Black Swan Farming

by siavosh • 14 years ago

703 303 14 years ago

grueful• 14 years ago

I disagree with some of the meta-cognition.

Take the "seems like a bad idea" bit. Many of the big hits are really well-worn ideas done with better marketing, better timing, and a user experience which makes it available to new markets.

Dropbox? File sharing. Facebook? Geocities. Both are interesting in that they take something that was a giant pain in the neck but useful enough to put up with anyway, and then they make it usable enough that virtually anyone can do that stuff routinely.

But the meta-cognition isn't all that important. What's important is that they're getting out there and helping new companies learn and grow. They can be wrong all day (or not) about the why because they've developed a process which provably works, and which they can measure and improve upon.

paul4• 14 years ago

Can you honestly not tell the difference between Facebook and Geocities?

Also, the fact that Dropbox and Facebook were "unoriginal" is exactly what made them seem like bad ideas at the time. I saw Dropbox present at demoday, and the main question on my mind was, "How is this different from the million other attempts at online file storage? (xdrive, etc)".

mikeleeorg2• 14 years ago

If I had the time, I would do a bunch of research into trying to determine what made Dropbox, Facebook, AirBnB, et al, succeed in their markets. I assume the answer involves the founding teams, but what traits did these founders have that others did not?

I don't have the time though, so if any bloggers/journalists are reading, this could be an interesting article, or even book, if you get enough info.

Whether or not this info would actually help another team become successful is another story though.

harryh3• 14 years ago

Isn't this an example of the winner take all phenomenon?

It seems to me that both Dropbox & Facebook are example of companies pursuing good ideas that lots of other companies were also pursuing. They just happened to be the ones that executed the best (and possibly also had the best luck) so they were able to win the market.

If this is the case then your job as a funder of startups might be to try to identify the companies capable of out executing everyone else on a good idea that a lot of people are working on.

This is much different than the great idea that looks bad phenomenon that pg discusses in his essay.

mikeleeorg2• 14 years ago

History tends to get rewritten by big successes, so that in retrospect it seems obvious they were going to make it big. For that reason one of my most valuable memories is how lame Facebook sounded to me when I first heard about it.

As a thought experiment, I would love to hear what pg and team would have thought about the following companies, had they applied to YC before they grew in popularity (assuming YC existed when they were starting out):

PayPal, Twitter, Pandora, SalesForce, Instagram, FourSquare, and Pinterest. And perhaps a few others as well.

pg11• 14 years ago

That is a very interesting exercise.

I feel pretty sure we'd have been impressed enough by Max and Peter to fund them regardless of the idea (which initially had almost nothing in common with Paypal).

I knew Ev before Twitter so I'm sure we would have funded that.

Pandora I know nothing about, so I can't guess there.

SalesForce I'm pretty sure we would have funded because Benioff radiates "winner" in much the same overwhelming way that Zuckerberg does.

Instagram is the one we'd most likely have missed. It all depends when we'd talked to them. They were a kind of overnight success in traffic. If we'd talked to them even a day after they launched we would certainly have said yes. But before that it might have seemed too speculative.

I don't know about FourSquare. I've never met the founders and don't understand the business.

Pinterest we definitely would have funded, because Ben is a two time YC alum (with different companies alas). We knew he was good because the first time he was part of a startup that as an experiment we didn't make move to California. As Demo Day approached, they were in terrible shape. But Ben swooped in at the last moment and gave one of the most convincing Demo Day presentations.

dschobel3• 14 years ago

a guy 'radiates "winner"'? Really?

I sincerely hope you're being flippant and don't mean that as a serious answer.

juniorer2• 14 years ago

Anyone know what the two YC companies Ben from Pinterest was a part of?

00000000swan2• 14 years ago

This seems to suggest the decision to fund has less to do with the idea and more to do with the founders. We already knew that.

Does this also mean that the "big winners" will not come merely from a pool of what appear to be bad ideas, but from a subset of that pool: bad ideas put forth by founders the VC thinks are impressive? That too, seems somewhat obvious.

Taking it one step further, can you separate the "idea" from the "founder" in assessing the project's chances of being a "big winner"?

Maybe that was the goal of requesting that people should apply to YC even if they had no "idea".

After all, the supply of "bad ideas" is potentially limitless.

asmithmd1• 14 years ago

Here is what Bessemer said about PayPal when they passed:

"Rookie team, regulatory nightmare"

http://www.bvp.com/portfolio/antiportfolio

aptwebapps5• 14 years ago

Great link.

"Cowan’s college friend rented her garage to Sergey and Larry for their first year. In 1999 and 2000 she tried to introduce Cowan to “these two really smart Stanford students writing a search engine”. Students? A new search engine? In the most important moment ever for Bessemer’s anti-portfolio, Cowan asked her, “How can I get out of this house without going anywhere near your garage?”"

sidcool2• 14 years ago

There will be several self professed disagreements posted here citing very specific situations.

autophil2• 14 years ago

I still shake my head with AirBnB, a total ripoff of couch surfing. For it to be comparable in any way, shape or form to the innovative and beautifully executed Dropbox boggles the mind.

seiji3• 14 years ago

I used to think airbnb was a direct for-profit, money grubbing ripoff of the pure-of-heart couchsurfing. Then I tried to use couchsurfing this year. Their website is virtually unusable. It looks like it hasn't been updated since 1995. They have a horrific profile system and verification process. They have one 500,000th of the audience they could have.

If you stagnate, you will be eaten. Just keep swimming.

autophil2• 14 years ago

Nicely said. I'll have to give you that. I used couch surfing a few years ago and distinctly remember thinking I should redo the site for them. I may have even written it on my profile.

asifjamil• 14 years ago

Is it possible that this is simply just the effect of a Bell Curve (i.e, the normal (Gaussian) distribution of a field)?

maxdemarzi2• 14 years ago

Read the book. http://www.amazon.com/The-Black-Swan-Improbable-Robustness/d...

seiji3• 14 years ago

I think that's the exact opposite of what pg means.

pg is basically writing http://blakemasters.tumblr.com/post/21869934240/peter-thiels...

gojomo• 14 years ago

There's a similarity to Thiel's analysis -- that few outliers provide all the returns -- but also a difference: PG seems more comfortable with the idea that early on, the ultimate winners are completely unknowable, and so 'many trails' (diversification) is absolutely necessary.

Meanwhile, throughout his lectures, Thiel seems to emphasize that with enough focus on the right people. important projects, and right 'secrets', outcomes are not as random as they seem... and both individuals and investors must concentrate on some big bets rather than endlessly diversify.

maxdemarzi2• 14 years ago

There is going to be nothing that will "explain" why or which companies could be the big winners. Trying to is falling into the narrative fallacy trap Taleb writes about.

Best strategy is to "win" in other ways, and let the cards fall where they may.

pmarca7• 14 years ago

Taleb has an exact translation of what Paul is talking about -- Taleb would, and has, described what Paul is saying as "construct a portfolio of cheap high-risk long-dated options, each of which has a high probability of losing all of your money but also uncapped upside". "Uncapped upside" being the key, of course.

Taleb's new book coming out soon will describe all this in a lot more detail -- should be very interesting.

paul4• 14 years ago

The counter-intuitive nature of startup investing is a big part of what makes it so interesting to me. In most aspects of life, we are trained to avoid risk and only pursue "good ideas" (e.g. try to be a lawyer, not a rock star). With startups, I get to focus on things that are probably bad ideas, but possibly great ideas. It's not for everyone, but for those of us who love chasing dreams, it can be a great adventure.

DanielRibeiro• 14 years ago

Peter Thiel recently talked a little about this[1] counter-intutive phenomena (that pg states as that effectively all the returns are concentrated in a few big winners):

One intuition is that people do not believe in a power law distribution. They intuitively don’t believe that returns could be that uneven. So when you have an up round with a big increase in valuation, many or even most VCs tend to believe that the step up is too big and they will thus underprice it.

Which is intersting, because he actually talked a little to pg about this during the class where he said it:

Peter Thiel: Do Y-Combinator companies follow a power law distribution?

Paul Graham: Yes. They’re very power law

But Thiel was not happy just stating the phenomena, but he also states on why most people discredit it, when he talked about secrets[2]:

The power law secret operates similarly. In one sense it’s a secret about finance. Startup outcomes are not evenly distributed; the follow a power law distribution. But in another sense it’s a very human secret. People are uncomfortable talking about inequality, so they either ignore it or rationalize it away. It is psychologically difficult for investors to admit that their best investment is worth more than the rest of their portfolio companies combined. So they ignore or hide that fact, and it becomes a secret.

The distribution secret also has two sides to it. Distribution is much more important than people think. That makes it a business secret. But it’s a human secret too, since the people involved in distribution work very hard to hide what’s going on. Salespeople do best when people do not know they’re dealing with salespeople.

[1] http://blakemasters.tumblr.com/post/21869934240/peter-thiels...

[2] http://blakemasters.tumblr.com/post/22866240816/peter-thiels...

martin_bech• 14 years ago

That actually makes a lot of sense. Ive been having some of the same thoughts, as almost all the profits from my own portfolio is from Apple stock, even though i also own, Amazon, Tesla, Arm and so on.

Perhaps thats why index investing is so succesfull, because you get the benefit of the outliers.. the bad ideas, or long shots, that suddenly skyrocket..

gersh2• 14 years ago

So, if you randomly decided which startups to invest in, would you be more successful? Can you really predict anything? If you randomly invested in 100 startups, would your returns be better than your screening process? Can you test this?

Gustomaximus• 14 years ago

They do something similar with equity trades. They get professionals and public entrants to select stocks and include a 'dartboard'. From my limited reading experience the dartboard rarely wins implying people do add value, but it would be interesting if someone could find a history (I didn't with a quick Google). In Australia one news paper includes an Astrologer which I find amusing.

With start-ups I think it would be too expensive an experiment to fund.

pg11• 14 years ago

We have a good deal of evidence that our selection process is better than random. We know it's at least internally consistent, in the sense that startups that are ranked higher in the application phase are more likely to make it past the interview phase. And we also in turn have (a necessarily small amount of) evidence that the startups that turn out to be big winners do the best in the interview phase.

majormajor• 14 years ago

You mentioning rock stars make me wonder if being a scout for a record label is similar. A band that's going to define a new genre or movement will sound nothing like anything currently popular, so it seems you have to identify the things that sound nothing like what's popular but that sound like what will be popular.

The returns aren't as dominated by just a few big successes, though. Although I suppose one-hit wonders are a manifestation of something similar: All the returns come from one song out of who knows how many dozens a band or artist may have come up with.

jseliger2• 14 years ago

Publishers, from what I can tell, have the same problem. One thing that I'm struck by is how many novels that we now consider classic, or novelists who we now consider important, barely scraped into publication. Tolkien famously saw Lord of the Rings in print because of Rayner Unwin, the then nine-year-old (I think) son of a publisher liked LOTR. John Barth and William Goldman have both written about how close they were to pursuing other opportunities—a PhD and insurance, IIRC. A Confederacy of Dunces was only published after O'Toole killed himself. Melville's poetry was self-published IIRC. Virginia Woolf needed to start her own press.

There are probably others with similar stories.

