Investment
Summer Camp for Startups
There’s an unassuming, slightly bizarre-looking building located at 135 Garden Street in Cambridge, Massachusetts. It’s the original home of Y Combinator. When Paul Graham, Jessica Livingston, Dr. Robert Morris, and Trevor Blackwell decided to start a new kind of seed-stage venture capital firm, not many people understood it, let alone expected it to revolutionize tech investment as it has. Today there are scores of Y Combinator clones all over the world, such as TechStars, 500 Startups, and Seedcamp. And I was lucky enough to have been in that first class of founders who showed up for what was then called the Summer Founders Program.
That first class at Y Combinator may have been a special sample of fortunate founders, but the group itself had a range of personalities. There was the braggart, the teacher’s pet, even the condescending misanthrope. The one thing we all had in common was that none of us had any idea what we were doing. Some postured better than others, but we were by and large recent college graduates with little or no experience in the professional workforce. Ignorance, in this regard, happens to be one of the best assets founders can have. Living like a college student essentially means being cheap, and being cheap is one of the best ways to not go out of business. If you don’t know what you’re missing by not having a full-time salary, it’s a lot easier to keep eating ramen5 and picking up leftovers from bakeries at closing time.
Once you’ve gotten some experience, though, you’ll be able to recognize your bad decisions and make better ones the next time. What Paul and the rest of the Y Combinator partners knew was that actually starting a company was going to provide us with a far better education than paying for one at business school would have. Steve and I just couldn’t believe we’d be having regular dinners with Paul Graham and a different (impressive) guest each week.
Steve and I showed up early for that first Tuesday dinner at a small building in the quiet suburb of Boston. It was a chance for us to spend some quality time with the partners at Y Combinator as well as with whomever the guest speaker was that week. It was like move-in day all over again, only everyone asked about business models and not hometowns or majors. We gathered around cheese plates, shaking hands and making introductions, before Paul called for everyone’s attention. Dinner was served. Crock-Pots bubbled with what would come to be affectionately known as glop. That said, the collection of beans, vegetables, and meats (topped with shredded cheese and/or sour cream!) provided sustenance for our roomful of hungry founders.
There’s a special kind of off-the-record camaraderie that exists within the walls of Y Combinator that allows guests to be far more candid than usual. This means that a roomful of hungry founders (remember, hungry for knowledge, because they’re full on glop) can probe the minds of leaders in their industry. Back then Y Combinator was so new that the speaker invite list was limited to Paul’s Boston network. But today the likes of Mark Zuckerberg and other famous startup CEOs show up. One of our speakers at that first dinner was a partner at Goodwin Procter, an international law firm, who patiently answered what must have seemed like inane questions from wide-eyed founders who at best had once taken a business law class. Afterward, the speakers lingered, and founders queued to follow up—the law partner not only ended up sticking around and chatting, he would also go on to represent us during our acquisition. He’s my personal lawyer to this day.6
All of us were there that first summer to learn as much as we could, both from the experts who visited every week for special off-the-record talks and Q&A and from each other. Over time, that network of Y Combinator guests and alums has become one of its strongest assets. At the time, however, not even Paul and the other founders of Y Combinator were aware of the value in the network they were creating. As more founders went through the program, the previous participants felt honor-bound to assist them, a tradition that continues to this day. Encounter a problem you’ve never experienced before? There’s probably someone in the network who has—just ask. It’s been referred to as the YC mafia. But it’s not exclusive to Y Combinator. The most healthy startup communities have a network of founders who are genuinely interested in helping one another. I see this today throughout the New York tech community. That level of camaraderie isn’t pure altruism; earning “startup karma” means you’re more likely to get the help you need when the times comes.
Networks like this don’t have to exist within a tech accelerator, but if you can find one that suits both you and your project, you’ll likely find many peers there to learn from and share with. Particularly in the Internet industry, there is a strong desire to distribute knowledge, not lock it up. Reputations are built by those who dish out experience and insight. The knowledge sharing happens online—these days within communities like/r/entrepreneur, /r/startups, and Hacker News as well as on Quora and even Twitter. But don’t get hung up on the particular platforms of the moment; you can find the discussions wherever they’re happening online.
And when they’re not happening online, they’re happening off-line, at cafés, bars, and work spaces. Even in an increasingly digital world, there’s still no replacement for quality face time (never turn down cannoli!). Keep in mind, though: no amount of networking is going to save a website that doesn’t actually do something people want.
The phrase “Make something people want” was emblazoned on the shirts each one of us received at the end of that first Y Combinator dinner. Jessica Livingston, one of the YC founders, illustrated this brilliantly in a fundamental way when she taught me people won’t wear uncomfortable swag (remember the previous chapter!). As founders, we’re never to forget this phrase comfortably adorned on our chests, which serves as a mantra of sorts for Y Combinator. Startups will never succeed unless they make something people want. It’s a lesson I come back to time and time again.
