Nice article, but drastically oversimplified. Paul ignores two critical issues: Risk, and non-linear utility-of-money functions. These two factors become critical when there is a tradeoff between probability of success and the payoff of success.
Suppose, as a simple example, that I have a startup which I think has a 50% chance of succeeding and being sold for $1M, and a 50% chance of failing and being worthless. Now suppose that Paul selects me to participate in YC, but wants 10% of the company, and I think his help will leave the potential valuation unchanged but increase the chance of success from 50% to 55%. If I accept his offer, my EXPECTED return drops from $500k (50% of $1M) to $495k (55% of $900k) -- but I'd still accept the offer, because increasing my chance of getting that first $900k is worth far more than getting an additional $100k on top of that.
On the other hand, suppose a venture capital company comes along and offers to help me expand into a much larger market, where I'd have a 10% chance of the company being worth $100M (and a 90% chance of the company being worthless), in exchange for taking 50% of the company stock. If I accept the offer, my EXPECTED return jumps from $500k to $5M (10% of $50M) -- but there's no way that I'd accept the offer, because I really don't want to spend years of my life on something which has a 90% chance of being worthless.
It's important to understand the numbers, but in the end the numbers, at best, have to guide you rather than making decisions for you.
Actually not. That's why I was careful to speak of the effect of trading equity on the "average outcome" rather than e.g. "average valuation at liquidity." What I'm literally saying is, does the trade improve your odds of getting what you want? That subsumes both your risk aversion and your utility function for money.
Your math is still wrong, because of the non-linear utility of money. If I give up 6% of my company, it costs me 6% of any MONEY I might end up getting, but it doesn't cost me 6% of the UTILITY. If I have a utility-of-money function of sqrt($), you don't have to increase my chance of success by 6.4%; it's enough if you increase my chance of success by 3.2%.
Then you're still wrong. I quote from the article: "For example, suppose Y Combinator offers to fund you in return for 6% of your company. In this case, n is .06 and 1/(1 - n) is 1.064. So you should take the deal if you believe we can improve your average outcome by more than 6.4%."
If by "average outcome" you mean "expected value of the utility function", and assuming that my utility-of-money function is sqrt($), I don't need to improve my "average outcome" by more than 6.4% for the deal to be worth accepting; it's enough if I can increase my "average outcome" by 3.2%, since that's how much UTILITY giving up 6% of the MONEY costs me.
Suppose your present hope of future utility from your startup varies
linearly with the number of shares. (This is not a radical assumption;
essentially all startup shareholders feel this, at least for numbers
near that of shares they own.) Suppose you trade 6% of your stock in a deal that will increase your average future utility by 6.4%. You've made a straight trade of hope of future utility for future utility. We don't even have to introduce money.
IF the expected utility varies linearly with the number of shares (and thus the expected amount of money received in the end), you're absolutely right. But does it?
For large investment or VC funds, the utility-of-money function associated with any particular investment is almost linear. There's a very good reason for this: As far as Sequoia is concerned, a dollar earned from their Google stock is pretty much equivalent to a dollar earned from their Loopt stock. Not quite equivalent, since there are non-tangible advantages for a VC fund to have many smaller success stories instead of one Google; but close.
As you point out in http://www.paulgraham.com/vcsqueeze.html, founders aren't "rational" in the sense of having the same approximately linear utility-of-money function as VCs: "... letting the founders sell a little stock early would generally be better for the company, because it would cause the founders' attitudes toward risk to be aligned with the VCs'. As things currently work, their attitudes toward risk tend to be diametrically opposed: the founders, who have nothing, would prefer a 100% chance of $1 million to a 20% chance of $10 million, while the VCs can afford to be "rational" and prefer the latter."
There's another reason to think that most people have concave utility-of-money curves: The insurance industry. If you buy house insurance, you are lowering your expected number of dollars (because even ignoring market friction, the insurance companies have to make a profit), but raising your expected utility.
Yes, for most founders hope of future happiness varies linearly with the number of shares-- at least, in the region of the number of shares they have. If someone gave them 10% more stock, they'd feel 10% richer-on-paper. (There are anomalies at the extremes. E.g. if you got 100% of the stock, your cofounders wouldn't be motivated, and that would decrease the value of your shares.)
No, I don't think they contradict one another. The reason is that the most likely outcome is just to the right of the step.
Most startup founders (initially at least) hope to get a few million, and wouldn't risk that to get a few billion. That's the step. And the most common form of liquidity event is a small-scale acquisition that gives the founders just that level of wealth, since otherwise they won't sell. So in the most common (and most commonly hoped for) good outcome, happiness varies linearly with the number of shares.