Not only that, but I have to wonder who barely didn't make the cut. Given the large number of writers who skated into print, there must be at least an equally large group who "should" have, but left no marks on history sufficiently legible to trace.

I think about these issues a lot for two reasons. The first is that I've had many close calls with literary agents, all of whom eventually said, "I like you, but not in that way." The second is the technological environment: now that ebooks mean self-publishing is much more pragmatic than it used to be, people who really want to publish have a means of going outside the conventional system. Some power-law-style stars have already emerged (Amanda Hocking, the 50 Shades of Grey author). Others probably will. Maybe I'll be one. But if I'm not, I don't think I'll be too bothered: I mostly want to write.

Yeah, 99% of self-published books are probably un- or poorly edited dreck, but that 1% count for a lot.

(A side note: I wrote about this a little more at the bottom of this post: http://jseliger.wordpress.com/2012/07/29/links-the-time-for-...).

gadders• 14 years ago

Back in the deep, dark days of the internet, when Napster was new, I believe this was one of the arguments that Def Leppard used against file-sharing.

Namely, that record companies are like VC funds, and the massive cash they make from Def Leppard (or Lady Gaga or whoever) pays for the 1000's of other acts that they fund and then fail.

ohashi• 14 years ago

Reminds me of this:

"The underlying thesis behind Andreessen Horowitz’s investing strategy is that in any given year only 15 companies will make up more than 90 percent of the returns. So it pays to get into those companies at almost any price."

(Source: http://techonomy.com/2012/08/the-andreessen-horowitz-effect/)

I guess once you figure out who the big winners are going to be, getting in is worth it at basically any cost when the returns are going to be so high. If others aren't comfortable with that much risk, you can win big because the price isn't driven up to expectation, leaving room for more profit.

tlogan• 14 years ago

This is probably true also for evaluating entrepreneurs where blindest is even greater (I call it "young white male syndrome").

It seems like if an entrepreneur is a little different (black, hispanic, women, little eccentric, older, etc.) he/she need to act and behave like "white young male" in order get noticed and funded. However, in that case he/she might be hiding the characteristics which will make them "rock star".

josdewolk• 14 years ago

Love to see a little race get tossed into Hacker News. Thanks for speaking up.

AndrewNCarr• 14 years ago

Ageism, racism, and sexism all in one, impressive. And what stereotypes do you attribute to that demographic which are unique and oppressive to others? Seems to me the only thing in question here is creativity and ambition.

wamatt• 14 years ago

> "The counter-intuitive nature of startup investing..."

The hidden premise of that statement, appears to imply there exists a universal intuition to which this is "counter". I'm not sure that is completely accurate, and is perhaps more useful to think about it in terms of a bifurcated process that can roughly segment the populace into two modes of preferred intuitive operation, but possibly more.

Without going into detail, both types of intuition make subconscious predictions, yet do so in markedly contrasting approaches, which may explain the root cause of arguments between a priori/a posteriori, bayesian/frequentist debates. The underlying ideologies may not necessarily be the effect of environmental upbringing as often assumed, but could instead be structurally rooted in the fundamental wiring and decision making of our cognition.

I'm sure some will disagree, but I naturally find frequentist methods rather challenging to understand, and typically intuit in a distinctly bayesian manner (which is probably less common, typically VC's tend to be good pattern matchers and skilled numeracy - aka natural frequentists). Coincidentally what PG thinks is counter-intuitive (like in this article), could seem rather intuitive to some. Likewise there are almost certainly other insights that are mundane, boring obvious and intuitive to PG, yet are highly counter-intuitive (and interesting) to others.

Of course it's all just anecdote and opinion for now and probably a controversial position, but hoping advancements in cognitive neuroscience research, would one day be able to test this empirically.

lmm2• 14 years ago

I think you're bluffing. For someone with normal human intuitions, the reward curve of startup investing should be counterintuitive, because it's very different from all the reward curves that were available in the ancestral environment.

bambax3• 14 years ago

Is it really that counter-intuitive, though? A sample of two "rock stars" doesn't seem to be enough to draw conclusions from it.

For instance, whereas Airbnb can admittedly be seen as a questionable idea (but not outright bad), Dropbox (the idea, before implementation) sounds like a very good idea. Maybe not a $7b idea, but still very good.

Of course, among the YC funded startups, there may be a lot of ideas that sounded bad at first; but if all those startups are in fact financially irrelevant, should they be used to try to build a theory of success?

- - -

It's interesting to learn that if YC funded 10x more startups they would be just as successful (and maybe more, since there could be a big success in the startups that are left out) -- it means that if the selection process rate is around 10%, YC could do without it entirely, with no significant effect to its bottom line.

Also, I took this picture this summer http://i.imgur.com/B30hL.jpg

adrianhoward2• 14 years ago

Dropbox (the idea, before implementation) sounds like a very good idea. Maybe not a $7b idea, but still very good

I don't think so. My first encounter with DropBox was very similar to my first encounter with Google... but it was "Oh look - another way to share files" rather than "Oh look - another search engine".

Or indeed many, many people's reaction to the release of the first iPod ("Oh look - another mp3 player").

Predicting their current level of success from the point of initial investment - pretty close to impossible without the benefit of 20/20 hindsight. Their success depending so much on how well they executed and the smart changes of direction that those companies made along the way.

(with, maybe, the exception of the iPod which was a bit more obvious for those that paid attention to iTunes)

E.g. Would DropBox be anywhere close to their current position if they hadn't figured out their freemium / recommendation based model for customer acquisition?

Estragon• 14 years ago

Frankly, I still don't understand why everyone's so excited about dropbox.

playhard• 14 years ago

Brilliant. From the heart.

cperciva7• 14 years ago

Quoth pg: It would hurt YC's brand (at least among the innumerate) if we invested in huge numbers of risky startups that flamed out.

Paul, you're sounding like a venture capitalist who is worried about whether he can find investors for his next fund.

I would posit that the people whose opinions you should care about are potential founders; and that their primary concern is themselves, not the performance of a fund (oops, I mean class) as a whole. You're damn right that it would hurt YC's brand if 70% of each class didn't survive past Demo Day -- because for an individual founder, success is pretty much binary, and having a 50% chance of becoming a millionaire is more attractive than having a 5% chance of becoming a billionaire, despite the 100-fold reduction in mean wealth.

You may be in in the business of farming black swans, but if they're all you worry about you'll find that all the swans end up laying their eggs elsewhere.

pg11• 14 years ago

I do care about would-be founders' opinions, but surely I don't have to use every essay I write to convince people to apply to YC. I've already written elsewhere about the founder's eye view of YC (e.g. http://ycombinator.com/atyc.html). This essay is just an exploration of the strangeness of startup investing as a business. The goal is not to convince anyone to do anything.

thaumaturgy4• 14 years ago

Off-topic, but something I've been chewing on lately: what's it like to have your every written (or spoken!) word analyzed by a bunch of people? Esp. people that you end up having some form of contact with.

It seems like it would be difficult to just have a public conversation about a topic. Do you think about that much when you write?

cperciva7• 14 years ago

You're missing my point -- I was objecting to the "(at least among the innumerate)" bit. It would hurt YC's reputation among everybody who matters, whether innumerate or not, if 70% of YC companies didn't survive past Demo Day.

Alex39173• 14 years ago

"I do care about would-be founders' opinions, but surely I don't have to use every essay I write to convince people to apply to YC."

The essay reminds me a bit of the argument that the Native Americans actually got a great deal when they sold Manhattan for $24, because that money would be worth about $30 trillion today if it had been invested at a return of just 7.5% for the past 385 years. I think it's interesting and worthwhile to explore these sorts of mathematical ideas, but at the same time it's impossible to make good business decisions without fundamentally basing them on human needs, human scales, and human timeframes.

fleitz2• 14 years ago

Do you think it might be possible to run this kind of program under a separate brand, similar to the relationship between Touchstone and Disney?

mnutt• 14 years ago

It would hurt founders' perceptions but wouldn't actually decrease any individual founder's chances of success. YC would just accept a bunch of people who aren't likely to get funded.

What would happen if you split up the batches into two groups, YC Classic and YC Black Swan, and placed founders into the groups post-interview? People who were placed in YC Classic could continue to have the expectation of ~100% demo day success they do now, while the people placed in YC Black Swan would be told "I find your idea interesting and we'll let you in but don't expect funding after demo day." People could take the Black Swan offers as rejections if they wanted.

There are a bunch of problems with this approach, but I wouldn't be totally surprised if way more than 30% of YC Black Swan was funded.

xianshou• 14 years ago

I love this idea, because it addresses the two fundamental issues at play here: the social and the financial. Considering YC as a single entity, the optimal funding strategy must take into account both the power law on returns and the prestige of the program. If YC loses its place as the most prominent and well-respected startup incubator, the Dropboxes and Airbnbs of the future will either forgo the application or suffer from lack of investor interest. If YC limits itself to only those companies that have an extremely high chance of getting funded, the outliers will never find a way in.

Let's say that p_accept is the probability that YC accepts the founders of the next Dropbox. YC itself cannot optimize for p_accept because of the factors mentioned above: instead, it has to optimize for p_apply * p_accept * p_fund, the product of the chances that those golden founders will apply to the program, be accepted, and find the funding they need to grow and thrive.

With the hypothetical YC / YC Black Swan split, the original YC can optimize for p_apply * p_fund, and YC Black Swan can optimize for p_accept. Not only that, but since all Black Swan candidates would have started as applicants to YC, Black Swan's p_apply would equal that of the original YC. Numerate investors with the same sense of the power law as pg would take care of Black Swan's p_fund.

Thus, all the prestige, cultural appeal, and midsize exits would derive from the original YC, but all the power-law returns would emerge from Black Swan.

So, pg, new business model?

sidman3• 14 years ago

If you could pull that off without discrimination that would be an awesome idea. It may cause somewhat of a North/South Korea kind of thing but if it can be done it would be a great data collection exercise that investors, founders can really learn from.

Would be interesting to learn why the black swans have done better then the normal batch, or why the normal batch did better or why it was a 50/50 split.

You might even learn that because a startup is considered as a black swan founders in that group work harder and thus have a higher success rate. This would really put into light debates about how much intelligence vs hard work may effect success rates in the world of startups.

cperciva7• 14 years ago

It would hurt founders' perceptions but wouldn't actually decrease any individual founder's chances of success.

In a world where potential founders are making a choice between YC or doing the startup anyway without YC, sure. But the world is more complicated than that, and I'm sure there are plenty of potential founders whose decisions are informed by what they hear from YC.

[...] split up the batches into two groups, YC Classic and YC Black Swan [...] People could take the Black Swan offers as rejections if they wanted.

This sounds like a very good model, in that it would separate the "is this something YC wants to invest in?" axis from the "does Paul Graham think that I'll succeed?" axis.

pmarca7• 14 years ago

I know which Demo Day I would go to! (The Black Swan one.)

aangjie• 14 years ago

Interesting, but am not sure it'll work from a marketing/founder-motivation perspective. There may be a segregation VCs can see, but it is not clear what effects it'll have on the company/founder's future efforts/commitment to the startup business.

