has evolved from a small number of big releases to a constant stream of small ones. But Apple doesn't understand that either. Their model of product development derives from hardware. They work on something till they think it's finished, then they release it. You have to do that with hardware, but because software is so easy to change, its design can benefit from evolution. The standard way to develop applications now is to launch fast and iterate. Which means it's a disaster to have long, random delays each time you release a new version. Apparently Apple's attitude is that developers should be more careful when they submit a new version to the App Store. They would say that. But powerful as they are, they're not powerful enough to turn back the evolution of technology. Programmers don't use launch-fast-and-iterate out of laziness. They use it because it yields the best results. By obstructing that process, Apple is making them do bad work, and programmers hate that as much as Apple would. How would Apple like it if when they discovered a serious bug in OS X, instead of releasing a software update immediately, they had to submit their code to an intermediary who sat on it for a month and then |
it because it contained an icon they didn't like? By breaking software development, Apple gets the opposite of what they intended: the version of an app currently available in the App Store tends to be an old and buggy one. One developer told me: > As a result of their process, the App Store is full of half-baked > applications. I make a new version almost every day that I release to beta > users. The version on the App Store feels old and crappy. I'm sure that a > lot of developers feel this way: One emotion is "I'm not really proud about > what's in the App Store", and it's combined with the emotion "Really, it's > Apple's fault." Another wrote: > I believe that they think their approval process helps users by ensuring > quality. In reality, bugs like ours get through all the time and then it can > take 4-8 weeks to get that bug fix approved, leaving users to think that > iPhone apps sometimes just don't work. Worse for Apple, these apps work just > fine on other platforms that have immediate approval processes. Actually I suppose Apple has a third misconception: that all the complaints about App Store approvals are not a serious problem. They must hear developers complaining. But partners and suppliers are always complaining. It would be a bad sign if they weren't; it would mean you were being too easy on them. Meanwhile the iPhone is selling better than ever. So why do they need to fix anything? They get away with maltreating developers, in the short term, because they make such great hardware. I just bought a new 27" iMac a couple days ago. It's fabulous. The screen's too shiny, and the disk is surprisingly loud, but it's so beautiful that you can't make yourself care. So I bought it, but I bought it, for the first time, with misgivings. I felt the way I'd feel buying something made in a country with a bad human rights record. That was new. In the past when I bought things from Apple it was an unalloyed pleasure. Oh boy! They make such great stuff. This time it felt like a Faustian bargain. They make such great stuff, but they're such assholes. Do I really want to support this company? * * * Should Apple care what people like me think? What difference does it make if they alienate a small minority of their users? There are a couple reasons they should care. One is that these users are the people they want as employees. If your company seems evil, the best programmers won't work for you. That hurt Microsoft a lot starting in the 90s. Programmers started to feel sheepish about working there. It seemed like selling out. When people from Microsoft were talking to other programmers and they mentioned where they worked, there were a lot of self-deprecating jokes about having gone over to the dark side. But the real problem for Microsoft wasn't the embarrassment of the people they hired. It was the people they never got. And you know who got them? Google and Apple. If Microsoft was the Empire, they were the Rebel Alliance. And it's largely because |
got more of the best people that Google and Apple are doing so much better than Microsoft today. Why are programmers so fussy about their employers' morals? Partly because they can afford to be. The best programmers can work wherever they want. They don't have to work for a company they have qualms about. But the other reason programmers are fussy, I think, is that evil begets stupidity. An organization that wins by exercising power starts to lose the ability to win by doing better work. And it's not fun for a smart person to work in a place where the best ideas aren't the ones that win. I think the reason Google embraced "Don't be evil" so eagerly was not so much to impress the outside world as to inoculate themselves against arrogance. That has worked for Google so far. They've become more bureaucratic, but otherwise they seem to have held true to their original principles. With Apple that seems less the case. When you look at the famous 1984 ad now, it's easier to imagine Apple as the dictator on the screen than the woman