Since you're talking about step functions and expectation, the final equation should be framed with a binary parameter in mind: x=0 (no liquidity event occurs), x=1 (liquidity occurs).
"The reason is that the most likely outcome is just to the right of the step."
"So in the most common (and most commonly hoped for) good outcome [...]"
Isn't the omission of good in the first paragraph a lapsus, i.e., do you mean most founders think success is the most likely outcome? Or do you mean founders should ignore the possibility of failure for the purposes of making these decisions about stock?
If a man is wrong, you don't need to tell him so. Just give it a rest and let others form their own opinions.
Seriously, these issues, and a lot of other issues, are covered in "How to Win Friends and Influence People". Read it. If I could figure out a way to get you to feel like you came up with the idea to read it, I would, but I can't, so just read it.
I know you are well intentioned, but if I'm full of it I'd rather someone told me, preferrably in a respectful but blunt way. I'll form my own opinion anyway.
I know I took criticism personally and reacted very badly once or twice in the past, so I see your point. But I realised I was being a baby and grew from the experience. No speech on humility can make you humble. At best, it will convince you you should be humble, and maybe by acting humble some of it will sink in and stick. Real humility comes from realising your mistakes. [Edit:] That's painful at first, but necessary to get over your ego.
[PS: Sorry, I drifted into replying to other comments of yours, and the end result may be confusing.]
No, really.. It is wise to never publically tell someone they are wrong, unless you're defending someone. You should wait until his friends and colleagues have left his side, then whisper your opinion into his ear. In the Internet world, that means sending him an email. To not do so is bad karma in every sense of the word.. My post above was modded down because I publically pointed out that he was wrong to point out Paul's percieved flaws in public; maybe I should have sent him an email instead. This wisdom is proven true over and over. My #lisp fiasco convinced me of that (long story).
You're wrong to tell people they're wrong to publicly tell people they're wrong.
Most mature and intelligent people love it when someone is able to offer useful critiques of their work, as long as they're civil about it. For example: http://en.wikipedia.org/wiki/Socratic_method
I don't see in there where you should prefix everything with "What an oversimplification! You're wrong, wrong, wrong!"
Seriously, would you want this guy making a few million? Not only would he be a douche, but he'd be a rich douche. Imagine how he'd treat his waitresses and waiters then. Or his local cops. Or anyone not as smart as he is, which is, apparently, EVERYONE. I'd even call him a detriment to our society, because the child just seems to act like a Paris Hilton with brains. Smart people can be civil, and it's just silly to watch everyone go "Cperciva you're so awesome! You should do X with your life!" and him go "Oh ho ho, didn't you think I already considered that? I turned down a headhunter yesterday, in fact. Now go make me a sandwich."
The dude's a genius, but he could learn a little humility. But he's obviously not going to learn until some event wakes him up to it, so I'm done caring that maybe one more nice person could exist in the world.
I would want this guy making a few million, if he doesn't steal them. His waitressers and waiters can quit anytime if their alternatives are overall better.
(Kudos for being able to imagine a Paris Hilton with brains.)
That's exactly the problem, a reward in the face of repugnant behavior. I wasn't going to respond, but I found this comment pretty depressing so I have to ask you: You seriously believe being rich is a license to be a douche? Or that everyone's allowed to act however they want to food service workers, or the people that guard you while you sleep? Or anyone at all? What if, for example, someone had to be a waitress to save up money for college? Sure, she could start a business, but what if she has literally zero money and no contacts, and she was just born like that?
What's depressing is how often people don't think of other people.
Being rich in this case wouldn't be a reward for his attitude, but for solving the problem of people who want secure, usable backup systems.
I'm not saying being rich would entitle him to any particular behaviour; they're orthogonal things.
About the hypothetical waitress, either she could find another job to pay for college, or otherwise her ability to go to college depends on cperciva getting rich.
There are other examples where you could argue that raw capitalism may not be in the general interest. Think, for example, of real state; that's more of a zero sum game. In my area, rich foreign people are buying most of the real estate for summer houses they'll visit once every other year or so, while locals have a hard time to find a first accomodation due to pumped prices. Many people have to migrate to save up for a house here. Since the utility of that real estate is way lower for the foreign rich than for the local poor, I claim that in this case raw capitalism is reducing overall value.
I know something about economics, but far less about finance. :-)
In any case, finance really doesn't interest me. I routinely tell Wall Street headhunters to stop bothering me because I would rather create something impressive than own something impressive. I'm not in this for the money.
Well, your demeanor is very ingrained into your personality. I doubt you can change it without a lot of effort. Even saying little things like "I routinely tell Wall Street headhunters to stop bothering me..." comes off as arrogant. Do you really not see that? Or do you just not care?