The group-think effects are to be considered, before adopting this model. Am obviously not predicting anything, except perhaps this move might make the Black swans even more unpredictable.i.e: if you look at the Tableau of payoffs here(http://edge.org/conversation/the-fourth-quadrant-a-map-of-th...). this move can push investments from complex payoffs to very complex payoffs easily. Personally, i am likely to even shoot for the YC Classic group deliberately or in rare optimistic moments, the Black Swan group.

brc• 14 years ago

The problem is you are applying post-hoc analysis.

While a theme was that the outsized returns can come from ideas which sound bad, it doesn't necessarily say that all outsized returns come from bad-sounding ideas.

Not only that, but I think reading the essay will show that the outsized returns are not known until several years after demo day.

Sometimes bad ideas are just bad ideas. In the Venn intersection between bad-sounding-ideas and good-ideas - the 'bad sounding and not good' is a much bigger area.

To me, the entire essay is about making sure that institutionally, the bad-sounding-but-ultimately-good ideas are not left out. Trying to further identify and silo them at application stage would be even more fraught.

DaniFong• 14 years ago

Khosla Ventures actually has two separate kinds of funds set up for such funding -- KV Seed for science experiments, and a larger fund for more classic investments.

The main difference in branding for KV's funds is really only to the LPs, though they do mention it to founders on their website. They want to cover themselves in case the seed funding both doesn't return anything and looked to be imprudent in retrospect. Luckily I think they're doing well.

Vinod is actually quite explicit about trying to find black swans in his pitches :-)

hotpockets• 14 years ago

Isn't there a simple solution to this problem? Bundle the unfundable ideas into a secretive spinoff. Say, call it YC BlackOps, or something. Keep it mysterious, like Google X Labs. If you do it right, it won't hurt the YC brand.

mixmax• 14 years ago

There's a pretty interesting lesson for potential YC candidates, particularly the ones that get turned down, here.

When you interview a startup and think "they seem likely to succeed," it's hard not to fund them. And yet, financially at least, there is only one kind of success: they're either going to be one of the really big winners or not, and if not it doesn't matter whether you fund them, because even if they succeed the effect on your returns will be insignificant.

What this means is that YC is not looking for sustainable businesses, but homeruns. Which is entirely fair, that's the business they're in.

But you and your startup are in a different business: Your measure of success isn't the same as Ycombinators. If your startup ends up making you a million dollars a year you will probably be very happy and rightfully call yourself a success. But as the post points out that won't be enough for YC since they need to fund a lot of other startups that will inevitably fail out of their minority share. Thus they need a much bigger success.

If you get turned down for YC it might well be that your idea is just a sound business idea that YC doesn't consider just crazy enough that it might make them a billion dollars. But that doesn't mean that it won't make you a million.

robryan2• 14 years ago

At the same time YC doesn't mind those businesses and certainly ha a lot to offer them. Just when defining success of the fund as a whole these businesses at comparatively little to that.

Granted when they initially pick your business it is probably by because you explained what a great lifestyle business it will be.

thaumaturgy4• 14 years ago

That was my knee-jerk reaction to it too, but I re-read it more carefully and paid attention to the parts that specifically say that that's not what they're looking for. e.g.:

> I'm not saying that the big winners are all that matters, just that they're all that matters financially for investors. Since we're not doing YC mainly for financial reasons, the big winners aren't all that matters to us.

Also,

> If we ever got to the point where 100% of the startups we funded were able to raise money after Demo Day, it would almost certainly mean we were being too conservative.

(and the entire rest of that section talking about how they can afford to take huge risks, and should be.)

On the whole, this piece sounds like some observations and thoughts from pg, and nothing more. I think founders shouldn't try to read too much into it, specifically whether or not YC would be interested in their business.

YC might choose to fund you just because they like you.

yesimahuman• 14 years ago

I've been rejected from YC several times, two of which were in interviews. The most recent rejection was supposedly because they thought it was unclear we could become a large venture backed company. I've also had YC founders trying to hire my co-founder and I, questioning why we were still running our company after the rejection.

Despite the rejection we are growing each month, turning down acquisition offers, our customers love our products, and at 24 years old, we are learning a ton. We have no investors, are profitable, and have a lot of time to grow the company and work on crazy ideas. I am having the time of my life.

It's really important to understand the business YC is in, and to separate your self-worth from it. It's also important to not hold any negative feelings towards them, since they are merely trying to maximize their outcomes, and they know the market quite well.

Go follow your passions and make stuff people love. The rest will follow.

a45l984• 14 years ago

But you have to convey the sense that annual profits of one million is not your idea of "success". Because if that is your idea of success, you will not likely be the "big winner" that YC is looking for.

Put an evil twinkle in your eye and make internet VC think you want to rule the world and will lie, cheat and steal to achieve this, when truly you're just an honest kid with good morals who'd be happy living a modest but financially secure lifestyle.

Founder 1 Internet VC 0

pmarca7• 14 years ago

> If your startup ends up making you a million dollars a year you will probably be very happy and rightfully call yourself a success.

I see this a lot from various corners of the startup ecosystem, particularly 37 Signals and their followers. The problem is that it's not really true, by which I mean there are not very many examples of it begin true, and there is an excellent reason to believe that it may never be true. Which is: you need to find a market big enough to support "lifestyle income" (or your million dollars a year) but not big enough that a startup or growth technology company that is really good at doing things at scale isn't just going to eat it, and kill you in the process.

One of the reasons Jason Fried needs to yell so loudly about 37 Signals being the model for lots of other companies is because it's really not -- it's really rare to find a lifestyle technology business.

dbul2• 14 years ago

One of the reasons Jason Fried needs to yell so loudly...

Another reason: marketing. People don't get that.

patio115• 14 years ago

it's really rare to find a lifestyle technology business.

The traditional challenge you'd level here is "Name three" (37signals, Fog Creek, Balsamiq) but, due to the type of people I hang out with, I could get to fifty before having to slow down and start checking my Gmail. A friend of mine who is in the selling shovels business estimated that there are 30,000 firms selling SaaS. (That number struck me as crazy until I realized that, oh yeah, I'm routinely in rooms with several hundred of them at once.) The overwhelming majority will never raise outside capital.

lsc10• 14 years ago

>it's really rare to find a lifestyle technology business.

You... must live in a different world from me. I mean, I am a lifestyle "technology" business. Most of my customers are, too... a whole lot of them are so small that they still have dayjobs. For that matter, most of my suppliers are, too.

But think of all the web design firms that exist. All of the small-business IT firms. The small consulting shops of various stripes. There are huge numbers of these "too small for important people to care" companies. and so many web applications are thrown together by one person, just messing around.

Many, probably most of my suppliers and competitors are also small operations owned by one or two people. Linode, as far as I can tell, started a lot like I did; and so did most of my smaller competitors. (Slicehost is the counterexample; my understanding is that they started in a very startup-y manner.)

I mean, obviously, you get fewer firms as you raise your revenue cutoff. If you require millions of dollars a year in revenue, nearly all my customers fall off the list... but actually, probably not that many of my suppliers. I mean, I'm buying one rack from coresite, 5g from cogent, and 1.1G and 2 racks from he.net, but that's less than half my monthly outlay, and other than that, all that money goes to small private companies (and really, he.net might be considered a small private company that grew to be a not-so-small private company.)

ryanbrunner2• 14 years ago

Isn't this article implying that it's awfully hard to find success in the VC model as well? With the traditional funding model, you're either an AirBnB, DropBox, or someone who ultimately isn't going to make much of a lot of money at all. If you're lucky, you'll come out of it with something that maybe makes up for the blood and sweat equity you put into the company for little or no pay.

Ultimately, I'd agree that successfully getting a 37 signals, Balsamiq, or Fog Creek off the ground is difficult, but compared to the VC model of "DropBox or bust", it seems like a much more attainable goal.

I think the main lesson is that there's really no free lunch in the startup world - we've all heard it a hundred times before, but there's no silver bullet that guarantees success, or even a decent chance at success in this business. It's not quite the lottery, but a 1 in 50 shot probably isn't unrealistic odds.

silverlake• 14 years ago

There's a huge world of $M businesses out there outside of the narrow Techcrunch-oriented ad-driven consumer internet biz. I did consulting for a while and met tons of small niche companies making millions for crappy software (and often crappy service). Long ago a guy at MSR told me they wrote up business ideas for Bill Gates' Think Weeks. He said it was easy to come up with lots of $100M ideas, but no one cared. MS needs $1-10B ideas to make it worth their while.

The reason I'm not rich is because these niches are hard to break into. It's all about enterprise sales to obscure niches. In fact, we need a dating event to pair enterprise sales people and tech founders. I tried enterprise sales, but within a month I wanted to kill myself. It takes a special breed of human to do that.

greendestiny• 14 years ago

"What this means is that YC is not looking for sustainable businesses, but homeruns. Which is entirely fair, that's the business they're in."

I think it means more than this - it means if you invest in companies the homeruns will dominate your returns no matter your preferences for it to be otherwise. So there might be no model of systematic investment that makes sense investing in companies with no homerun potential. At least at the risk levels of software startups.

aptwebapps5• 14 years ago

"What this means is that YC is not looking for sustainable businesses, but homeruns. Which is entirely fair, that's the business they're in."

Not really. He's saying that going by the numbers _should_ be only looking for homeruns but, for a number of different reasons, they don't do that.

Alex39173• 14 years ago

"A Demo Day where only 30% of the startups were fundable would be a shambles. Everyone would agree that YC had jumped the shark."

The reason that angels and VCs show up is because YC is providing a service for them, so from their perspective you would have jumped the shark. Each angel only has so much money to invest, and VCs feel it's necessary to provide value-add in other ways, so because their ends don't scale I'm having trouble seeing this purely mathematical strategy benefitting anyone besides YC. If there were a way for follow-on investors to benefit in a way that helps improve the overall startup ecosystem then it makes a lot of sense, but I think that's a case that needs to be made that this essay didn't touch on.

akkartik• 14 years ago

Does it matter?

I remember hearing PG comment that as a founder you need just a few million from a startup. That's as true today.

Perhaps the relationship between exit valuation and wealth created is elastic. If the goal is to make wealth, perhaps lots of 10-100M startups has a bigger impact on society than a couple of billion-dollar startups.

waterlesscloud2• 14 years ago

So is there value in increasing the class size every time around?

If there's only one winner in a class, at best, does it matter if the class is 10 or 50? 50 isn't going to give 5 winners, is it?

Is the idea that 50 gives a 5 times higher chance of finding the 1? Is that really true, though?

Would focusing on a smaller number of potentials actually be better for finding the 1? Thinking through the scenarios more thoroughly?

pg11• 14 years ago

There should be value in increasing the class size if (a) the number of applicants increases and (b) the average quality of the top applicants remains at least constant.

During YC's history so far, we know (a) is true and (b) seems anecdotally to be true.

martian2• 14 years ago

What strikes me about Dropbox and Airbnb more than anything is that they had incredibly strong growth strategies.

* Dropbox used rewards for more storage, as well as its fundamental file-sharing tools, to encourage users to sign up their friends and family.

* Airbnb gamed Craigslist [1] to encourage property owners to signup on Airbnb. With a strong supply of rental properties, Airbnb was able to build a true case for its value in the minds of travelers.