There’s Nothing Fun About Funding
Unless you get incredibly lucky (remember, there are already many factors going against you), you’ll need to have at least built something people want before you can get your first round of funding. The application process varies, but most accelerators follow Y Combinator’s lead and start with a written application (submitted online, of course) followed by offers for in-person interviews. I’m biased, but not only did Y Combinator create the blueprint, they also set the standard. So at least for as long as they’re doing that, let’s use them as a benchmark.
If you get in to Y Combinator, you’ll trade some equity (typically between 2 percent and 10 percent, but usually between 6 percent and 7 percent) for somewhere around $18,000 (on average) in funding and their three-month program. If you can’t ship something in that period, you’ve got to hard reset.
What if you don’t? Or don’t want to? Well, you’re not alone, as most of the successes in our Internet industry never went through an accelerator.
The cost of starting a company falls every day as the costs of hosting your website fall. When we started reddit, we ordered our servers online, as parts, and assembled them in our living room before schlepping them down to the co-location facility (a big room full of servers where you can rent space to put in your own). Just a few years later, Amazon launched a brilliant cloud computing service that did away with our need to ever see our servers—all it takes is a credit card, and your site can be up and running for a pittance (a price that heads down every month). Hosting a website is now essentially a utility.
When you’re not dealing with inventory, or a retail location, the barriers to entry plummet, and businesses can start from dorm rooms and coffee-shop tables. As long as you can cover rent and keep food in your belly, you can keep your business going—and growing—long enough to get that next round of funding.
This funding may come from friends and family, or it may come from wealthy individuals known as angel investors. The phrase is rather generous; I prefer to think of them as wearing monocles and top hats.
The breadpig above captures exactly what I look like at the moment I’m deciding whether or no
t to invest in a startup. In fact, all investors look exactly like this. No halos or wings, just monocles and top hats.
But the idea is that these investors are willing to take a big chance on a very early-stage company in the hope that they’ll get in on the ground floor of something huge. I’ve done more than sixty of these early-stage investments since selling reddit. For many of us, investing in an early-stage company is a risky investment strategy, but it’s something we do because we were entrepreneurs ourselves once. We think of it as startup karma—a way to give back to the community and honor all the folks who took a chance on us.
There are others who invest just because they’re fascinated by the industry and can offer some extra insights (this is what people mean when they say they’re “value-add investors”—but everyone says that, so you need to figure out specifically what that means). A community of these early-stage investors is important for a startup hub to develop in a particular geographical region, because investment can become a virtuous cycle. Silicon Valley is what it is precisely because of this: some geeks got rich and invested in more geeks, some of whom got rich and did the same. But it’s happening all over the world now, and as the costs for starting a company fall, many more companies are getting funding.
It seems obvious, but companies die because they run out of money. Among all the hundreds of startups I’ve advised over the years, only one has actually been put out of business by a competitor.7 Despite being in an environment where your primary costs fall every day, the leading cause of death for a startup is running out of cash, one would assume that the need to keep costs low is obvious, but it’s not.
Additionally, young founders are challenged by a lack of connections and the appearance of youth, which, in many industries, unfortunately, correlates with a lack of legitimacy. Adam Goldstein at hipmunk, then twenty-two, overcame these hurdles through sheer determination. Many other founders do their business development over the phone first, where one is judged only by one’s voice and one’s choice of words. Then when it comes time for an in-person interview, one’s youth becomes an asset, as the executives who would’ve once been skeptical are now impressed.
Unless you’ve got a rich and generous uncle, you’re going to have to be resourceful. Actually, even with a rich and generous uncle, you’d still better be relentlessly resourceful, because in this industry, if you’re not making something people want, you’re hosed.
Getting Your Leverage On
Real talk: fund-raising sucks. It’s frustrating, and it’s a distraction from the most important thing: building your business. But you still have to learn how to do it.
Funding is out there, but most investors are creatures of the herd, sadly. We investors try to tell ourselves we’re not, but every founder has been asked, “Who else is in?” There are a few exceptions, but don’t count on finding them. Meanwhile, founders are inherently trying to adopt an anti-herd mentality as they build something that solves a problem no one else is seeing. You’ve no doubt seen the catch-22 here—how does one get investors without an investor?
It’s frustrating, but not insurmountable; remember: you’re not doing this because it’s easy. And when it works, when you do land some solid investors, you can use that social proof to turn the herd mentality to your advantage (just like doing business development in chapter 3). Once investors know they could miss out on the deal, you become infinitely more appealing. A refrain I hear often from founders is “We’re closing soon” or “We’re oversubscribed, but we’re going to try to make room for you.” They’re trying to create a sense of urgency, and when it’s genuine, it’s effective at getting me to open my checkbook.
This strategy works because normally investors have the leverage, although that’s shifting every day as it keeps getting cheaper to start and grow these startups. But founders still need the capital, and investors want to fund the companies that will win. Showing you’re going to be one of those winners with or without an investor’s money is a sure way to take back some of that leverage and make him or her want to invest. It’ll never completely balance out until you’re wealthy enough to fund your own company, and even then you’ll likely still want quality investors on your team—but assuming you’re still working your way toward obscene wealth, let’s take it one step at a time.