with the hammer. In fact, if you read the dictator's speech it sounds uncannily like a prophecy of the App Store. > We have triumphed over the unprincipled dissemination of facts. > > We have created, for the first time in all history, a garden of pure > ideology, where each worker may bloom secure from the pests of contradictory > and confusing truths. The other reason Apple should care what programmers think of them is that when you sell a platform, developers make or break you. If anyone should know this, Apple should. VisiCalc made the Apple II. And programmers build applications for the platforms they use. Most applications—most startups, probably—grow out of personal projects. Apple itself did. Apple made microcomputers because that's what Steve Wozniak wanted for himself. He couldn't have afforded a minicomputer. Microsoft likewise started out making interpreters for little microcomputers because Bill Gates and Paul Allen were interested in using them. It's a rare startup that doesn't build something the founders use. The main reason there are so many iPhone apps is that so many programmers have iPhones. They may know, because they read it in an article, that Blackberry has such and such market share. But in practice it's as if RIM didn't exist. If they're going to build something, they want to be able to use it themselves, and that means building an iPhone app. So programmers continue to develop iPhone apps, even though Apple continues to maltreat them. They're like someone stuck in an abusive relationship. They're so attracted to the iPhone that they can't leave. But they're looking for a way out. One wrote: > While I did enjoy developing for the iPhone, the control they place on the > App Store does not give me the drive to develop applications as I would > like. In fact I don't intend to make any more iPhone applications unless > absolutely necessary. Can anything break this cycle? No device I've seen so far could. |
and RIM haven't a hope. The only credible contender is Android. But Android is an orphan; Google doesn't really care about it, not the way Apple cares about the iPhone. Apple cares about the iPhone the way Google cares about search. * * * Is the future of handheld devices one locked down by Apple? It's a worrying prospect. It would be a bummer to have another grim monoculture like we had in the 1990s. In 1995, writing software for end users was effectively identical with writing Windows applications. Our horror at that prospect was the single biggest thing that drove us to start building web apps. At least we know now what it would take to break Apple's lock. You'd have to get iPhones out of programmers' hands. If programmers used some other device for mobile web access, they'd start to develop apps for that instead. How could you make a device programmers liked better than the iPhone? It's unlikely you could make something better designed. Apple leaves no room there. So this alternative device probably couldn't win on general appeal. It would have to win by virtue of some appeal it had to programmers specifically. One way to appeal to programmers is with software. If you could think of an application programmers had to have, but that would be impossible in the circumscribed world of the iPhone, you could presumably get them to switch. That would definitely happen if programmers started to use handhelds as development machines—if handhelds displaced laptops the way laptops displaced desktops. You need more control of a development machine than Apple will let you have over an iPhone. Could anyone make a device that you'd carry around in your pocket like a phone, and yet would also work as a development machine? It's hard to imagine what it would look like. But I've learned never to say never about technology. A phone-sized device that would work as a development machine is no more miraculous by present standards than the iPhone itself would have seemed by the standards of 1995. My current development machine is a MacBook Air, which I use with an external monitor and keyboard in my office, and by itself when traveling. If there was a version half the size I'd prefer it. That still wouldn't be small enough to carry around everywhere like a phone, but we're within a factor of 4 or so. Surely that gap is bridgeable. In fact, let's make it an RFS. Wanted: Woman with hammer. ** |
| March 2009 _(This essay is derived from a talk atAngelConf.)_ When we sold our startup in 1998 I thought one day I'd do some angel investing. Seven years later I still hadn't started. I put it off because it seemed mysterious and complicated. It turns out to be easier than I expected, and also more interesting. The part I thought was hard, the mechanics of investing, really isn't. You give a startup money and they give you stock. You'll probably get either preferred stock, which means stock with extra rights like getting your money back first in a sale, or convertible debt, which means (on paper) you're lending the company money, and the debt converts to stock at the next sufficiently big funding round. There are sometimes minor tactical advantages to using one or the other. The paperwork for convertible debt is simpler. But really it doesn't matter much which