[1] http://venturebeat.com/2011/06/02/airbnb-admits-gaming-craig...

paul4• 14 years ago

By definition, every huge success has a strong growth strategy :)

That said, it often isn't obvious from the beginning. When I met Dropbox at YC, I don't recall them having any great plans for how to grow. I think that was discovered later on.

Also, that often-repeated Craigslist claim about AirBnB is actually false. They got very few listings from Craigslist.

martian2• 14 years ago

Thanks for the clarifications.

jasonshen• 14 years ago

Well, the way you should think about it is that in order to become big successful businesses, Airbnb and Dropbox needed to have incredibly strong growth strategies. Airbnb struggled for many years before hitting a solid growth strategy (which is far beyond CL) and Dropbox tried tons of other user acquisition strategies before realizing that the double-sided reward system was their way to go.

gabrielbutu• 14 years ago

Thiel had a nice way of approaching this question in his CS183 class. In assessing a venture's probability of success, think in terms of calculus -- and not statistically. Since many of these founders are charting new territory, the standard deviation in this sample size of 1 will be infinite. Statistical analysis can't happen.

So instead you treat it as a calculus problem. The metaphor Thiel used was that of space travel and the Apollo missions. You assume you know exactly what's going to happen and behave as such. In a nutshell, "no-one would want to ride in a statistically, probabilistically-informed spaceship."

It's a hard task spotting black swan founders (so instead you just leave yourself as open as possible to them). But the conviction of calculus (in them and in you) is almost certainly a necessary ingredient.

You could stretch a Wilde one-liner around this: "We are all in the gutter, but some of us are looking at the stars."

karpathy• 14 years ago

Great post. I hope that by "idea", what is really meant is a more general notion of "some kind of weighted average of the idea, the context, the team dynamics, and an estimate of how capable they could be in the execution".

fleaflicker• 14 years ago

This same idea was discussed in CS 183, the power law:

http://blakemasters.tumblr.com/post/21869934240/peter-thiels...

markerdmann2• 14 years ago

Did Dropbox appear to be a bad idea at the time? I seem to recall that the market was pretty crowded when Dropbox launched, and that everyone was expecting Google to announce a "GDrive".

Or does PG mean that the idea can seem bad because the market is already very crowded? I remember talking to William Morgan about the early days of GitHub. He knew the founders from Powerset, and he told me that at the time he thought to himself, "Really? Another hosted version control startup? That seems like a bad idea."

pg11• 14 years ago

Yes, Dropbox was in the Google category of bad ideas: there were already lots of similar things. Success turned out to depend on execution. Dropbox was the first application of its type that worked sufficiently well. But that sort of thing is hard to predict.

harryh3• 14 years ago

I asked a similar question of paul down below but it seems to me that big successes can come in 2 flavors:

1) Execution driven success in a winner take all market. The idea seems good, but there is lots of competition so it's hard to see how the startup will break through & win the market.

2) A genuinely "good idea that initially looks bad" like you describe in your essay.

It's hard to think back and decide which, now successful, companies are 1 vs 2 because of the memory distortion effect, but it really does seem to me like #1 is more common. What do you think?

nostrademons5• 14 years ago

My recollection of Drew's YC app was that it was posted on HN before he applied to YC and it received wide acclaim, so I went and Googled it:

http://news.ycombinator.com/item?id=8863

Turns out my memory was only half right. DropBox had many people that loved the idea and thought it would revolutionize filesharing. It also had a large number of people who pointed out all the reasons why it wouldn't work.

I wonder if there's a lesson here in that good ideas that seem bad tend to be highly polarizing. I've recalled Paul Buchheit say here that GMail met a lot of internal resistance, with many Googlers saying it was a distraction and would never work. I also recall Larry saying that there was significant support for GMail at all levels of the company, going up to the founders, and many Googlers loved it.

00000000swan2• 14 years ago

Can you afford to fund 100% bad ideas?

Assume you could separate the funding vehicle from the YC reputation, having it as a separate unassociated entity.

That is, assume the "reputational" cost could be managed. And no one would accuse you of being "insane".

I liked this essay. I think it's sufficiently honest.

jmtame• 14 years ago

I'm curious if this would affect how you give advice to founders. For example, let's say a team is working on an idea that isn't working out. If you had two ideas or recommendations in your head, one that seems intuitively good and one intuitively bad, would you ignore the intuitively good idea in favor of the intuitively bad idea because it seems that the best ideas start out as bad ones?

steve8918• 14 years ago

What is the value of all companies that weren't picked by YC? Are there any notable black swans that are known YC-rejects?

It would be interesting to do an analysis of those companies that were rejected by YC, and see how many "black swans" were present in those rejects, as well as maybe relative value of the rejected startups vs the chosen ones to see how effective the YC selection process is.

pg11• 14 years ago

There aren't any black swans yet that I know of, though there are at least two companies we rejected that must have valuations close to a hundred million, judging from the amounts they've raised. What worries me most is the possibility that we missed some we never heard about, because they either died or didn't happen.

SoftwareMaven• 14 years ago

The chance of that having happened or happening in the future is surely 100% at the stage you invest at. There are also undoubtedly many companies who could have been black swans that you did/will invest in who don't for execution's sake.

Take the swans you get an enjoy them. :)

jstreebin• 14 years ago

Is that really a black swan, tho? I used the term the other day wrt wearing eyeguards while playing squash (to avoid losing an eye) but think I misused it then, too.

abbasmehdi4• 14 years ago

Interesting to observe from that really big successes are better executed versions of ideas/products that exist on the market in a big way already (e.g. airbnb, facebook, dropbox, google) and the reason they seem like a bad idea (to investors) is not because they offer something nobody wants, but because they already exist in a too-big-to-challenge of a way? And that they might also seem bad because their starting point might seem like a niche (facebook).

pytrin• 14 years ago

I think the unproportional returns of the really big hits are blinding investors, and even pg a bit in this essay. Yes, it's easy to look at it from that viewpoint and say - 3/4 of our returns are from 2 companies and 1/4 from all the rest. But it misses a couple of important points - 1/4 of 10 billion is not small change, you would still like to have those companies in your portfolio, all things considered, and second, considering the (very) small sample size - it could've been just 1 company worth a 1/4 of the total or 0. That's how variable it is.

Another thing to consider is that the best teams often pivot into a big success rather than start with it. There are countless of such examples, and it just goes to show that even starting with what appears a relatively safe but limited idea can eventually grow into a huge success. Sometimes founders need to get their hands dirty in the market to realize what is the real opportunity. If you pass those teams up because you think their idea cap is too small, you'll be missing a lot of big hits.

What it all comes to for me is investing in people. People make big hits, not markets. Markets can grow and startups can span multiple markets, but it all starts with the people who direct it forwards.

ashrust• 14 years ago

I think the opportunity to reinvest in repeat founders is a large, if currently potential, factor. Stripe & Hipmunk being the likely big win examples, but in our batch there was shoptiques and exec.

I expect it will take a few more years but it will turn out to be financially rational to invest in teams with repeat YC founders.

markerdmann2• 14 years ago

From the essay: "And since risk is usually proportionate to reward, if you can afford to take more risk you should."

I think I understand the intent of what you're saying here, but it could also be read to mean that you can increase your reward simply by taking on more risk. It might help to clarify that whenever a market isn't perfectly efficient (which is apparently always, unless P=NP), there will be investments that carry more risk without offering a higher return (i.e. that have a negative alpha). Perhaps it's better to state that as the potential reward (or return) of an investment increases, you can tolerate more risk.

qeorge• 14 years ago

Do you think YC helped the Black Swans become Black Swans, or were the founders unstoppable?

hiddenstage3• 14 years ago

Dropbox and AirBnB may currently have the biggest valuations, but I imagine it would be difficult to say they are YC's biggest successes (both in financial and historical terms).

If YC had funded Paypal, they would have made a nice return with the $1.5B eBay acquisition. But their valuation would've ended there. In reality though, they currently make up 44.9% of eBay's revenue. eBay is a $63.45B company.

I don't know YC's policy on holding stock in the acquirers company after someone in their portfolio is bought out, but assuming they keep stock, a company acquired by Google a few years ago which allowed YC to accrue a few million dollars worth of Google stock could very well be their biggest financial gain in 50 years.

loumf• 14 years ago

eBay and Google stock is available for anyone with cash. You'd have to get acquired with pre-IPO stock for it to make a difference.

hiddenstage3• 14 years ago

A lot of acquisitions are funded via stock. I imagine YC owns a sizable amount of publically traded stock through acquisitions.

My point though is that in 50 years, their minute percent ownership in Google they received via an acquisition could be worth far more than their much larger percent ownership in Dropbox.

So which was the better investment?

sidman3• 14 years ago

So it seems for investors, the big winners are simply based on luck, there is no logical factor that you can easily pick out that will give you a better chance of winning accept for possibly experience over a number of years that allows you to pick the features of a successful startup that initially doesn't look like they are going to be successful (maybe a glimmer in the founders eyes, something that isn't completely obvious to the general investment population).

But whats the thought process and how does it change given this insight ? It should still be the case that as an investor you still should focus on the best opportunities and try to maximize a decent return from the majority of your investments then focus on picking that facebook, dropbox or AirBnB right, just as you would if you were a trader in the stock market ... otherwise your just gambling ?! Focus on the technicals and data that give you the best odds and just take those trades cause taking trades where you are waiting on information from the fed chairman or draghi without insider info for example (even though they have big pay offs if you swing the right way) will earn you pretty much the same amount of returns as losses in the long term.

If the potential to win big time is counter intuitive what do you trust from data in front of you to make the decision to invest other than the "gut feeling" ?

In any case, i would think with dropbox it never really sounded like a bad idea and the founder/founders (Drew and Arash) sounded very promising even from the start. If this is the case even good bets do pay of big time to :) maybe these are easier to pick then the facebooks where at the time it does look like a bad idea.

Basically, Im curious as how this insight in PG's essay would change how an investor should invest or is it just an FYI and something to keep in the back of your mind as an investor ?

pmarca7• 14 years ago

> So it seems for investors, the big winners are simply based on luck...

That's not quite right. It's more a question of taking enough of the right kind of chances in funding the companies that you do fund, as opposed to all the companies you don't fund.

I think of it as the concept of "search space" -- you need to define your search space properly, so that you have a good chance of having some big winners in the search space. You have to define your search space because you can't invest in everything. The investors that do the best job of defining their search space (having the most accurate criteria, best judgment, best mental models, etc.) have the best chance of funding some of the winners -- almost as a side effect.

When you talk to old successful VCs, what they tell you is that they had almost no ability to judge which of the companies they funded would go on to be the big winners in their portfolios at the point of funding them. They only learned that later. The challenge was to get enough of the right kinds of risk "above the line" and then give the portfolio time to develop.

rsheridan66• 14 years ago

I think there is a way to improve your chance of winning big - don't invest in startups that serve niche markets. Look at this list of YC companies from last summer: http://www.quora.com/Who-are-the-Summer-2011-Y-Combinator-co...