Let's put it this way: How arrogant you are perceived as can be measured by how many times you say "I".
In this case, oversimplifying is warranted, mostly because the things glossed over are either sufficiently complicated that it's hard to make simple, or are things are already generally known.
Take, for example, the 50% point. Once you hand over so much stock that the amount you and the people you implicitly trust hold dips below 51%, you've lost control. Clearly an issue outside of the 1/(1-n) equation, and yet not really relevant. Everyone knows this already.
Then there's the general notion of not handing out too much stock to too many factions, but this too is more or less established knowledge amongst the target audience.
Having said that, the nuance of factoring in odds of success is a worthwhile consideration. Hat off for explaining it!
I agree that simplifying is warranted! I can't understand complex things anyway. Plus if you can't explain it, you don't understand it.. here I feel like I got some modicum
of insight.
"I really don't want to spend years of my life on something which has a 90% chance of being worthless."
How does that mesh with the fact that a failed startup is probably worthless (in the literal sense that you can't make money from it), and most startups probably have >90% failure rate?
I know there is a learning experience in startups and that working hard on something fun is valuable, so worthless is really just talking about immediate money here.
I don't think my probability of failure is 90%. :-)
This isn't as naive as it sounds: If you take VC with standard liquidation preference terms, the company needs to do really well before you get anything back -- so the amount of money you need to avoid "failing" is dramatically increased.
In my case, since I don't intend to take any VC, there's a wide range between "failure" (making less money than I would have earned risk-free by working at the university for the same duration) and "success" (making enough money that I never need to work again).
Also, on a more self-serving note: I'm a heck of a lot more competent than 90% of startup founders. Or even 90% of YC-funded-startup founders for that matter -- and YC-funded startups have distinctly less than a 90% failure rate.
Of course it's a bold statement. But if I wasn't bold, I wouldn't have started university at age 13, set three world records for calculating pi (a stunt, I admit), ranked in the top six mathematics undergraduates in North America, received a $100k+ scholarship to Oxford University (not the Rhodes, unfortunately -- their mistake), received a doctorate in computer science from said university, and become the security officer for the FreeBSD operating system.
So you've shown that you have some (impressive) academic achievements, but have you had any business success? Just because you're book smart doesn't mean you will have a successful start up.
Many times people think that they can transfer great success from one domain into other domain. Michael Jordan and his short baseball stint is the first thing that comes to mind.
You're quite right, and if I do fail I entirely expect it to be due to a lack of business experience. But on this topic I'm working entirely based on what Paul says -- that being able to build something which people want is far more important than being able to sell it.
One personal tip, you come off as an arrogant prick because of your "I am holier than thou" statements. These kind of behaviors will drastically reduce the amount of people that will want to work with you or help you.
I work with MDs and PhDs on a daily basis, analyzing their technologies for their start up companies. By far, I am much more willing to put in extra hours for friendly people than those that cram down my throat how much better they are than me.
Again you're right, and I'm sorry about the attitude. Over the past year I've started to get rather defensive when people have suggested that I'm wasting my time on this project...
I get a whole lot of that (even from my family: my sister told me "So, mom and I were talking in the car, and it's great that you're doing this startup, but honestly I don't think you'll succeed.") When I gave notice today, I had to listen to my boss go on about how I was too young to start a startup (I'm 26), how he spent about 15 years after getting his Ph.D learning about business and working in the industry, how my technical skills were too weak (nevermind that I wrote two of his products, and he's never seen me program in a language other than Java), and how if my idea was any good at all, I'd have been able to secure funding for it (nevermind that we're not interested in outside funding until we have some traction).
I've found that the best response is to sit there, listen carefully, take note of any valid points, and ask followup questions if you need more information on one. You may learn something: despite the overall negativity of the conversation, my boss had many points that I'm going to want to keep in mind as we move forwards.
Understand, there is a lot of self-justification going around when it comes to entrepreneurship. As long as rich people are the distant Bill Gateses and Warren Buffets, people can put them up on a pedestal or say "Oh, they got lucky." But if someone you've grown up with or someone who used to work for you gets rich, you have to ask yourself "Why them and not me? Are they just smarter than me?"
Many smart people will do just about anything to avoid admitting that others are smarter than them, so they instinctively say "Oh, he's just going to fail." And when you succeed, they'll say "Oh, he just got lucky." If you succeed again they'll start saying "The game is rigged!".
