tag:www.aaronkharris.com,2013:/posts Aaron's Blog 2017-04-26T02:39:37Z Aaron Harris tag:www.aaronkharris.com,2013:Post/1148936 2017-04-24T17:10:16Z 2017-04-26T02:39:37Z Fooled by experts

Experts are generally right until they're wrong. Unfortunately, it's very easy to get fooled into thinking that experts are always right. This is because they are...experts. They are authoritative and knowledgeable. This is especially true when it comes to trying new things in existing fields. We are biased into believing that knowing a lot about something confers an ability to predict the future.

The problem with expertise is that it doesn't necessarily come paired with an openness to new ideas. Expertise can be used to shut down new ideas and avenues of exploration just as easily as it can aid in invention. I've been guilty of this when hearing about new ideas. In fact, it often feels easier to shut things down than to use what I know to figure out how to make something new actually work.[1] Perversely, being negative may make someone seem like more of an expert than they are, creating a negative feedback cycle.

When you don't know much about a subject, you're free of the constraints of what has been tried. That means people who are inexpert will often have wilder ideas. Sometimes, that's called naive or stupid. However, when those ideas happen to work, then it's called genius or groundbreaking.

That doesn't mean that every problem can be solved by creative ignoramuses. There seems to be a level of expertise which, when paired with the right environment, is conducive to productive creativity. I wish I had a way to know those levels for different areas.

Without a clear set of rules to use in evaluating expertise, I instead try to evaluate founders based on what I can learn from talking to them. This is especially true in areas that I understand fairly well. While there are certain things I might expect a founder to understand about what they're doing, I'm much more interested in how they think and test assumptions. This is part of how I try to figure out if I'm investing in potential (good) or track record (not so good).

One of the tricks in doing this is to see whether or not the tests that founders run cause them to ask increasingly interesting questions. Coming up with questions is a good sign of creativity, while answering them well builds the expertise necessary to actually get something done.

Technology increases the likelihood that a seemingly naive approach to a problem will work because it reduces the iterative cycle of trying that approach. Given enough time and resources, you could try every single solution[2]. In the real world, though, we have to pick solutions to work on. This is where the good founders are separated from the bad ones. The good ones get better and more open as time goes on, while the bad ones get more closed down and start rejecting ideas out of hand.

The same is true for investors. The best ones use new knowledge to open up new ideas, while the worst use it to close out entire categories of ideas.[3] That's short sighted because the world constantly changes, which makes new things possible. Founding and an investing in those new possibilities is what creates the companies that change the world. That creates new areas in which to be expert, starting the cycle all over again.

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[1] https://archive.org/stream/ERIC_ED211573#page/n0/mode/2up

[2] And enough monkeys at enough typewriters will eventually produce Hamlet.

[3] This is different than investors who understand the limits of their expertise and focus on specific sectors. An investor can be sector focused and open to lots of new ideas within that sector, just as an investor can say they'll invest in anything only to shoot down every idea.

Thanks to Craig Cannon for feedback.

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Aaron Harris
tag:www.aaronkharris.com,2013:Post/1111732 2016-11-29T17:11:20Z 2017-03-20T17:10:36Z Why VCs sometimes push companies to burn

Originally posted on the YC blog, here: https://blog.ycombinator.com/why-vcs-sometimes-push-companies-to-burn-too-fast/

In Investors and their incentives, I tried to give a broad breakdown of the incentives that drive the major types of startup investors. I want to dig deeper into a behavior that VCs sometimes exhibit which seems strange from the point of view of founders. Despite praising frugality, VCs sometimes push companies to spend more money, faster. Sometimes this leads to faster growth. More often it leads to empty bank accounts. I've seen a number of companies get killed by this dynamic, and it took me a long time to understand why it happens.

Misaligned Incentives

Though VC firms generally act in ways that they believe are most likely to help a company succeed, their incentives can become misaligned around questions of burn because of uncertainty and time. Since VCs know that most of their returns come from a very small number of bets, they need individual partners to spend large amounts of time with the companies that they've funded. That time is required to help (in the best scenarios) and to figure out which bet is actually worth further investment of time and capital. In an ideal world, VC firms would be able to increase partners and investing capital whenever they want to add investments. That would, however, require infinite accessible capital and ever larger partnerships. The first doesn't exist and the second would be hard to manage and support.

