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Black Swan Farming

• grueful 14y 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.
  • paul 14y 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)".
    • mikeleeorg 14y 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.
      • paul 14y ago
        As best I can tell, success = luck * skill. The big successes that I've seen all have exceptional founders, but that's clearly not enough. Timing is a huge component as well. Often a good idea will fail simply because the market or technology isn't ready. My own experience with Gmail reflects some of that. When we decided to write the whole frontend in JS, everyone said that it was a bad idea doomed to failure. It had been tried before (e.g. desktop.com) and had always been a disaster. They were right about the past, but wrong about the future. We released Gmail right around the time that browsers were finally getting good enough, and were were very careful to keep our code as fast and slim as possible.
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        • Alex3917 14y ago
          "As best I can tell, success = luck * skill." The actual formula that academics use is Performance = AMO, ability * motivation * opportunity. I think there are a couple of modified versions but I can't remember what they are off the top of my head.
          • drblast 14y ago
            I've found that in instances where my ability is 7 and motivation is 34 but opportunity is something like, say, 23, I've had better performance than when my ability is 22 and my motivation is 12 compared with a 13 opportunity. This is to say that my experience confirms that there probably is some completely subjective formula that will fool people into thinking there is some reason behind my good luck. :-)
        • felixmar 14y ago
          I am sure that you knew that browsers were finally getting good enough. Getting the timing right is still difficult but it is not pure luck. I suppose you also need some luck (and skill) to convince others that something is now becoming possible. Finding an investor that also sees the opportunity can be hard.
    • harryh 14y 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.
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• mikeleeorg 14y 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.
  • pg 14y 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.
    • dschobel 14y ago
      a guy 'radiates "winner"'? Really? I sincerely hope you're being flippant and don't mean that as a serious answer.
      • pg 14y ago
        I mean it. Have you met either of them? They both seem unstoppable.
• sidcool 14y ago
  There will be several self professed disagreements posted here citing very specific situations.
• autophil 14y 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.
  • seiji 14y 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.
    • autophil 14y 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 14y ago
  Is it possible that this is simply just the effect of a Bell Curve (i.e, the normal (Gaussian) distribution of a field)?
  • maxdemarzi 14y ago
    Read the book. http://www.amazon.com/The-Black-Swan-Improbable-Robustness/dp/081297381X http://www.amazon.com/The-Black-Swan-Improbable-Robustness/d...
  • seiji 14y ago
    I think that's the exact opposite of what pg means. pg is basically writing http://blakemasters.tumblr.com/post/21869934240/peter-thiels-cs183-startup-class-7-notes-essay http://blakemasters.tumblr.com/post/21869934240/peter-thiels...
    • gojomo 14y 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.
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• maxdemarzi 14y 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.
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  • icandoitbetter 14y ago
    Best strategy is to "win" in other ways, and let the cards fall where they may. So you're saying that the probability of picking up the big winners would be the same if YC accepted applicants at random? Edit: I have sympathy for the Black Swan theory, but I also believe that the startup market is way more tractable than, say, the CDO market – that there do actually exist investment strategies that will increase your chances of hitting the billion dollar jackpot.
  • pmarca 14y 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.
• paul 14y 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 14y 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-cs183-startup-class-7-notes-essay http://blakemasters.tumblr.com/post/21869934240/peter-thiels... [2] http://blakemasters.tumblr.com/post/22866240816/peter-thiels-cs183-startup-class-11-notes-essay http://blakemasters.tumblr.com/post/22866240816/peter-thiels...
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• cperciva 14y 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.
  • pg 14y 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 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.
    • thaumaturgy 14y 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?
      • pg 14y ago
        It's pretty grim. I think that's one of the reasons I write fewer essays now. After I wrote this one, I had to go back and armor it by pre-empting anything I could imagine anyone willfully misunderstanding to use as a weapon in comment threads. The whole of footnote 1 is such armor for example. I essentially anticipated all the "No, what I said was" type comments I'd have had to make on HN and just included them in the essay. It's a uniquely bad combination to both write essays and run a forum. It's like having comments enabled on your blog whether you want them or not.
• mixmax 14y 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.
  • robryan 14y 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.
  • thaumaturgy 14y 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.
• Alex3917 14y 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 14y 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.
• waterlesscloud 14y 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?
  • pg 14y 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.
• martian 14y 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-craigslist/ http://venturebeat.com/2011/06/02/airbnb-admits-gaming-craig...
  • paul 14y 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.
    • martian 14y ago
      Thanks for the clarifications.
  • jasonshen 14y 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 14y 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 14y 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 14y ago
  This same idea was discussed in CS 183, the power law: http://blakemasters.tumblr.com/post/21869934240/peter-thiels-cs183-startup-class-7-notes-essay http://blakemasters.tumblr.com/post/21869934240/peter-thiels...
• markerdmann 14y 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."
  • pg 14y 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.
    • harryh 14y 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?