Even when you get a commitment, it’s not a done deal until the money is in the bank. Never forget the wise words of Paul Graham: “Deals fall through.” I’ve applied it to every deal I’ve ever done since he first uttered that warning. I even scrawled it on a photo of Paul that I put up in our bathroom after we started talking to Condé Nast about an acquisition. Every day we’d walk in there and see Paul Graham reminding us to stay focused on building a company, not on a potential acquisition deal that could fall through.
How America Gets Her Swagger Back
People are investing in Internet startups even at a time when the US economy is still finding its swagger. Investment capital continues to flow, having faltered only for a brief period after October of 2008, when the bad deeds of the banking community caught up with them (okay, not really; they all did pretty well—some even got great big golden parachutes; it’s more like their bad deeds caught up with the rest of us). But now, just like everything else, the investor industry is being disrupted by the Internet.
Innovators Naval Ravikant and Babak Nivi, for example, developed a platform designed to tear down the inefficiencies of angel investing. AngelList is a social network of investors who can share recommendations (or follow the leads of prominent investors) or simply browse seemingly endless pages of profiles of startups seeking funding. A number of companies in my portfolio have been funded this way, including Creative Market and Massive Health, which raised $1.3 million and $2.25 million respectively, thanks to AngelList’s seamless network of digital props and connections. It’s still not a perfect market, but it’s getting better every day. Startups with traction (those that are making money and growing) are having less and less trouble finding funding, whether they’re based in the Bay Area, in Brooklyn, or someplace in between.
Once you raise that first round of funding, you’ll embark on the startup “process,” which has been charted by none other than Paul Graham in this now-famous traffic graph:
At this point, decisions that were once made with hunches should be made with data (now that you’ve got a decent sample). Start from there, but also know that even those of us who know we’re more rational than everyone else are still human. Most decisions still get made on gut instinct—just make sure data is part of the meal before you choose your entrée. Remember: you’re not Steve Jobs. And even if you were, you now have real-time data telling you just how good an idea that extra button on the home page is.
You might have the world’s best muffin recipe, but as long as you’re in the business of baking muffins, your muffinry (that’s a bakery that bakes only muffins) will never grow fast enough to be a startup. That’s okay, though, because a muffinry can still be a great business. We need more great startups and more great businesses.
On that note, the Internet is revolutionizing the way traditional businesses, such as my hypothetical muffinry, get funded (the more I write about it, the more I want to start it). Crowdfunding has hit its stride only in the last few years, with the emergence of sites like Kickstarter (and many, many more in different flavors and for different verticals; see chapter 7), which let anyone with a credit card contribute a reasonable amount of money to a project he or she believes in. For now, investment is technically prohibited (unless you’re a rich angel investor), but crowdfunding a project—whether it’s a means of taking preorders or simply a means of bringing a dream to fruition—is helping enterprising people help themselves, one small contribution at a time.
These contributions add up. The platform is still young, but there are already examples of projects that have funded companies like Pebble, makers of an innovative new watch that communicates with your smartphone. Pebble had troub
le, even after graduating from Y Combinator and after a dogged effort at raising awareness on AngelList—too many investors were worried about hardware startups, reflecting the fact that most investors prefer software, which scales, over anything else. So Pebble began a Kickstarter campaign to fund production of their first batch of watches, aiming to raise one hundred thousand dollars in preorders.
They raised that in mere hours. Once potential customers got a look at their product, everything changed. Granted, these watches look awesome, and the “dream team” they’d assembled was a bright group of Canadians from the University of Waterloo, but even founder Eric Migicovsky was surprised when the campaign raised more than ten million dollars from about sixty-eight thousand people worldwide ($10,266,845, to be exact).8 They actually capped preorder requests in order to satisfy expectations, but not before nearly every publication that covers tech or gadgets gushed about their unprecedented Kickstarter campaign.
I know this team well, not only because I was there in the room for their Y Combinator interview but also because I ended up managing the team that does their social media. That started just after their monumental launch on Kickstarter, which shattered all previous fund-raising records for the site—in five days.9 We watched a global consumer frenzy grow around this product after investors had responded so lukewarmly (remember, even other founders can be wrong). I caught up with Eric months later, when he was in a hiatus between trips to China, where the Pebble watch is manufactured. With the first working prototype on his wrist, the soft-spoken Canadian CEO explained the shock of fund-raising from people around the world, most of whom he didn’t know:
Launching on Kickstarter was the first time we were able to eloquently describe our product to the broader market. We tuned the project page and video until my mom was able to understand the entire thing perfectly. One of the coolest moments was when my friend in Amsterdam saw the page for the first time. All of my friends have been supportive of my work over time, but I knew something was different with Pebble when my friend was telling me to shut up and take his money for Pebble. Then to see the rest of the world think the same was just awesome.
Without Their Permission: How the 21st Century Will Be Made, Not Managed Page 11