Funds are also under pressure to produce returns within a given timeframe in order to demonstrate quality for raising further funds. These capital raises are important because many VCs make more off of management fees than they do from investing well.[1] The most important thing for the near and medium term success of a firm is its ability to generate more fees. With an average fund life for early stage investors of 10 years - and a pattern of raising a new fund every 2-4 years - VCs must show some kind of progress. There is rarely enough time for a firm to return capital to LPs before raising a new fund, so they use private valuations to mark their portfolios up or down. If a fund can show a material markup, they have an edge in marketing for their capital raise. While funds that don't produce meaningful returns to investors generally fail after a while, it takes a really long time for that to happen.

Combining these two incentives creates a situation in which it is better for a VC firm to push a company to demonstrate success or failure quickly rather than move more slowly. Companies that succeed quickly lower the uncertainty involved in investing further in that company, and justify the amount of time spent by an individual partner on that investment. If a company is doing well it is also likely to attract new investments at higher valuations, which allows the firm to mark up its investment.

Conversely, companies that fail remove themselves as a time commitment for a partner. That's not an ideal outcome, but it means that the VC firm can refocus energy on companies that are doing well and on finding new companies to make up the valuation lost through the failure of one piece of the portfolio. The faster this happens, the better for the investor.

The worst situation for a VC is one in which the firm has made a significant investment in a company that just muddles along, constantly threatening success and failure. These companies require a lot of time and effort to figure out whether or not they can be saved. They generally generate significant team drama which investors sometimes mediate. They often present difficult bridge financing questions, and they rarely function as good marketing fodder.

How Founders Should Respond

Figuring out how to deal with these pressures is important, and varies depending on your relationship with your investor. The most important thing to remember is that the CEO controls the bank account. Investors can pressure founders to spend faster, but they cannot force them to do so. Founders need to have their own understanding of where and when to spend money, and what rate of spending makes sense.

Next, remember that promises of more funding made when things are going well aren't worth much. All that matters is the money currently in your bank account. It can be easy, during heady days of growth, to justify any and all expenditures. I've talked to founders who have done just that, saying that they need to hire more engineers to develop new features for new users or that they need to spend on advertising to ramp up acquisition. Invariably, they talk about how investor x or y told them that they're special and had promised to keep funding them no matter what. Investors will often point to the burn at successful companies like Uber to prove that spending is good. Founders will sometimes accept this logic without thinking deeply enough about whether or not the lesson applies to their own situations.[2] A company can get away with this so long as growth is working, but as soon as that company goes sideways, spending becomes problematic.[3]

The closer your company edges towards “not likely to return a meaningful part of the fund,” the faster investor capital will dry up, no matter the promises made early on. This is where investor incentives diverge from those of the company. As the investor gets surer that the company will fail, the investor usually pulls back. As the founder gets closer to failure, the founder's need for active engagement and help grows. This mismatch can kill companies and relationships.

It may not be surprising, then, that the more money a founder has in the bank, the stronger their position when fundraising. In fact, we've seen a few YC companies raise financing rounds without having spent any of the money from a prior round. They do this because they get offered very friendly terms. They can do this because they've figured out how to grow without spending lots of money.

The Second-Worst Case

When incentives start to diverge, one of two things can happen. The first case is a bit better, though not great for the founders. There are times where the VC will see a failing company and decide that success is still possible. When this happens, the VC may invest more into the company but will only do so on terms materially more favorable to the investor than would otherwise be the case. This results in significant loss of control and equity for the founder, and may involve the founder being replaced. Whether or not this happens depends on how much leverage the founder has left, and as a bank account approaches 0, leverage decreases asymptotically.

Still, the company may survive.

The Worst Case

The company runs out of money.
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[1] https://hbr.org/2014/08/venture-capitalists-get-paid-well-to-lose-money
[2] I addressed a bit of this here: http://www.aaronkharris.com/exceptionalism
[3] My partner, Dalton Caldwell, wrote a great post about what you should do if you find yourself in this situation: http://www.themacro.com/articles/2016/01/advice-startups-running-out-of-money/.

Thanks to Craig Cannon, Paul Buchheit and Dalton Caldwell for your edits. Thanks to Paul Graham for initially explaining this dynamic.
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Aaron Harris
tag:www.aaronkharris.com,2013:Post/1108711 2016-11-16T22:24:36Z 2017-04-20T23:31:58Z Fundraising isn't predictable

I recently had a conversation with a founder who'd just finished a number of unsatisfying conversations with investors. The founder's company was growing well, had crossed $1mm ARR, but still couldn't raise money. According to conventional wisdom, that should have been enough to open some checkbooks. Unfortunately, that's not how fundraising works.