you use. Don't spend much time worrying about the details of deal terms, especially when you first start angel investing. That's not how you win at this game. When you hear people talking about a successful angel investor, they're not saying "He got a 4x liquidation preference." They're saying "He invested in Google." That's how you win: by investing in the right startups. That is so much more important than anything else that I worry I'm misleading you by even talking about other things. **Mechanics** Angel investors often syndicate deals, which means they join together to invest on the same terms. In a syndicate there is usually a "lead" investor who negotiates the terms with the startup. But not always: sometimes the startup cobbles together a syndicate of investors who approach them independently, and the startup's lawyer supplies the paperwork. The easiest way to get started in angel investing is to find a friend who already does it, and try to get included in his syndicates. Then all you have to do is write checks. Don't feel like you have to join a syndicate, though. It's not that hard to do it yourself. You can just use the standard series AA documents Wilson Sonsini and Y Combinator published online. You should of course have your lawyer review everything. Both you and the startup should have lawyers. But the lawyers don't have to create the agreement from scratch. When you negotiate terms with a startup, there are two numbers you care about: how much money you're putting in, and the valuation of the company. The valuation determines how much stock you get. If you put $50,000 into a company at a pre-money valuation of $1 million, then the post-money valuation is $1.05 million, and you get .05/1.05, or 4.76% of the company's stock. If the company raises more money later, the new investor will take a chunk of the company away from all the existing shareholders just as you did. If in the next round they sell 10% of the company to a new investor, your 4.76% will be reduced to 4.28%. That's ok. Dilution is normal. What saves you from being mistreated in future rounds, usually, is that |
in the same boat as the founders. They can't dilute you without diluting themselves just as much. And they won't dilute themselves unless they end up net ahead. So in theory, each further round of investment leaves you with a smaller share of an even more valuable company, till after several more rounds you end up with .5% of the company at the point where it IPOs, and you are very happy because your $50,000 has become $5 million. The agreement by which you invest should have provisions that let you contribute to future rounds to maintain your percentage. So it's your choice whether you get diluted. If the company does really well, you eventually will, because eventually the valuations will get so high it's not worth it for you. How much does an angel invest? That varies enormously, from $10,000 to hundreds of thousands or in rare cases even millions. The upper bound is obviously the total amount the founders want to raise. The lower bound is 5-10% of the total or $10,000, whichever is greater. A typical angel round these days might be $150,000 raised from 5 people. Valuations don't vary as much. For angel rounds it's rare to see a valuation lower than half a million or higher than 4 or 5 million. 4 million is starting to be VC territory. How do you decide what valuation to offer? If you're part of a round led by someone else, that problem is solved for you. But what if you're investing by yourself? There's no real answer. There is no rational way to value an early stage startup. The valuation reflects nothing more than the strength of the company's bargaining position. If they really want you, either because they desperately need money, or you're someone who can help them a lot, they'll let you invest at a low valuation. If they don't need you, it will be higher. So guess. The startup may not have any more idea what the number should be than you do. Ultimately it doesn't matter much. When angels make a lot of money from a deal, it's not because they invested at a valuation of $1.5 million instead of $3 million. It's because the company was really successful. I can't emphasize that too much. Don't get hung up on mechanics or deal terms. What you should spend your time thinking about is whether the company is good. (Similarly, founders also should not get hung up on deal terms, but should spend their time thinking about how to make the company good.) There's a second less obvious component of an angel investment: how much you're expected to help the startup. Like the amount you invest, this can vary a lot. You don't have to do anything if you don't want to; you could simply be a source of money. Or you can become a de facto employee of the company. Just make sure that you and the startup agree in advance about roughly how much you'll do for them. Really hot companies sometimes have high standards for angels. The ones everyone wants to invest in practically audition investors, and only take money from people who are famous and/or will work hard for |