      • femto 14y ago
        I'd give bonus points to #2 if the idea seems so bad that you go though periods of doubt yourself, but keep on returning to the view that "it's great". If you're absolutely certain of yourself, chances are that there are others out there who are just as certain, so you will have competition. If you're uncertain, and feeling lonely, there's a better chance that you have the field to yourself. My experience of this is being involved in the development of the first WiFi (802.11a) system. It was only with hindsight that the significance was clear. The reality at the time was an isolated toil in the dark, not a high flying roller coaster ride.
• 00000000swan 14y 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 14y 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 14y 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.
  • pg 14y 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 14y 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 14y 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.
• abbasmehdi 14y 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 14y 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 14y 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.
• markerdmann 14y 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 14y ago
  Do you think YC helped the Black Swans become Black Swans, or were the founders unstoppable?
• hiddenstage 14y 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 14y 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.
    • hiddenstage 14y 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?
• sidman 14y 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 ?
  • pmarca 14y 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.
• batgaijin 14y 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_fingers 14y 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.".
• cdixon 14y 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.
• neilk 14y 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_fingers 14y ago
  Ah, how to use the law of large numbers and utility functions to make money!!!
  • YuriNiyazov 14y 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 http://ycombinator.com/newsguidelines.html
    • ten_fingers 14y 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.
      • YuriNiyazov 14y ago
        I responded to your post about large numbers and utility functions only because it was your most recent one. I would've sent you a private message had the site supported PM functionality or if you had some e-mail address in your profile. The point that I am making is about your general behavior in this thread. You have broken multiple guidelines: 'Be civil. Don't say things you wouldn't say in a face to face conversation.' 'When disagreeing, please reply to the argument instead of calling names. E.g. "That is an idiotic thing to say; 1 + 1 is 2, not 3" can be shortened to "1 + 1 is 2, not 3."' 'Please don't use uppercase for emphasis. If you want to emphasize a word or phrase, put asterisks around it and it will get italicized.' 'Please don't bait other users by inviting them to downmod you.'
• JumpCrisscross 14y 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.
• neilk 14y 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 14y 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.
    • danenania 14y 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 14y 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 14y 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.
• dbul 14y 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 http://news.ycombinator.com/item?id=4497561
  • waterlesscloud 14y ago
    Funny. I was just today thinking of something similar for finding unknown creative breakthrough talent.
• trevor99 14y 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?
• patio11 14y 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 14y 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.
    • nostrademons 14y 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."
• ivankirigin 14y 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.
  • dirtyaura 14y 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 14y 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.
• lsc 14y 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.
  • Andrex 14y 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-combinators-paul-graham-just-emailed-portfolio-companies-warning-of-bad-times-in-silicon-valley-2012-6#ixzz263AllOkW http://www.businessinsider.com/facebook-fallout-y-combinator...
• caf 14y 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.
• fleitz 14y 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 14y ago
  Japanese Investors need to adapt to this way of thinking -- you'll get some duds, but certainly having flow is what is important.
• marcamillion 14y 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!
  • JumpCrisscross 14y 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.
    • marcamillion 14y ago
      Ahh....ok....I get you.
• lionhearted 14y 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.
• hasenj 14y 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?
  • rsheridan6 14y ago
    I have no idea, but isn't that exactly what Facebook and Google did?
    • hasenj 14y 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.
      • rsheridan6 14y ago
        I assume that any awesome product that's free can sell ads, since people will be looking at it.
    • debacle 14y ago
      When Google launched, being ad supported was still highly lucrative. It was a different time.
      • hasenj 14y ago
        It still is highly lucrative ...
        • debacle 14y ago
• lifeisstillgood 14y 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 14y 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 14y 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 14y 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 14y 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 http://karma-engineering.com/lab/wiki/Hiring
• gregcohn 14y 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 14y 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 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-presented-at-Y-Combinator-Demo-Day-was-it-swarmed-by-investors-or-misunderstood 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 14y 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 14y 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.
• rsheridan6 14y 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.
  • lmm 14y 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.
• sytelus 14y 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 14y ago
  My takeaway seems to be don't apply to YC unless my startup has the potential to become a billion dollar company.
• barking 14y 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 14y 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 14y 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?
• marcofloriano 14y ago
  Investors like to think they can predict the Market. It happens in Forex, Stock Market, Business ... and Startups. Nobody can predict the human nature. If i was the guys behind YC, trying to figure out new investments, i would try to measure precisely one thing: the passion of the founders for their startups. Because everything else is just luck.
• its_so_on 14y ago
  I wrote the following email to PG some time ago, which I hope have helped inform the present essay. ---------------------------------------------------- 1. 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. reply * 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". reply ---------------------------------------------------- 3. 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.
• theorique 14y 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 14y 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 14y 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 http://on.fb.me/Pb3DeP)
• mp99e99 14y 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 14y 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 14y 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 14y 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 14y 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 14y ago
  We think we have a good idea that seems like a bad idea: http://hometract.blogspot.com/2012/09/connectwithcontractorscom-hacking-home.html http://hometract.blogspot.com/2012/09/connectwithcontractors...