This is strange because of the way we generally talk about startups. In attempting to set up the kinds of experiments on which startups are built, we tend to put precise milestones in place to gauge results. This is great when measuring progress, but it implies a false sense of precision with regard to raising money.

I've started borrowing a concept from insurance to frame this problem: Parametric triggers. Parametric triggers are a tool used by insurance companies to govern payouts from policies. These triggers remove subjectivity from the claims process by using independently verifiable, empirical evidence as the decision tree for claims.[1] Applying this concept to fundraising would mean that there is a precise set of things a startup could do to get funding. That's how we'd all like it to work, but there are no specific events that will automatically get money from an investor.

In reality, fundraising happens for companies under a ranged set of conditions. Those ranges and the accompanying outcomes are generally different for different companies, or even for the same company at different times. To make matters even trickier, those ranges are only apparent in hindsight when looking at aggregate information about a large number of deals. What those ranges don't tell you is where the actually successful companies sat in those ranges.

This dynamic is apparent in the aftermath of Demo Day at YC. If you were to isolate on a single characteristic of companies within a batch (say, revenue), you'd find companies with impressive revenue growth failing to raise capital, and ones without much revenue raising significant capital. In a parametric world, this wouldn't happen.

The reason this does happen is that parametric triggers are a great tool for deciding what to do about something that happened in the past. In insurance, parametric triggers determine a specific payout for a specific event - an earthquake of 4.7 magnitude will pay a policy, while one of 4.6 will not. Parametric insurance doesn't account for costs after the event or the payout. The system has all the information it needs to make a decision at the decision point.

Investing in startups isn't about what has happened. Investing in startups is about what will happen. Investors are trying to find small companies that will become multibillion dollar ones. They use past performance as an indication of the quality of the founders and the idea, but no metric is a perfect predictor of the future. The ranged conditions that investors often use as filters - i.e. 15-20% growth per month for SAAS companies [2] - are useful tools to use when sorting for worthwhile conversations given limited time. Those filters are never sufficient for actually making an investment, and every investor has a different framework for making that final decision.

When investors turn down a deal, the good ones will give the founders at least one reason. This may take the form of “we don't understand how you can scale,” “we think there are too many competitors,” or “we don't think you're growing fast enough.” While it is important to think about the reasons given, never assume that the only thing between you and the investment is proving that you can solve for that condition.

What you actually need to do is figure out what pieces of evidence you can use to create a future for your company that investors would be foolish to ignore. This will likely require some mix of your traction, the market you are attacking, and how impressive you and your team are. You also need to recognize that there are contra-indicators of success which investors have been trained to recognize. If they see a small ultimate market with no adjacencies, then incredible early growth has no chance of producing a big company, so they will pass.

Much has been written on how to pitch and fundraise, which is part of the problem. Founders are drowning in examples that seek to turn fundraising into a deterministic process. Accepting that it isn't is a counterintuitive and critical lesson in fundraising successfully.

Here are examples of meaningful achievements that won't automatically get you funded but will get an investor's attention and can be used as part of the story you tell:
  • $1mm ARR
  • 10% weekly growth
  • Repeat founders who were previously funded
  • 2 Fortune 500 pilots, 5 in pipeline
  • Engagement rates that are higher than Facebook

Fundraising is a frustrating process that resists well-meaning attempts to make it into a predictable science. That's actually quite fitting, though, since while much about startups can be measured, that measurement never guarantees success. Success comes from using the unique advantages you have and combining them into a coherent, self-reinforcing story and product.
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[1] https://www.wikiwand.com/en/Parametric_insurance
[2] http://tomtunguz.com/mrr-growth/

Thanks to Craig Cannon, Dalton Caldwell, Sam Altman, and Andy Weissman for your edits.

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Aaron Harris
tag:www.aaronkharris.com,2013:Post/1064585 2016-06-22T16:37:26Z 2017-04-21T22:18:07Z Investors and their incentives

It is incredibly important to understand the incentives of investors when you are raising money. This used to be fairly easy - you raised money from Venture Capitalists who wanted to see a big return on their investment. The best of these investors were incredibly focused on doing the one thing they did well: investing in technology companies.