But don't feel like you have to put in a lot of time or you won't get to invest in any good startups. There is a surprising lack of correlation between how hot a deal a startup is and how well it ends up doing. Lots of hot startups will end up failing, and lots of startups no one likes will end up succeeding. And the latter are so desperate for money that they'll take it from anyone at a low valuation. **Picking Winners** It would be nice to be able to pick those out, wouldn't it? The part of angel investing that has most effect on your returns, picking the right companies, is also the hardest. So you should practically ignore (or more precisely, archive, in the Gmail sense) everything I've told you so far. You may need to refer to it at some point, but it is not the central issue. The central issue is picking the right startups. What "Make something people want" is for startups, "Pick the right startups" is for investors. Combined they yield "Pick the startups that will make something people want." How do you do that? It's not as simple as picking startups that are already making something wildly popular. By then it's too late for angels. VCs will already be onto them. As an angel, you have to pick startups before they've got a hit—either because they've made something great but users don't realize it yet, like Google early on, or because they're still an iteration or two away from the big hit, like Paypal when they were making software for transferring money between PDAs. To be a good angel investor, you have to be a good judge of potential. That's what it comes down to. VCs can be fast followers. Most of them don't try to predict what will win. They just try to notice quickly when something already is winning. But angels have to be able to predict. One interesting consequence of this fact is that there are a lot of people out there who have never even made an angel investment and yet are already better angel investors than they realize. Someone who doesn't know the first thing about the mechanics of venture funding but knows what a successful startup founder looks like is actually far ahead of someone who knows termsheets inside out, but thinks "hacker" means someone who breaks into computers. If you can recognize good startup founders by empathizing with them—if you both resonate at the same frequency—then you may already be a better startup picker than the median professional VC. Paul Buchheit, for example, started angel investing about a year after me, and he was pretty much immediately as good as me at picking startups. My extra year of experience was rounding error compared to our ability to empathize with founders. What makes a good founder? If there were a word that meant the opposite of hapless, that would be the one. Bad founders seem hapless. They may be smart, or not, but somehow events overwhelm them and they get discouraged and give up. Good founders make things happen the way they want. Which is not to say they force things to happen |
a predefined way. Good founders have a healthy respect for reality. But they are relentlessly resourceful. That's the closest I can get to the opposite of hapless. You want to fund people who are relentlessly resourceful. Notice we started out talking about things, and now we're talking about people. There is an ongoing debate between investors which is more important, the people, or the idea—or more precisely, the market. Some, like Ron Conway, say it's the people—that the idea will change, but the people are the foundation of the company. Whereas Marc Andreessen says he'd back ok founders in a hot market over great founders in a bad one. These two positions are not so far apart as they seem, because good people find good markets. Bill Gates would probably have ended up pretty rich even if IBM hadn't happened to drop the PC standard in his lap. I've thought a lot about the disagreement between the investors who prefer to bet on people and those who prefer to bet on markets. It's kind of surprising that it even exists. You'd expect opinions to have converged more. But I think I've figured out what's going on. The three most prominent people I know who favor markets are Marc, Jawed Karim, and Joe Kraus. And all three of them, in their own startups, basically flew into a thermal: they hit a market growing so fast that it was all they could do to keep up with it. That kind of experience is hard to ignore. Plus I think they underestimate themselves: they think back to how easy it felt to ride that huge thermal upward, and they think "anyone could have done it." But that isn't true; they are not ordinary people. So as an angel investor I think you want to go with Ron Conway and bet on people. Thermals happen, yes, but no one can predict them—not even the founders, and certainly not you as an investor. And only good people can ride the thermals if they hit them anyway. **Deal Flow** Of course the question of how to choose startups presumes you have startups to choose between. How do you find them? This is yet another problem that gets solved for you by syndicates. If you tag along on a friend's investments, you don't have to find startups. The problem is not finding startups, exactly, but finding a stream of reasonably high quality ones. The traditional way to do this is through contacts. If you're friends with a lot of investors and founders, they'll send deals your way. The Valley basically runs on referrals. And once you start to become known as reliable, useful investor, people will refer lots of deals to you. I certainly will. There's also a newer way to find startups, which is to come to events like Y Combinator's Demo Day, where a batch of newly created startups presents to investors all at once. We have two Demo Days a year, one in March and one in August. These are basically mass referrals. But events like Demo Day only account for a fraction of matches between startups and investors. The personal referral is still the most common route. So if |