Don't you think you can you pick out some that had zero chance of becoming massive-scale homeruns, because they served sort of a niche market? There are none that were obviously (to me, or apparently to pg and co) going to be unprofitable, but if you want the next Facebook, you're not going to get it by investing in, say, Codecademy, which, as laudable as its goals are, only appeals to newbie coders, who are a tiny slice of the population.

sidman3• 14 years ago

> but if you want the next Facebook, you're not going to get it by investing in, say, Codecademy, which, as laudable as its goals are, only appeals to newbie coders, who are a tiny slice of the population

Well you would just never know. Computer science and software engineering could become part of the basic school curriculum in the next few years. In the news you see that "the 14 year old boy developed an X for the iPhone and is now a millionaire". Enough of these stories could prompt the education system to deem coding as a basic skill like math, english and science. Code academy could end up being the platform that schools use to teach it.

But i guess the chances are slim because as it stands now the population is small though the possibility is there.

batgaijin• 14 years ago

It's funny how this focused on "making it" and not disruption, which is what I assmed by the title and was wishing for.

I am still surprised how YC hasn't transitioned to that entirely. They already have the money; optimizing for that is tryin to play a financial game that others have already mastered.

ten_fingers16• 14 years ago

PG,

In part you are correct, but you are making some huge mistakes and, in a saying from my past, are "straining over gnats and forgetting elephants".

> That's made harder by the fact that the best startup ideas seem at first like bad ideas. I've written about this before: if a good idea were obviously good, someone else would already have done it.

That's likely true from what you and Silicon Valley see, but that's just a gnat.

Basically you are saying that success is a shot in the dark and it is impossible for an entrepreneur and their financiers to design success with good reliability. That is, from enormous data, obviously nonsense.

Paul, instead of shooting in the dark, you need to turn on a light!

I claim that we can design success, on just clean sheets of paper, with high reliability and that how to do so is well known with a fantastic track record with the long track record right in front of us.

Also, we need to address your:

> if a good idea were obviously good, someone else would already have done it.

Nonsense. Paul, where do you get such stuff? You have one of the best backgrounds of anyone in Silicon Valley entrepreneurship, and yet you still fall for that nonsense that fills the trash and the offices on Sand Hill Road.

What you mean by "a good idea" is just a good 'business idea', e.g., a very short, nearly superficial, description of the business to, say, an early customer. But, Paul, that's nearly irrelevant.

Want a good business idea? Make a billion dollars quickly? A sure fire winner? Okay, this is your lucky day. May I have the envelope, please (drum roll). Yes, here it is: One pill to take once that provides a safe and effective cure for any cancer. That's your guaranteed, 100% true, died in the wool, sure fire, billion dollar "good business idea". And it's obvious, and no one has done it. Done.

Since the 'idea' is obvious, why has no one done it? Sure: No one knows HOW to do it.

Are you beginning to understand?

So, for a hand up, in case you were up all night drinking beer with the boys, here is a 'generic method' (ALL TRUE hackers just LOVE such verbiage):

Step 1. Think of a big, unmet need, something a billion people will pay a little for or thousands of people will pay a lot for. E.g., the one pill cure for any cancer. That is, think of an important, unsolved problem.

Step 2. Find a way to meet this need. E.g., for the cancer pill, have to do some quite good biomedical research. Uh, did I say that it was all easy? I don't remember saying it was all easy. If Step 2 is too difficult, then return to Step 1 (we're writing this in the form of an 'algorithm' since ALL TRUE hackers just LOVE algorithms). Else proceed to Step 3.

Step 3. Sell the solution to the customers and take the money to the bank.

There it is, in just three steps. Of course, likely the bigger the unmet need from Step 1, the more difficult will be the research in Step 2. Whatever, the key to the 'algorithm' is the research in Step 2.

Did I mention 'research'? Gee, does anyone on Sand Hill Road consider research? Well, Paul, you and Y Combinator have high qualifications in evaluating research, but a cursory look at several of the best known venture capital firms in Silicon Valley, Boston, Winter Street, and NYC show little to no ability or willingness to evaluate research. Uh, to evaluate research, as usual, we want at least a relevant Ph.D., a tenure track faculty position in a research university, and some relevant peer-reviewed publications of original research.

So, research is being ignored! Opportunity knocks!

Now, should we have any faith in the promise of research to get solutions to practical problems, or is all of research just ivory tower intellectual self-abuse that has yet to be proven totally useless forever?

Let's see: It turns out that there is in all of the world in all of history exactly one, unchallenged, unique grand champion of doing research to get powerful solutions to important practical problems. And the track record is much better and much longer than that of Silicon Valley.

Without further ceremony, here's the envelope. Yes, the answer is, the US DoD. They got going about 70 years ago and did little projects like "the bomb, the hydrogen bomb", radar, synthetic aperture radar, spread spectrum radar, encoded with shift register sequences, adaptive beam forming passive sonar, inertial navigation, GPS, and on and on.

So, for the question, is it possible to do research that yields powerful solutions to important practical problems? Sure. Done.

So, should Silicon Valley fund research? Well, perhaps not. But, if an entrepreneur has selected a good "unmet need" in Step 1 and done some good research to get a powerful solution in Step 2, should Silicon Valley consider the research?

Hmm ...? But, such research is rare! Right! Did I notice that you have already noticed that big winners are rare, 'black swans', outliers, "few"? Yup.

How many $200 billion winners does a $100 million venture fund need to give good returns to its limited partners? Many? Several? A few? How about just one?

Silicon Valley is shooting in the dark into a pond with nearly only small fish. Silicon Valley needs to turn on some lights, look, pay attention to powerful research for big unmet needs, and then evaluate pulling the trigger.

My guess is that the real problem is the limited partners (LPs) who really prefer to look at reports from accountants. So, the LPs tell their venture funds to do all evaluations as close to accounting as possible. Since the usual accounting metrics are not yet available, the venture firms use surrogates, and their favorite is 'traction'. They want their coveted 'traction' to be high and growing rapidly. E.g., in the case of the bomb, they would have said "You build and test one and get one ready for delivery, and we will chip in for the gas for the Enola Gay.".

ten_fingers16• 14 years ago

Okay, you dirty, filthy, rotten chicken bastards, ANSWER with THOUGHTS or STOP the voting attacks, you dirt bags.

ten_fingers16• 14 years ago

More attacks. No thoughts. WHAT a flock of bird brains.

harryh3• 14 years ago

I'm sympathetic to what you are saying, but the DoD bit is the worst part of your argument. The DoD wasn't trying to profitably conduct (or fund) research.

ten_fingers16• 14 years ago

You deliberately misread or need a remedial reading course: I was clear, totally clear, crystal clear: My point was that the DoD research shows that research can be powerful for finding solutions to practical problems.

Your point does not contradict what I wrote and is hardly even relevant.

Also I was totally clear that venture capital might not want to fund research. Instead my point, my recommendation, was that venture capital should consider and evaluate research that has already been done. But in information technology, Sand Hill Road will NOT do that. A-H won't do it. Menlo won't do it. KP won't do it. Sequoia won't do it. Founders's Fund won't do it. Silicon Valley will NOT evaluate research. PERIOD. No wonder their returns suck.

For the DoD, actually, if do some arithmetic on something like ROI, their deployments and even their research look good, MUCH better than Silicon Valley.

Let's take a simple example: If read Richard Rhodes, the atomic bomb project, The Manhattan Project, cost about $3 billion. And there was a LOT of duplication and failed directions. But apparently the Bomb saved about 1 million US casualties by avoiding invading the islands of Japan. So, we're talking $3000 per casualty. We're talking a financial bargain.

Want to do some ROI calculation on, say, GPS? How about the ROI of GPS and laser guided bombs? So, roughly get one bomb to do the work of some power of 10 bombs without GPS and laser guidance.

Want to do some ROI on, say, packet communications networks, i.e., the Internet, and just for the DoD uses?

Again, yet again, my point was that DoD has shown in rock solid terms for over 70 years that research can provide astoundingly powerful solutions to important practical problems. So, in my 'algorithm', the key in Step 2 is just such research, and the DoD has shown that such research is possible.

Just what part of this simple argument is too difficult to understand?

Look, guys, I know that it's possible to dream of typing in some Java, Python, C++, etc. for a social, mobile, sharing, app and hope to get rich. But, PG's essay explained how tough it is to evaluate such work early on, and the averages along Sand Hill Road just SUCK.

But the DoD has done well in essentially my three steps for 70+ years.

Gotta tell you, in broad parts of our economy and technology, what YC and SV use as project evaluations won't pass either the giggle or sniff tests. Instead, projects in applied science and engineering receive careful, detailed evaluation early on and, when a passing grade is given, execute with high success. We're talking dams, bridges, tall buildings, airplanes, and much more. Net, the evaluation techniques of SV are back in the paper airplane days.

ucee0543• 14 years ago

You overestimate the value of academic research and of PhDs

ten_fingers16• 14 years ago

No, I never claimed that academic research and Ph.D.s have high average value.

The "value" of these two in nearly all cases is low. But, the value in particular cases is astoundingly high, totally blows away nearly everything else. What is crucial, then, as I explained very clearly, is EVALUATING the research. Then what the "value" is in most cases is irrelevant. Instead, what is relevant and crucial is the value after good results from a careful evaluation.

I didn't suggest investing in research and only suggested evaluating research that has already been done.

The US DoD has a fantastic track record both in evaluating projects to do research and in evaluating research already done.

The US research universities are also good at evaluating projects to do research and also research already done. Believe me, in technical fields, the US research community is quite good at evaluating both research proposals and completed research.

The information technology part of Silicon Valley won't even attempt to evaluate research even that is already done.

Does Silicon Valley get a lot of project proposals with such research? Likely not. But, as PG's essay explained, so far Silicon Valley nearly never gets project proposals for projects that are "big wins" and that SV can tell with good accuracy are "big wins" early on.

So, since, as in PG's essay, SV is struggling, especially in project evaluation and refuses to evaluate research, I mentioned, as in my Step 2, that research can yield powerful solutions to important problems from my Step 1 and that the US DoD does well in evaluating research. So do many other parts of our economy, e.g., essentially all of aerospace and huge fractions of all the parts of our economy involved with challenging engineering, and in these cases the evaluations are for high financial ROI.

In simplest terms, the ROI averaged across Sand Hill Road and Winter Street sucks; as PG's essay explained early project evaluations are shot in the dark; research can provide powerful solutions for important problems; research really can be evaluated with good accuracy; but SV refuses to evaluate research. As PG's essay explained, to get SV's returns up takes only a tiny number of "big wins"; well, the US DoD has done well evaluating "big wins" with high accuracy for over 70 years. So, I made a contribution, but I got attacked with heavy down voting. There are people on HN with a lot of power who don't want to hear about different ways to operate that promise to solve the problems they are struggling with. Piss poor.

sidcool2• 14 years ago

Why's your post blurred?

bryanallen22• 14 years ago

It's a downvoted post. (There are a few shades of gray.)

Note that you can't downvote until you have enough karma, which I believe is 500 right now. The threshold goes up as the site grows and karma becomes easier to acquire.

cdixon• 14 years ago

"You have to ignore the elephant in front of you, the likelihood they'll succeed, and focus instead on the separate and almost invisibly intangible question of whether they'll succeed really big."

This reminds me of Arthur Rock's heuristic: he said he invested in startups that were "open ended with no limits to their success" as opposed to ones that seemed likely to succeed.

neilk2• 14 years ago

What if you changed how YC operates so even more of the startups flamed out before Demo Day? An internal Demo Day, perhaps?