The world looks different now. There are a lot of different types of startup investors, each with a different approach to investing and different incentives for doing so. While they’d all prefer not to lose money, the differences in how their incentives and expectations are structured are critical in understanding how to decide whether or not to work with them, how to negotiate with them, and how to interact with them over the lifetime of your relationship.

Below, I've tried to highlight the key motivations and structures of each of the investors you are likely to encounter. While I haven't attempted to catalogue all the ways in which the incentives of investors influence their behavior - sometimes to the detriment of the startup founders - this should work as a starting point to think through those issues.

One big incentive difference that I've chosen not to address here is preferred vs. common shareholders. That creates a whole other set of questions that is out of scope. Assume the investors below will hold preferred shares.

VC Firm
The classic startup investor that is primarily working to achieve returns for the funds they’ve raised from a set of Limited Partners. The partners at these funds are usually paid in two ways: they earn a % of the funds that they’ve raised and they earn a % of the return they make on the total fund from which they invest in you. These firms generally raise further funds based on the performance of earlier investments.

While investors make money off their management fees (the % of what they've raised), the big pay outs only happen when they return a multiple of the total capital raised. Because of how concentrated venture returns are, VCs generally invest only in deals which they believe will return all or most of their returns.

Angel [1]
Usually a wealthy individual who invests their own money in startups. Sometimes these are people that made money through their own startups. Sometimes they are coming from different industries, and sometimes they inherited their wealth. It can be useful to know which category of angel you are talking to.

Angels have become hugely important to early stage startups as the number of companies have grown beyond the financing ability of traditional funds. More importantly, the wide distribution of Angels has materially decreased the access barrier which founders face when raising capital.

There are a lot of different incentives at play for Angels. While many of them are hoping for huge financial returns, many also want to be able to brag about having invested in a hugely successful startup. What's strange is that Angels often just want to brag about investing in startups, regardless of the success of those companies. Investing in startups has become a badge of pride in a lot of circles.

Though most angels invest as a part time activity, there is a wide range in the amount of time and effort they devote to investing. Knowing that they have other things on their minds should change how you approach and interact with them. You also need to understand how experienced they are, the size at which they invest, and how much time and energy they'll actually spend on their investing.

At one end of this spectrum, you'll find angels who are essentially small seed funds. They invest significant amounts of money in startups, and do so frequently. In the best case, these investors have a deep understanding of the companies in which they invest and can be incredibly helpful. These investors understand that they are likely to lose all their committed capital, understand the standard terms and instruments through which startups raise money, and are generally low maintenance.

At the other end of this spectrum, you'll find small, inexperienced investors who just want to invest in startups wherever they find them. These investors will put a small number of small checks into whatever company they can get into. Because they are unfamiliar with how startups work, they are often hard to deal with and incredibly focused on the risk of losing their principal. These are investors you should avoid unless you absolutely need them.

Accelerator
Accelerators are, for the most part, a subset of VC firms where there are professional investors who raise funds from outside parties to invest in startups. They usually fund more companies than classic VC firms, and do so in batches. Similarly to a VC, most accelerators need to demonstrate return to investors to continue to raise funds.

Accelerators also have a non-financial incentive - they need breakout successes to prove that they are providing operational help to companies and actually “accelerating them.”

Syndicate
Syndicates come in a number of different flavors, but are generally groups of angels who come together to invest in a single deal. Usually, these syndicates have a lead who will be your main point of contact. This lead usually puts money at risk for a return and gets some sort of performance fee for the other funds that they bring into the deal.

Watch out for syndicates where the syndicate runner is taking a management fee on funds raised and is encouraging you to raise more money than you think is wise. Also, be careful with syndicates since you don't know ahead of time who will invest in your company, and might find that one of the investors is a direct competitor who just wants some privileged information.

Crowdfunder
Any and all comers on the internet who pre-order an unbuilt item in the hopes that it will some day get built and be cool/solve a problem. They’re not expecting financial return, but do want regular updates on what’s going on with the project and when they can expect delivery. Hiding problems is a lot worse than transparently failing to deliver.

Family and Friends
While your friends and family are probably hoping to get a huge return from their investment, they’re more likely motivated by wanting you to get a chance to succeed and be happy. They are unlikely to try to negotiate terms, though in contrast you will feel the worst for losing their money. Take money from them if you need it and only after making sure they fully and completely understand that they are likely to lose anything they give you. You also need to be okay with losing all of the money someone you care about gives you. If you don’t think this is true, don’t take money from them because it will likely hurt your relationship.