But if you stoop to their level and say "Oh, look how smart I am, of course I'm going to succeed," you're just engaging in self-justification yourself. And that's a dangerous mental attitude to get into, because it blinds you to details. The reason you're smart in the first place is because you pick up details that other people don't; you can easily become stupid by believing yourself smart. This comes from experience: I did precisely this in high school and college, and then found that when I actually tried to get something done, the results were much more disappointing than I would've liked.
(Therapy for myself: I think you're smarter than me, I think you will succeed, and I think that if you do succeed, it will be because of skill. But keep what I say in mind anyway. It may be useful.)
I have a friend who (years ago) told me "Damn you're lucky! You have a horseshoe stuck up your [butt]. But you seem to work really hard for it..."
I never forgot that, and in the intervening years I've attributed the majority of my success to luck, rather than skill. Luck, however, that I work hard to create.
The reason is this: If you believe that your success is due to your own skill, you become lax. Complacent. Entitled. You've succeeded so far, so clearly you're da man and you should succeed going forward.
If, on the other hand, you ascribe it to luck, you acknowledge that there's little that you did to make it work. And so you have to keep working hard and scrambling to make the next project successful. Because your previous successes have little bearing on future performance.
But if you stoop to their level and say "Oh, look how smart I am, of course I'm going to succeed," you're just engaging in self-justification yourself. And that's a dangerous mental attitude to get into
Good god, the amount of useful and practical advice in this comment is astounding. I hope you get 20 karma points. If you follow that advice you're 90% to success, because it says a lot about your personality. No wonder YC wants people to participate in YC News.. If I had any money I'd invest it in you.
Were these people questioning your ability to pull off the technical challenges? If they were questioning the business potential of the idea, your impressive credentials in math and programming are besides the point.
That is entirely the wrong way to respond: you will get a lot of that (from VCs, prospective clients, etc.) and dealing with it like that is guaranteed to lead you to failure, simply because everyone will come to see you (rightly or wrongly) as a complete prick.
A crucial part of making something people want is finding out what people want. Intelligence is an advantage, of course, but is no guarantee. For one thing, it may make it harder for you to understand the needs of the less gifted and educated.
Friend, if you don't mind taking more of Paul's advice, read "How to Win Friends and Influence People" by Dale Carnegie. That, combined with your impressive record, will make you an unstoppable force at whatever you pursue.
Yes, only once. But I actually consider my first score on the Putnam (53, ranked 53.5th in North America) to be my most impressive performance on the Putnam, considering that I was only 14 years old at the time.
Test Pilots are bold by definition. Entrepreneurs are not necessarily bold. People tell me all the time how "brave" and "bold" I am for starting a startup and it's complete BS. The only think we're risking is some money, reputation and ego. All of which grow back in time. If we were doused with gas, lit on fire and smashed with ewok log traps if our startups failed then we would be bold. As it is we're just different.
That is my startup idea. I don't want to take this thread even more off-topic (if that's even possible), but please feel free to contact me at the address in that first post to explain why you think it is a bad idea.
we're in a similar space -- http://www.getdropbox.com (and part of the yc summer 07 program) basically, sync and backup done right (but for windows and os x). i had the same frustrations as you with existing solutions.
let me know if it's something you're interested in, or if you want to chat about it sometime.
It looks like a great idea - except - the sucking up of bandwidth to make the first backup. I'm definitely looking for a better remote backup service for my Architecture firm, for which I currently pay far too much, but my server unfortunately is Windows SBS 2003 - whose OS I truly dislike. I am forced to do this for compatibility with my Revit BIM software unfortunately, so I guess your product won't help me.
As a major bandwidth user, mainly bandwidth actually. But having the first upload for free would be a great incentive.
I think it took several days to move my data to the current system remotely which was not fun. I think its just an unavoidable problem. The severity was lessened by the service calibrating the upload to occur in the middle of the night, which really did help a lot. All of the incremental uploads also are scheduled at night, which is an obvious move.
I think it's a good idea, but already done, though. I use Carbonite to keep an online remote backup of my hard drive. They charge a fixed rate regardless of the capacity of the drive. Of course there is always space for competition, so if you think you can improve on their offering, then go for it.
If you use Carbonite, you're considerably braver than I am. Carbonite has no effective technological security, so you'd better hope that nobody breaks into their offices, none of their employees "go bad", and they're never confronted by a subpoena or have the PATRIOT act invoked against them; and they only keep the latest version of any file, so if you ever accidentally mangle a file you'd better hope that you can retrieve the unmangled version before Carbonite backs up the mangled version and throws away the older copy.
Right, but they're secure enough for most people. Think about it, the chances that someone gets access to my own computer (stealing it, breaking into my home, or hacking it over the Internet) are higher than the chances of that happening to a professional service provider. At least that's the case for most computer users. I heard recently that 25% of all computers in the world are zombified. So much for security on your own computer.