If the public Demo Day is now fraught with too much expectation perhaps it should be treated as a PR event rather than a goal for the startups to shoot for.

This doesn't solve the other problem you mention, which is that you'd be surrounded by people flaming out, which would be stressful in a lot of dimensions.

ten_fingers16• 14 years ago

Ah, how to use the law of large numbers and utility functions to make money!!!

YuriNiyazov3• 14 years ago

You seem to be new here. Let me give you a tip: you will be hellbanned very shortly if you continue commenting on the site the way that you have been doing so far. Please read the guidelines:

http://ycombinator.com/newsguidelines.html

ten_fingers16• 14 years ago

You responded to my post about the law of large numbers and utility functions?

That is actually a good and appropriate observation.

Of course, some mods came along and down voted it. I doubt that they understand either the law of large number or utility functions. Of course, the law of large numbers is a crown jewel of 20th century probability theory, and utility functions are one of the better contributions of von Neumann.

For being HELL BANNED, sure, that is the shame of HN. I no longer care about HN. I've had it.

I long ago read the 'guidelines', and I've done nothing wrong. But HN is run by some arrogant, nasty people. To HELL with HN.

JumpCrisscross2• 14 years ago

I remember drawing a similar diagramme - the x-axis was the "agreeability of the trade" and the y "realised yield". Bottom left quadrant (disagreeable and low yielding) is eccentric crap and top-left (agreeable and low-yielding) is bubble land. The bottom-right (disagreeable and high-yielding) is where that magical alpha lives while the top-right (agreeable and high-yielding) is not sustainable in an even remotely efficient market - it quickly devolves and when overcrowded becomes a bubble (many people thinking it's disagreeable makes it agreeably disagreeable).

That we can accept and reject trades (or ideas) based on their agreeability, or dispersion of opinions, is not often considered as a metric. So long as the difference between eccentric crap and alpha is difficult to discern and costly if one goes all in on the wrong bet the uncertainty should be dealt with by diversifying across only disagreeable trades.

As a former quant trader who left a large bank and found the centre of Silicon Valley uncannily similar to the heart of Wall Street, this essay is illuminating. Wall Street is being too conservative, consigning itself to blindly jumping between mediocrity (low expected return) or bubbles (strongly negative expected return) in the top two quadrants. Just like Silicon Valley, though, at its edges it allows itself to be different. It's interesting seeing how similar mantras, based in sound financial theory, change in their aesthetics as they cross domains.

It's telling, though, that the concept of a "black swan", implying a tail event generally unforeseen by the relevant population, is met with trepidation by much of Wall Street and corporate America yet seized with zeal by a select few.

neilk2• 14 years ago

Just curious, YC people - let's say that an eccentric billionaire asked you to "invest" in things that would have the greatest impact on the world, even if they weren't profit-generating enterprises.

Would you have invested in Wikipedia? Tim Berners-Lee's WorldWideWeb project? WikiLeaks? Linux?

I guess I'm interested because it's not clear to me that any of the founders of these things radiate "winner" in the same way that you seem to look for in your founders. Or maybe they do?

jnw2• 14 years ago

Improving medical technology with a goal of curing currently-uncurable diseases, making health care cheap enough to make Medicare sustainable (perhaps specifically by looking for ways to eliminate 90% of the costs associated with the half dozen or so families of diseases that Medicare finds most expensive), and improve quality of life with better treatments.

Better transportation infrastructure, especially high speed rail. (Notice how the French have better track than the Germans because the Germans put off investment while playing with maglev; Elon Musk might be at risk for repeating the same mistake in the US with Hyperloop.)

Fiber optic cable to just about every building in the world, owned by people who charge at a rate that isn't much higher than the construction cost and don't try to keep charging more and more for higher data rates.

Possibly some more good parks.

We need cheap solar and batteries too, but I think those things are likely inevitable given enough time at this point.

danenania2• 14 years ago

What we need to stop doing is strictly equating profit with money. A venture can be extremely profitable without making a dime if it improves people's lives in a significant way. Money is only a tool to accomplish this, and monetary profits are only loosely correlated to true profits, the kind that add value to the world by making a it a healthier, happier place.

buro9• 14 years ago

If I had money to invest, I would invest in the impact.

The biggest wins have been to invest in advertising and walled-gardens. I much prefer the thought of investing in people though, that which can make the greatest difference to individuals.

I don't have money, but I do have time and skill. And my money is where my mouth is, the idea I'm working on does need to be profitable to self-sustain, but the goal I have is to change lives of individuals.

To me it doesn't matter that others don't define this as winning. I think their definition is faulty.

EricDeb• 14 years ago

This article implies that many potentially successful start ups will not make the cut. Another reason not to get down if one's team doesn't make it in YC.

dbul2• 14 years ago

For that reason one of my most valuable memories is how lame Facebook sounded to me when I first heard about it.

This is partially why I think the YC application process is flawed. If you think about the idea for 20 seconds or so, what good is that? You may be wasting 20 seconds trying to rectify an idea you can't logically determine to be good.

A better process is a continuous one: you'll get an excellent stream of actual data and not just made up answers to "What is your best non-computer hack?" The YC partners could start out the morning looking at their Twitter-like feed of what have potential startup teams done today? At some point a partner would say, "We have to pull these guys into our next batch."

Incidentally, this would be better for startup teams looking to break the threshold of project to startup. By updating this proposed feed, the startup feels obligated to not only continue to put out data, but good data. Eventually the team would realize they can't cut it or they will keep mutating teams or changing ideas until one has great prospects.

EDIT: I'll buy someone a smile and a coke if the above hypothesis is implemented and tested. The following is exactly why: Instagram is the one we'd most likely have missed. It all depends when we'd talked to them. They were a kind of overnight success in traffic. If we'd talked to them even a day after they launched we would certainly have said yes. But before that it might have seemed too speculative.[1]

[1] http://news.ycombinator.com/item?id=4497561

waterlesscloud2• 14 years ago

Funny. I was just today thinking of something similar for finding unknown creative breakthrough talent.

trevor99• 14 years ago

"It means the probability of a startup making it really big is not merely not a constant fraction of the probability that it will succeed, but that the startups with a high probability of the former will seem to have a disproportionately low probability of the latter."

The "not merely not" phrase here is a little confusing. What PG is saying is that the probability of it succeeding is inversely related to the probability of it being a big success?

patio115• 14 years ago

This is a very interesting essay, if for no other reason that when smart people observe that other smart people have mental blocks against believing the truth of measurable features of material reality, that suggests a market inefficiency. Persistent market inefficiencies should always ping your radar a little bit, because exploiting them makes you rich.

onwardly• 14 years ago

One inefficiency could be related to this point Paul makes:

We can afford to take at least 10x as much risk as Demo Day investors. And since risk is usually proportionate to reward, if you can afford to take more risk you should. What would it mean to take 10x more risk than Demo Day investors? We'd have to be willing to fund 10x more startups than they would. Which means that even if we're generous to ourselves and assume that YC can on average triple a startup's expected value, we'd be taking the right amount of risk if only 30% of the startups were able to raise significant funding after Demo Day.

So- if a VC can triple a startups expected value that's great, but you'd need to do a bunch of them. I think this is essentially what Dave McClure is doing- making lots of smaller bets to "hit singles" as he says.

Reminds me of my college days playing online poker. The best players would have a 20% ROI at the $55 10 person tournament tables, and each game would take an hour. If you just play one at a time, you'd make about $10/hr. That's why everyone played 10 tables at a time- we made 10 times as much.

nostrademons5• 14 years ago

That quote was the sketchiest part of the article for me, because the same math was used to justify the subprime mortgage bubble.

The implicit assumption is that the population of startups is uniform across both the set that YC funds and the set that YC does not fund, such that startups in the latter group have the same chance of being a big hit (modulo YC's mentoring, which is accounted for with the "triple a startup's expected value" clause). But the implication of that assumption is that YC is picking startups at random, and that their filtering process is totally useless!

This sort of math comes up all the time whenever there's a screening process. Imagine that you're hiring for a large tech company, you currently hire 1% of applicants, and you find that among the employees hired, there is no correlation between your interview scores and the employee's eventual job performance. Can you conclude that your interviewing is useless? Should you ramp up hires so you get more workforce of equal quality?

Well, maybe. Because there are a bunch of possible hypotheses that could give this result. Perhaps your interview process is designed to weed out false positives more than false negatives, so it's accurate to the 99th percentile, but then gives no discriminatory power. (Many IQ tests are like this; they're highly correlated with life outcomes up until an IQ of about 140, but beyond that they break down entirely and there's often an inverse correlation with income, happiness, etc. past that). Or perhaps your applicant pool is bimodal: 1% come from other employers and are fully qualified, while 99% are the same jobseekers that every other company rejects. Or perhaps your interview process is broken, and you would do better to find a new one. Or perhaps your interview process is okay, but a number of well-qualified applicants are not even applying to your company.

Which of these is correct? You can't know without randomly sampling the population that was rejected and making an estimate of their quality. This is why all decent scientific experiments have a control, and why financial models get backtested on data that was not part of the training set. Even then, there're lots of things that can go wrong in experiment design, and lots of different ways to interpret data that don't necessarily mean "Fund 10x more startups."

Jun8• 14 years ago

"Persistent market inefficiencies should always ping your radar a little bit, because exploiting them makes you rich."

If I had to teach middle and high-school kids just one thing about entrepreneurship, this would be it!

ivankirigin• 14 years ago

It seems like there could be more than one way forward. The big successes dominating point to one path: finding those wild outliers.

But many startups exit without making it big and return 2-3X to their investors. If the median startup were doing 3X, you'd be making a great return. I don't hear much about this strategy. It would be interesting to look at the remainder of YC's portfolio with Dropbox and Airbnb removed to see what that distribution looks like.

dirtyaura4• 14 years ago

My guess is that it will still resemble a power law curve.

If we just examine YC exits to date, Heroku and OMGPOP are around $200M each, $400M in total, which is likely over 50% of the rest. If we remove those too, there are a few exits in $30-60M range (Loopt, CloudKick etc.) which are quite likely to be over 50% of the rest. At the lower end of exit price curve, the power law might not hold, as acqui-hires typically have a rather standard price ($1-2M per an engineer)

coolswan• 14 years ago

I would love to see a demo day of YC companies that are still around who either quietly launched / didn't have much on demo day or who pivoted to something entirely different. Sort of like a "where are they now" demo day.

lsc10• 14 years ago

The thing of it is that a bubble is not the right time to start a lifestyle/sustainable business. During a bubble there is all sorts of investor money floating around driving up prices on things you might want to buy as a sustainable company, and as a sustainable company, you can't compete with investor money for inputs.

So yeah; right now? PG is absolutely doing the right thing. But if I'm right, after the crash? assuming he comes through financially able (which I assume he will; he doesn't seem the type to bet the farm on facebook stock) and wanting to continue investing, at that point? he will look for sustainable companies. If you are trying to start a traditional sustainable company, in many ways, it's easier to do during a downturn. There is little competition for inputs, so you can get everything you need much more cheaply, and there is a lot less competition, so if you come up with something new, you won't have 5 other 'me too' companies copying you in the first year.