Family office
These are the private investment vehicles for super high net worth individuals and families. Whereas some individuals invest their own money as angels, those that get to a certain scale often employ staffs of portfolio managers and investment professionals. There are many different structures here. Some family offices are structured like single limited parter hedge funds with a high tolerance for risk, and others are structured more conservatively. Whatever the risk tolerance, the staffs of family offices generally get carry on their investments as well as salary, which introduces some of the incentive dynamics present at VCs.

Generally, these entities are very concerned with not losing their principal. Whereas a VC fund that loses an entire fund will have a hard time raising other funds, a family office that loses all its principal has no recourse for more funds. Generally, if you get an investment from a family office, it will come from a small portion of a portion of an overall investment portfolio.

Corporate investor (direct)
There are a lot of corporations that like to talk about investing in startups. Some of them actually do this, and some do not. When an investment comes directly from the company's balance sheet at the direction of a particular business line, the corporation is usually looking for strategic value from the investment. Most of these companies know that investing in startups is unlikely to change the valuation of the investor.[2]

This means they either want an inside edge to acquire you at some point, or believe that investing in you will help improve their bottom line. They may want to prevent you from selling to competitors in the same space, and may have other confusing and onerous ideas. This is because their incentives are different that those of most startups - they are more concerned with how you can help them than with how they can help you get gigantic.

Corporate investor (venture arm)
While corporate venture arms have some of the misaligned incentives of direct corporates, they generally have a mandate to generate financial returns for the company's balance sheet. This means they act more like VCs, and are typically more conversant with how startups work.

Government
Governments have many reasons for investing in startups. There are many government grants available in various countries that are designed to promote startups as way to increase job growth. There are also government agencies with their own venture funds, generally designed to fund technology that will help the government in the long run.

University endowment
University endowments are similar to family offices, but they represent an endowment. They are designed to produce returns to fund the university over time. These entities do not generally invest in early stage companies except in conjunction with a fund with whom they have a strong relationship.

Seed fund
Seed funds are VC funds that write smaller checks at early stages of companies. They usually have the same incentives and structures.

Hedge fund
Hedge funds are largely unrestricted pools of capital. Traditionally, these were focused on public market investments, though in the last few years have started investing in startups. Generally, they invest in later stages and are looking for returns on capital as they have LPs and similar incentive structures to VC funds.

Mutual fund
These are large pools of capital run by portfolio managers. They don't have LPs, rather they have large groups of retail investors who buy shares in the funds, which capital they can then deploy. These funds only invest in late stage startups, because they need to deploy a lot of capital to have any kind of impact at the portfolio level. These managers are paid based on performance, and often have reporting requirements that cause them to publish their internal marks for private companies. This has caused a lot of consternation lately as Fidelity has been publishing widely oscillating valuations for a number of companies like Dropbox.

Sovereign wealth fund
These are the largest pools of capital in the world, and are essentially very large family offices for entire countries. These funds are large enough to invest in any and all asset classes that the managers believe will produce a return on investment. Like mutual funds, these funds rarely invest directly in startups - they are more likely to invest in funds that do.

In the last few years, however, a number of them have begun to invest directly in startups. While the managers of these funds are generally paid on a performance basis, there are a lot of other complicated incentives in place at certain funds deriving from political requirements. These are pretty hard to parse.


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[1] I don't actually love the term Angel as it seems insufficiently precise given the wide range of investors to whom it applies. While it would probably make sense to find other terms for subgroups, the key thing to know is that. Maybe we'll try to rename them down the road.
[2] Yahoo's investment in Alibaba is a rare exception to this rule.

Thanks to Paul Buchheit, Geoff Ralston, Daniel Gackle, and Dalton Caldwell for your help writing this.
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Aaron Harris
tag:www.aaronkharris.com,2013:Post/1058740 2016-06-02T17:09:55Z 2016-10-10T00:26:55Z Carts without horses

Investing in emerging markets such as India, Kenya, and Nigeria isn’t quite what I naively thought it would be. Before I started, I thought that finding a good company in an emerging market would just mean copying models that worked in developed markets. All I’d have to do is figure out how the business would need to be tweaked for a lower price point, identify the best founders working on the problem in the new market, and invest in them. Any structural difference in the new market would just serve as a barrier to other companies from moving in. In the last few years, though, I’ve learned that while this is one way to invest, it’s unlikely to identify the largest companies that have yet to be built. I now think that the better way to invest in startups in the developing world is to ask “How would you solve a problem if you started fresh with today’s technology?”