But anyway, that's why I said if you can improve on their offering then go for it. Given the current options, they're the best that I know of; and I say that knowing that they have a lot to improve. So, if you build a better service, I'd consider switching.
If you get a subpoena for a passphrase for a client, you will give it up. Yes you will. Now, if someone was holding terroristic bombcodes or whatever and REALLY didn't want people getting them, they ain't backing up anything online. The same people who need real security aren't going to be uploading their data anywhere .
"If you get a subpoena for a passphrase for a client, you will give it up."
Not if I don't have it. This is the point of strong security -- you don't NEED to trust me, because I am not technically capable (nor, unless I'm quite mistaken, is the NSA) of decrypting data backed up using tarsnap.
This would be off-topic in this thread, but definitely not in this forum. If you make a new top level post requesting feedback, more people will be able to contribute and benefit from it.
My first reaction was: I see this more as donationware open source. But then again, if you feel your technology would be hard to replicate, and if the cost is on the S3 ballpark, I'm in.
Interesting project, unfortunately I didn't found any way to enter in contact with you. You can contact me through my project web site http://www.disnetwork.info
I'll be glad to discuss this remote secure backup project with you. It was once on top of my list for a DIS application, but I dropped it for various reasons that I would be glad to share with you.
Remember that success comes from improving OTHER people's lives. All your achievements, while probably very gratifying to your mother, have not improved my life at all.
Do you use OS X or Mozilla? Have you ever used their software update mechanisms?
If yes, I've improved your life -- they use my delta compression work (bsdiff, originally written as part of FreeBSD Update) to reduce the size of updates which have to be downloaded. As of about a year ago, my work had saved users around the world well over a hundred years of waiting for updates to download.
"Remember also that every time you open your mouth in the presence of a person who has an abundance of knowledge, you display to that person your exact stock of knowledge or your lack of it! Genuine wisdom is usually conspicuous through modesty and silence."
That's a two-way street, dbosson. I wouldn't hasten to silence him, nor chasten him for opening his mouth "in the presence of a person who has an abundance of knowledge," as you put it.
If we assume 100 million internet users that you saved 100 years, that's roughly 30 seconds per user. Let's say just 10% of people use OS X or Mozilla - that's 5 minutes per user.
This is not to belittle, just to put your "100 years" in context. It's great work and you've saved me personally a lot more than 5 minutes.
yep, immediately thought of that too. PG writes VERY good stuff most of the time and is very smart about a lot of things, but when he strays into areas in which he is not well versed (the unions essay comes to mind), he ends up writing pieces with obvious holes.
I read the union essay a while ago, but your failure to sufficiently consider risk-aversion in this one was a major hole. I don't mean to really criticize that much, you write consistently great stuff.
That works, except then I guess the hole was not making it clear enough that you were talking about utility rather than expected value. The problem with your response, and the reason that I don't really see it as a good explanation, is that your basic principle is far less useful if it requires the user to calculate their expected utility.
Entrepreneurs face some pretty tough questions at a very early stage. Should I take Angel or VC money? How much money should I raise? How much equity should I give up? How much equity should I grant to early employees?
The math equation is correct, but the likely outcomes are nearly impossible to estimate. I have been on the management team of 5 startups and advised many others. There are some "norms" and guidelines for how much to raise at each stage, how much equity to give up, and even how much stock to grant employees as you grow the company.
I wrote an in depth blog on these questions, too long to detail here, but Paul is on the right track. For more details see How much Equity for Investors and Employees?
Suppose, as a simple example, that I have a startup which I think has a 50% chance of succeeding and being sold for $1M, and a 50% chance of failing and being worthless. Now suppose that Paul selects me to participate in YC, but wants 10% of the company, and I think his help will leave the potential valuation unchanged but increase the chance of success from 50% to 55%. If I accept his offer, my EXPECTED return drops from $500k (50% of $1M) to $495k (55% of $900k) -- but I'd still accept the offer, because increasing my chance of getting that first $900k is worth far more than getting an additional $100k on top of that.
On the other hand, suppose a venture capital company comes along and offers to help me expand into a much larger market, where I'd have a 10% chance of the company being worth $100M (and a 90% chance of the company being worthless), in exchange for taking 50% of the company stock. If I accept the offer, my EXPECTED return jumps from $500k to $5M (10% of $50M) -- but there's no way that I'd accept the offer, because I really don't want to spend years of my life on something which has a 90% chance of being worthless.
It's important to understand the numbers, but in the end the numbers, at best, have to guide you rather than making decisions for you.