Really, there's less opportunity cost for the founder, too. I mean, right now, the temptation to get a job at facebook or google is really strong, even for me; I'd get to work with some really great people, and probably make about 3x more 'profit' than I do now.

During the downturn, getting those plum jobs that pay really well while letting you work with really great people is a whole lot more difficult, so taking the pay cut while you get your business off the ground is not as big of a deal.

Andrex2• 14 years ago

If you are trying to start a traditional sustainable company, in many ways, it's easier to do during a downturn.

This was basically the message of PG's recent leaked "bad times" email:

"The startups that really get hosed are going to be the ones that have easy money built into the structure of their company: the ones that raise a lot on easy terms, and are then led thereby to spend a lot, and to pay little attention to profitability. That kind of startup gets destroyed when markets tighten up. So don't be that startup." [1]

What I take away from all this is: have a revenue model built into your startup from the start. Use it. Generate profits of some kind. Not only will this help when you need investors (since they like businesses that can stand alone), but it will help you even more if they don't come.

[1] http://www.businessinsider.com/facebook-fallout-y-combinator...

lsc10• 14 years ago

Interesting. That's completely the opposite of what I was taking away from PG's essay; My takeaway from the essay was that investors want you to swing for the fences; in my mind, that means not worrying about profitability early on.

I mean, twitter didn't introduce advertising at all until they were absolutely huge. I had the impression that facebook was similar (though I could be off; I'm not a regular user of facebook) - I mean, in a very real sense, it's easier to grow if you don't monetize (assuming you can still keep the lights on.)

caf• 14 years ago

You not only have to solve this hard problem, but you have to do it with no indication of whether you're succeeding. When you pick a big winner, you won't know it for two years.

That's a lot like distilling whisky - you have to wait at least a decade to find out how good a batch was.

fleitz2• 14 years ago

Given the small number of companies that 'return the fund' is the YC dataset even statistically meaningful for 2 events out of all the companies accepted?

Would the outcome possibly be better by using an approach similar to index funds. By focusing on repeatability would it be possible that one might be able to put together a fund where 30 to 40% of the return is made up by 'average' companies and then take the outliers as bonuses rather than focusing on an event that's unpredictable given the amount of statistical data available?

Or is YC as close to an index fund as it gets?

kristopher• 14 years ago

Japanese Investors need to adapt to this way of thinking -- you'll get some duds, but certainly having flow is what is important.

marcamillion2• 14 years ago

This paragraph read a bit confusing to me:

The fact that the best ideas seem like bad ideas makes it even harder to recognize the big winners. It means the probability of a startup making it really big is not merely not a constant fraction of the probability that it will succeed, but that the startups with a high probability of the former will seem to have a disproportionately low probability of the latter.

It could be that it's a bit late, and I am tired. But it sounds a bit awkward.

Anyone care to clear that up for me?

Thanks!

JumpCrisscross2• 14 years ago

There is a tradeodd between are startups that will succeed, i.e. return their risk-adjusted capital, and those that will make it big - the subset of the prior that are able to scale. One can get return-of-capital startups in niches that cannot scale or attempt to take on Google or Fb with a very low probability of success.

marcamillion2• 14 years ago

Ahh....ok....I get you.

lionhearted• 14 years ago

> It would hurt YC's brand (at least among the innumerate)

Worse, even -- innumerate and/or people who don't have domain knowledge. Probably considerably over 99% of all people.

hasenj3• 14 years ago

Am I the only one to notice that both AirBnB and DropBox actually have a viable business model and a real way to make money?

I think this would be a good metric. I mean think about it, if you're a startup and your only strategy is to burn money making an awesome product that's free, how on earth are you going to return 1000x on investment?

rsheridan66• 14 years ago

I have no idea, but isn't that exactly what Facebook and Google did?

hasenj3• 14 years ago

Facebook (AFAIK) is not quite profitable yet, but it does have a business model: selling ads. The same business model that Google used, and the same business model that the TV industry has been using (very successfully) for decades.

If you build a company with no business model other than hoping for a nice exit (usually as a talent acquisition) there's no chance that you can give your investors 1000x returns. This should be obvious.

debacle2• 14 years ago

When Google launched, being ad supported was still highly lucrative. It was a different time.

lifeisstillgood• 14 years ago

Is this 10000x return that makes everything else counter intuitive a function of startups or of startups in a bubble?

Are the returns going to remain of this order over the next 20 years ? I understood that VCs rule of thumb was 10x return paid for the other 9. is this difference earlier stage, bubble or other?

nsns• 14 years ago

Startup investing seems counter-intuitive only from a traditional business point of view, it makes a lot more sense if you perceive it as the business firm equivalent of the mass-media model: a few 'hits' that make up for all the rest, rising exponentially then falling precipitously, producing a (very) few classics on the way, just like the pop charts gambles taken by record companies (where sometimes the seemingly silliest song lyrics might unexpectedly draw millions of listeners).

hansc• 14 years ago

What about analysing the other way around: Objectively look at the companies that made it (not just YC companies) and the ones that didn't make it and try to see if there are clues that distinguish them. Were the founders really big dreamers for instance, or was the traction immediatelly high from the start, or was tracction high + no interest from investors?

samikc• 14 years ago

A part of any investing activity requires risk taking (truer now than ever as sovereign debts are defaulting or on verge of that), the other part is making profit based on risk. In case of startup seed funding the risk are much higher but profits are high too (like 1000x). Now an investor can make profit by selling their share to other (future) investors. The point to note here is: the first investor sells thinking that the venture’s value has reached a reasonable price which was expected or it’s now overpriced.

The point is, profit has to be booked to be realized.My question to PG is how does YC decide when to sell?

dschiptsov• 14 years ago

It is almost the same idea as of scientific revolution - to make a paradigm shift one must discover something which is orthogonal, incompatible with a main-stream view, with current scientific consensus. There are lots of readings for students about how to become a new Darwin or Einstein.

To make a paradigm shift one should pick up a special kind of person (let's call him focused, disciplined introvert) place this person in a good environment (or just help the person to make one for himself) and it must be done in a right moment - create a wave others will try to catch and ride. Luck could be summoned by avoiding being too narrow focused and self-centered, by being awake.

There is a small essay which, I think, is related to the subject - http://karma-engineering.com/lab/wiki/Hiring

gregcohn• 14 years ago

...in purely financial terms, there is probably at most one company in each YC batch that will have a significant effect on our returns, and the rest are just a cost of doing business.

Clearly you don't look at YC in purely financial terms, but it would be an interesting thought experiment to consider whether there would be more efficient ways to generate returns if you did.

Among other things, there may be more efficient ways of testing variations of ideas around a theme, or testing/ranking skills, or assessing likelihood of success for various experimental team combinations.

To use a casino metaphor, it seems like you're taking a 50-100 completely binary and largely independent bets per class and hoping to beat the house on average. As opposed to, say, trying to create the MIT blackjack team to beat the house systemically.

6ren• 14 years ago

  > the one thing you can measure is dangerously misleading [Demo Day fundraising]

That this is misleading follows from the thesis that the best ideas look like bad ideas. But - historically - didn't the best ideas (dropbox and airbnb) raise funds after Demo Day?

Footnote [4] http://paulgraham.com/swan.html#f4n says airbnb did get funded; and dropbox was unanimously voted the best in their class (according to one of them http://www.quora.com/Y-Combinator/When-Dropbox-first-present...)

So this is an intriguing thesis, but not supported by the (admittedly scanty) evidence of the two biggest outsize hits. Do the other outsize hits support it (i.e. by not raising funds after Demo Day)?

pitchups• 14 years ago

Great insights and lots of lessons for both investors and entrepreneurs. Especially the one about the best ideas looking like bad ideas initially. This should give pause to all aspiring entrepreneurs, and keep them moving towards their vision if they are convinced, even if everyone else thinks their idea will never work. In fact one could almost say that it is a necessary but not a sufficient condition for an idea to be the next big thing is for it to be considered bad or crazy initially by most people. Reminds me of Neils Bohr famous quote (paraprhasing) : "Yes your theory is crazy, but is it crazy enough to be correct!" It also reminds one of how some of our most successful books in publishing history have been rejected dozens of times by publishers - Harry Potter by JK Rowling, Carrie by Stephen King, Dr. Seuss' books, plus many others.

stchangg• 14 years ago

Is it really so counterintuitive? I think PG is making it out to be more complicated than it really is.

Solve a big, annoying problem for lots of people. Dropbox was obviously a great idea; look at how much trouble people went through to share files (using flashdrives, CDs, email, spammy uploading sites or ones that enforced a delay) before it got big. Just because there are existing players in the space doesn't mean the problem is solved. There are so many other major inconveniences that people have to put up with that are incredibly ripe for disruption. Healthcare - why is it so damn hard to get an instant, cheap medical opinion on a non-urgent but still worrying issue if you don't have a doctor in the family? Apartment rental (for both owners and tenants).

The hard part is not telling whether or not something is a good idea. It's evaluating whether or not the team can pull it off.

rsheridan66• 14 years ago

I'm not a VC, but I don't see how most successful startups seemed like bad ideas. Google was entering a crowded field, but the field sucked (still does, actually) and Google was obviously superior early on. As for Paypal, do you remember mailing checks after winning Ebay auctions back in the 90s? As for Youtube, do you remember what it was like to share videos in 2004? Enough said. Dropbox was about unbreaking broken informal filesharing via email that everybody did at the time, an obvious improvement. Evernote was to Dropbox what notes were to files (I still have an ancient set of emails with every address, employers address, etc I've ever had, and it's extremely awkward). And did anyone else think it was odd to pay outrageous sums of money to make international phone calls when you could IM anywhere for the cost of an internet connection before Skype existed? Or that it was odd to have to buy a bundle of cable channels to watch shows at times chosen by someone other than yourself over the same internet connection your cable modem used (before Hulu and Netflix, that is)?

I wanted all of those services before they existed, which to me says that they never seemed to be bad ideas, unless you were unduly afraid of implementation/regulatory difficulties. It may not have been obvious which competitor was going to win, but it seemed likely without the benefit of hindsight that somebody would.

Facebook and Twitter seemed like fundamentally bad ideas to me at the time (in fact, they still do, but the world appears to disagree), and I just don't get instagram, but those are the exceptions that prove the rule.

lmm2• 14 years ago

It wasn't at all obvious that Google could do better than the big four of the day. There were at least thirty upstarts that had good results in some way or other. My money wouldn't have been on google.

With paypal it seemed crazy that sellers would hand over control of their bank accounts to this unqualified, unregulated company. Given paypal's history of account freezes, it still does.

Video sharing sucked in 2004, damn right. Microsoft and Real and Aol and Apple were pouring big money into making it work. Could we've guessed that someone was going to make a lot of money in internet video? Sure. Could we have predicted that it would be youtube? Much tougher. Dropbox was the same; there were hundreds of other products making much the same claims about how they could synchronize your files easily. Likewise skype; we'd had netmeeting for years (even today, polycom are still in business selling software that works less well than skype for hundreds of thousands).