This probably seems like an obvious question, and one that founders and investors should be asking themselves with any opportunity. But, one of the more surprising things that I've learned is the degree to which the sequence of technological adoption changes the opportunity set available to startups and how we think about them. This isn't something you can actually see when looking at a single market, it's similar to comparative literature where each pair of markets that you examine in tandem illustrate the differences and gaps.

Credit cards and payments are a good way to illustrate this dynamic. We'll use the US as the base case. The US has an extensive and well established financial system, from trustworthy savings banks to a wide array of credit options to standardized and reasonably secure systems for transferring money. When M-PESA, Kenya's mobile money transfer system launched in 2007, Kenya did not have many of these pieces of infrastructure. What they did have was an unmet need to quickly and safely transfer money over long distances. They also had Safaricom, the largest cellular operator in the country. Not only did Safaricom provide the phones and coverage needed to make transfers possible, their network reached more of the population than the branches of any bank. On top of that, the banks lacked the lobbying power to kill off an upstart that was actually being run by a powerful company.[1]

Contrast this situation with the one faced by companies like Venmo on launching in the US. The foundation of the market is different here, with huge amounts of regulation governing money transfer alongside a fairly sophisticated (if not perfect) system to send money. Mobile money is just a convenience in the US and also faces barriers to widespread adoption from entrenched technologies, user behaviors, and regulations. In contrast, mobile money is a solution to a deep and unmet need in Kenya with a relatively green field from competition, regulation, and behavioral norms.

M-PESA wasn’t a startup that investors had access to, but let’s pretend it was. If those investors had focused on how a payments company would ever make significant revenue given the small size of the average transfer, they would have missed the opportunity to invest in a system that was handling 25% of Kenya’s GNP in 2013!

Something similar is currently playing out in India. Imagine if the first credit cards had been created today, with ubiquitous smartphones, rather than in the late 40s. Instead of serial numbers printed on paper[2], you’d probably have an app tied to your phone and some uniquely verifiable identity token. It would be easier and more efficient to create a vertically integrated system that combined the features of multiple players within the payments stack. This is the situation in India, where there are around 20 million credit cards and 220 million smartphones. Credit and debit cards aren’t a big thing there, which is why payment is so often handled in cash. In fact, they have a Cash on Delivery (COD) rate of close to 80% for goods purchased online[3]. That means that there are opportunities to build startups in India that look like credit card processors in the developed world, but there’s an even bigger opportunity to invent a new way for people to pay, and to own all the pieces.

It probably makes sense to always try to identify the optimal solution to a problem no matter where you are investing. However, finding ideal solutions is harder to do in developed markets because there are layers and layers of infrastructure, technology, and regulation that have gradually built up around most big problems. No matter what approach you take to a problem, those factors will influence how you think about it.[4]

It seems to me that the best investors are those that can most clearly articulate this thought process and hold onto it while accommodating the particulars of a given market. This is the underlying logic for investors who talk about the importance of identifying new platforms, or of catching the next wave. The companies that fit these criteria rewrite the rules of how their markets work by building entirely new foundations of infrastructure and user expectations. By doing so, they unlock the types of huge opportunities that you'd otherwise only expect in a developing world market with a clean slate.

While some great founders may think this way, many of the best simply have a vision of the world as it should exist that’s only possible with what they are making. Rather than trying to work around barriers, these founders either ignore them or are naive about their existence. Either way, they end up building things that others would have deemed too hard or pointless because of all the things other people had done. I think that's why so many great companies start as projects without much attention to commercial relevance.[5] When you start thinking about all the million different things that an existing market imposes on a new idea, it can be enough to stop you in your tracks. That's not to say that great founders ignore the market. What they actually do is react rapidly to what their companies encounter on first contact and move quickly to adjust and get better.

Developing markets are a kind of mirror of the future, or maybe of the present if things had happened differently. As such, they're hugely instructive in understanding the types of companies that can be built, and of the founders who can build them. I think it’s clear that there will be huge startups built in the developing world. More importantly, though, thinking about how and where those startups will occur forces us to think about solving problems from first principles. Starting with a clean slate lets founders and investors think about how to change the world as quickly as possible, rather than incrementing their way forward.