want to hear about new startups, the best way to do it is to get lots of referrals. The best way to get lots of referrals is to invest in startups. No matter how smart and nice you seem, insiders will be reluctant to send you referrals until you've proven yourself by doing a couple investments. Some smart, nice guys turn out to be flaky, high-maintenance investors. But once you prove yourself as a good investor, the deal flow, as they call it, will increase rapidly in both quality and quantity. At the extreme, for someone like Ron Conway, it is basically identical with the deal flow of the whole Valley. So if you want to invest seriously, the way to get started is to bootstrap yourself off your existing connections, be a good investor in the startups you meet that way, and eventually you'll start a chain reaction. Good investors are rare, even in Silicon Valley. There probably aren't more than a couple hundred serious angels in the whole Valley, and yet they're probably the single most important ingredient in making the Valley what it is. Angels are the limiting reagent in startup formation. If there are only a couple hundred serious angels in the Valley, then by deciding to become one you could single-handedly make the pipeline for startups in Silicon Valley significantly wider. That is kind of mind-blowing. **Being Good** How do you be a good angel investor? The first thing you need is to be decisive. When we talk to founders about good and bad investors, one of the ways we describe the good ones is to say "he writes checks." That doesn't mean the investor says yes to everyone. Far from it. It means he makes up his mind quickly, and follows through. You may be thinking, how hard could that be? You'll see when you try it. It follows from the nature of angel investing that the decisions are hard. You have to guess early, at the stage when the most promising ideas still seem counterintuitive, because if they were obviously good, VCs would already have funded them. Suppose it's 1998. You come across a startup founded by a couple grad students. They say they're going to work on Internet search. There are already a bunch of big public companies doing search. How can these grad students possibly compete with them? And does search even matter anyway? All the search engines are trying to get people to start calling them "portals" instead. Why would you want to invest in a startup run by a couple of nobodies who are trying to compete with large, aggressive companies in an area they themselves have declared passe? And yet the grad students seem pretty smart. What do you do? There's a hack for being decisive when you're inexperienced: ratchet down the size of your investment till it's an amount you wouldn't care too much about losing. For every rich person (you probably shouldn't try angel investing unless you think of yourself as rich) there's some amount that would be painless, though annoying, to lose. Till you feel comfortable investing, don't invest more |
that per startup. For example, if you have $5 million in investable assets, it would probably be painless (though annoying) to lose $15,000. That's less than .3% of your net worth. So start by making 3 or 4 $15,000 investments. Nothing will teach you about angel investing like experience. Treat the first few as an educational expense. $60,000 is less than a lot of graduate programs. Plus you get equity. What's really uncool is to be strategically indecisive: to string founders along while trying to gather more information about the startup's trajectory. There's always a temptation to do that, because you just have so little to go on, but you have to consciously resist it. In the long term it's to your advantage to be good. The other component of being a good angel investor is simply to be a good person. Angel investing is not a business where you make money by screwing people over. Startups create wealth, and creating wealth is not a zero sum game. No one has to lose for you to win. In fact, if you mistreat the founders you invest in, they'll just get demoralized and the company will do worse. Plus your referrals will dry up. So I recommend being good. The most successful angel investors I know are all basically good people. Once they invest in a company, all they want to do is help it. And they'll help people they haven't invested in too. When they do favors they don't seem to keep track of them. It's too much overhead. They just try to help everyone, and assume good things will flow back to them somehow. Empirically that seems to work. ** |
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