Can you predict that a given service could be done much better? Maybe. But picking which startup is going to win based on that is a whole lot harder.

rsheridan66• 14 years ago

I agree with almost everything you said, but being leery of a startup because it has stiff competition or regulatory hurdles is not the same as reacting with a "WTF?" to the basic idea like PG did when Facebook was new. It was an odd example for him to use.

sytelus• 14 years ago

The important question is, can this be changed? Several processes involving randomness generates power law but with appropriate understanding and interference, these processes can yield either less drastic function or a bigger constant. The challenge is to understand exactly where, how and why our intuition fails and correct for that.

Tichy• 14 years ago

My takeaway seems to be don't apply to YC unless my startup has the potential to become a billion dollar company.

barking• 14 years ago

I can't think of any reasons why Dropbox would have 'seemed like a bad idea'. OTOH I can't understand why it's so valuable either because 1)it seems pretty vulnerable to being replaced by something smarter. 2)I think there must be a lot of people like me who keep their storage below the free 2GB limit.

JoelMarsh• 14 years ago

Great essay. Enlightening, actually. A few somewhat provocative questions:

If you could theoretically "randomize" start up ideas, founders, business models, and every other primary ingredient in current "start-up theory", like a giant multivariate test... would we not see similar results to now?

Or similarly, if you closed your eyes and invested "blindly" how would you expect your results to differ (ROI-wise)?

It seems like investing results more closely resemble a lottery than a predictive model, based on your description.

Sort of a scary thought: what if current investment criteria (and therefore start-up goals) are largely irrelevant?

For example, IQ is distributed in the same way as winners and losers in start-ups. What if that is a key factor,(purely hypothetically, of course)?

In theory, shouldn't "good criteria" for investing generate progressively better results within smaller and smaller samples?

noiv• 14 years ago

Paul has described the problem very well and he also made a habit of insisting a startup needs to solve a real problem.

Now, I wonder whether the understanding of both aspects is enough to put him in a position to recognize founders on the other side of the table capable to provide a solution to random black swan farming?

Eventually more interesting is the question what would be his best guess from which field of science he expects useful outcome enhancing the criteria to make more educated decisions on founders?

Am I alone with the impression the essay sounds stucked?

its_so_on2• 14 years ago

I wrote the following email to PG some time ago, which I hope have helped inform the present essay.

----------------------------------------------------

You know, I came across:

" I think they're not so much dense as bitter. There's a subset of HN readers who regard startups as a whole as a sort of con game, and are angry that the participants get so much attention. There may not be that many of them, but their anger makes them disproportionately active as commenters and voters. "

I want to tell you that I don't like the fact that you and ycombinator only look at immediate sales vehicles and hardly any big ideas, like Google or Skype. Mine is a Big Idea - it's not a sales vehicle. You almost have negative things to say about $100B market aspirations. And your results speak for themselves - smaller companies with no big vision.

That's what I don't like.

----------------------------------------------------

2. this was after leaving him this comment which I hope he also saw

(PG here on HN): Financially, as if you were an investor. They're the people whose job it is to evaluate startups' prospects, and they care above all about two things: the founders and the market. The founders should be relentlessly effective, and the market should ideally be of a size that can only be obtained by riding on trends beyond the startup's control (but visible to few besides the founders, or the market would already be full). Joining the young Microsoft, for example was a bet on Bill Gates and microcomputers, both of which turned out to be very good bets.

As a hacker you may be able to judge market bets as well as or better than many investors. E.g. I think HN readers knew Dropbox was onto something before most investors did. So if you go wrong it will be in judging founders. For many hackers, especially the unwordly sort, it's hard to distinguish true Bill Gateses from mere good talkers.

I wish I could offer some advice about distinguishing, but that would take a whole essay. The best simple hack I can think of is completely self-serving, but I'll offer it anyway: piggback on our filter. YC specializes in distinguishing between genuine Gateses and good talkers. We're occasionally fooled, but far less often than a typical hacker looking for a job would be.

1 point by its_so_on 0 minutes ago | link | edit | delete

where's your Microsoft?

My only problem with your filter is that it filters out companies that genuinely have a plan to grow to revenues in the billions or tens of billions annually. This doesn't happen by chance alone, but through planning and commitment. That very commitment is a red flag for you and reason enough for you to say "no".

----------------------------------------------------

To drive the point home: it's almost impossible to adjust to investors like YC with a big idea. You can't sell what you have, however cheaply - which I think is ridiculous.

If you are holding a winning lottery ticket that is worth $20 billion and you need $500,000 to go and cash it, you would think that selling 7% of your company for the 500k amount is a no-brainer. Yeah, it's expensive, but so is taxes. You can live with 93% of the $20Billion. Expensive for you, not for the investor.

The ticket in this example is worth $1,400,000,000 (7% of the $20b) minus a bit of net-present-value calculation, and you are selling it for $500,000. This means the built-in return is 2800x or 280000%. Selling this share is very expensive for you, the owner of the company/holder of the winning ticket.

But would an investor like YC jump on this? No. An investor like YC will go ahead and take the step of applying a "0.000..% chance of successfully cashing" to the winning lottery ticket you hold. (If you are honest with them about what you will do and what you need to do it.)

NOT 1%, leaving an expected 28x or 2800% return (2800x built-in * 1%) from the 2800x or even 0.1% which would leave a 2.8x or 280% expected return (2800x * 0.1%) out of the built-in 2800x. But, exactly 0.000..% with unlimited precision. And then, obviously, in their estimation "it doesn't make sense to invest." (Even though in reality they have a built in 2800x return from the terms you are offering them. A cool 1.4 billion dollars basically for free.)

Then they will go ahead and say "no".

What is interesting is that you can show that the "0.00..%" they go ahead and apply to you really does have unlimited significant figures. If you were to hypotehtically need only $50,000 instead of $500,000 in this round you have to lie if you want their money.* The above calculation still produces a "no".

Yet another way to show significant figures in the 0.000%: if your winning ticket has 200b written on it (mine doesn't, mine has 20b written on it) it does not increase your chances of funding or interest in it. The 0.0000 that YC and several other "investors" apply really has that many sig figs.

So now you understand why I would never like to be associated with an outfit like YC. If I need money to cash my check, why would I ever want to associate with someone whose only M.O. implies they will go and apply a 0.000000000000% (infinite zeros) factor to it? I don't need that kind of tarnish. Where is YC's "Google"? Nowhere. They wouldn't touch a $200B or even $20B seed-stage company with a 200-foot pole.

* how can you build a $50b company from $50,000? Maybe you're an Indian-American entrepreneur and an able CTO and single founder, and you can get nearly unlimited high-quality output for peanuts, while personally overseeing it, from your Indian network. Then $50,000 is easily as much as $800,000 in the hands of a non-tech MBA who must first of all find a CTO and then insists on expensive labor.

yen223• 14 years ago

Wait I don't understand, are we assuming that the lottery ticket has a 100% chance of being worth $20 billion? Are we ignoring the fact that there's a sizeable chance that it is worth $0?

its_so_on2• 14 years ago

The lottery ticket has $20 billion winner written on it. I gave you a range of probabilities that the ticket can actually be cashed. The point is that this probability is clearly not exactly 0.00000... given others have cashed theirs.

But YC assigns it a probability of exactly 0.00000... that you can cash it, given any amount of "seed" money.

However, if you lie and claim the ticket has "$20million winner" written on it (you are misrepresenting the business plan by a factor of 1000 in this case) their ears will perk up and they will assign a non-zero probability (actually an extremely high one), and give you a seed to go ahead and cash it, in exchange for owing them 7% of the winnings.

Given the size of these seeds this behavior doesn't make any sense at all. It is like refusing to take 7% of big winners, only small winners, when most of the lottery payoff is in big winners.

theorique• 14 years ago

Excellent article, but this little section misses the mark slightly.

YC would be a pretty lonely place if we only had one company per batch. And yet it's true.

The point is that not only would it be lonely, it would also be impossible to pick that one perfect company per batch. (Well, not impossible, but vanishingly unlikely.)

And I think pg understands this well, as shown by the rest of the article - a person or investment team can't possibly pick that 1000-bagger without it being a complete lottery. So you invest in a large number, knowing that most of them won't do too much, a few will tank, and one in a hundred will be a grand slam that pays for all the others.

david927• 14 years ago

Now the question seems to be, based on this, will you alter the application process for YC? It currently seems to me to be more reliant on "have you often have you got on base," than, "are you swinging for the bleachers?" criteria. I hope you experiment a bit and share the results!

mwww• 14 years ago

The secret of creating wealth is identifying a solution that will improve the world and is not evident before it does.

(http://on.fb.me/Pb3DeP)

mp99e99• 14 years ago

Hi, I'm with Atlantic.Net cloud so I speak with startups quite frequently.

In terms of dialing up risk, I think you're looking @ it backwards. You have a finite life, which means you are slowly eroding to zero. You have nothing to lose by taking risk because you are already eroding towards zero.

Even worse, the remaining days you have left are a greater percentage of the remaining days in totality of your existence, so therefore each day is eroding FASTER than the previous one.

So, relatively speaking, you should be increasing risk over time in any case because the rate at which you are eroding is accelerating.

Basically, rather than looking @ risk as what you have to lose, really its about what you have to gain. There isn't any true risk because the end game is the same.

Kilimanjaro• 14 years ago

Investing in startups has become a giant ponzy scheme where the idea that can be transformed in a giant hype machine can bring more results as more people invest in the hype before the bubble bursts.

Facebook is useless, Airbnb will be gone in five years when more horror stories surface, as well as dropbox, today storage is so cheap anybody can have 20GB for free when buying a cheapo hosting plan. Even GAE gives you 10GB free, all you need is a piece of software.

So, etsy will last forever, facebook won't, amazon will, dropbox won't, godaddy will, airbnb won't.

Sometimes I think, investing a billion dollars in instagram is running a freight train loaded with money over a cliff.

That money would have been better invested in a new eBay (without auctions) that would last forever, empowering small merchants and providing a complete experience for ecommerce, from payment to delivery.

We already had enough with social, but the hype machine won't die just yet, so fuck investors, I hope they lose all their money and then blame the economy.

fredBuddemeyer• 14 years ago

perhaps paul's intuition is right - there is something wrong here. certainly real world business success is not so binary as this.

if there is a 500 pound supposition in the room it's liquidity. if the only way an investor can achieve it is through a massive "event" such as an ipo or sell out then any otherwise successful company is a non-entity for investors.

if y combinator were holding securities with some liquidity it needn't devolve into a 20th century vc. there are many ways to achieve this, all disruptive yet also quite well suited for this institution and its community.

committed_lp• 14 years ago

Reading this, I wonder if pg & co. have done an experiment where they do two sets of interviews for applicants: One to assess anything at all about their business, and another which is more or less a normal technical (or marketing) interview _without informing the interviewer about the applicant's potential business idea_.

This would basically be a test of the notion that "ideas don't matter", and it would allow you to correlate how even knowing a founder's idea might bias you towards believing they might succeed.

Tycho• 14 years ago

I heard Taleb actually run a portfolio called 'the Black Swan fund.' I didn't really think of it before but that pretty much what YC is.

alliemobley• 14 years ago

We think we have a good idea that seems like a bad idea: http://hometract.blogspot.com/2012/09/connectwithcontractors...

Black Swan Farming

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