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[1] The Economist has a great analysis of M-PESA’s success here: http://www.economist.com/blogs/economist-explains/2013/05/economist-explains-18. Sorry about the paywall.
[2] I was recently in the office of a Final (https://getfinal.com/), where Aaron Frank showed me a bunch of the early charge and credit cards. They have them in lucite boxes, like really valuable baseball cards, which I thought was really cool.
[3] As crazy as it might seem to hand cash to the UPS driver when he delivers your latest Amazon order, that’s exactly what happens in India (minus UPS and probably Amazon).
[4] There’s an echo here of George Oppen’s belief that it is impossible to actually be objective when writing because of the degree to which bias is ingrained into the subconscious and influences everything we do.
[5] There are, of course, founders who started with full knowledge of the challenges of their market and built huge companies designed to capitalize on existing inefficiencies.

Thanks to Scott Bell, Garry Tan, Geoff Ralston, and Nitya Sharma for your help thinking this through.
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Aaron Harris
tag:www.aaronkharris.com,2013:Post/1013826 2016-03-16T16:44:23Z 2016-10-25T14:02:24Z Bad Terms

Every startup fundraising process is influenced by the balance of power between the founder and the investor. When the founder has a company that is doing incredibly well, and is being chased by lots of investors, the founder has more leverage. When the founder is inexperienced, or has a company that hasn't yet gotten a lot of traction, the investor has more leverage.

Often, the output of this shifting balance is reflected in the price agreed to by the two sides. It tends to be higher relative to progress when the founder is stronger, and lower when the investor is stronger. When the two sides are equally experienced, the negotiation is usually “fair” in that both sides know what they are agreeing to. Whether or not they are happy with that is another question.

There are, however, situations that arise in which investors take advantage of inexperienced founders and get them to sign terms that are potentially harmful to the company. Investors that do this want more economic upside and know that they can exploit the founder without the founder even knowing what's happening.

How bad terms can hurt

While I've seen a number of examples of this, there's one I saw recently that was particularly bad. An investor got a first time founder to give them a Right of First Refusal (ROFR) for 2.5x their initial investment on any fundraising that that founder subsequently raised prior to an equity financing round. There are a number of bad things there, but the part that makes this even worse is that the investor has 60 days to say yes or no to the ROFR, no matter what the company does.

Imagine the company were to raise $50k on a 4mm cap safe today, and then 500k on an 8mm cap safe in 55 days - which can be a very long time in the life of a startup - the investor could put in 250k at 4mm! This means that the founders of the company cannot adequately plan out their allocations to new investors, figure out how much dilution they'd be taking, or even know how much money they'd raised until 60 days after the last financing. This kind of uncertainty is terrible for founders and for companies. It is a major distraction and complication at a time when the founder really needs to focus and know what's going on.

This isn't just true about early stage rounds. Founders who are really successful at early stages may find themselves raising late stage rounds where they are again inexperienced. This can lead to founders signing terms that seem good or inconsequential at signing, but lead to really bad things down the road. For instance, a number of founders agreed to ratchets as a trade off against higher valuations in late stage rounds. This is fine if everything goes better than planned, but can hurt the company, founders, and earlier shareholders if things don't go as well as hoped.[1]

Some terms to watch out for

It would be hard to make a comprehensive list of all the bad terms out there, but here are some to watch out for: How to avoid bad terms

There's no way to list out all of the bad terms that investors can put into term sheets. There are, however, things that founders can do to stop this badness from hurting them:
  1. Read every word of every financing that you sign. Make sure you understand each clause, and what that clause will do in the future in different scenarios. If there's anything a doc that you don't understand, don't sign the doc until you do understand those things.
  2. Get a lawyer that understands startups. It's important to find someone with experience. Not only can a good lawyer explain what's going on with terms of your agreement, he/she can tell you if those terms are standard. Lawyers can also help you negotiate, though this is usually more relevant in priced rounds.
  3. Be really careful of side letters. If you're using a standard doc, like the YC safe, it's probably already well balanced and understood. When an investor wants a side letter, they want something non-standard. This isn't necessarily bad, but it should make you extra cautious.
  4. Get help from more experienced founders, particularly ones that have seen multiple financings. They'll be able to give you perspective on what makes sense and what you should push on. They may also be able to help you negotiate.
  5. Know that, ultimately, if you are desperate for financing, you may have to accept bad terms. While that's suboptimal, it is ok if you understand what you are agreeing to. It's rare that a single bad term you understand will kill your company, though the aggregate impact of terms you don't understand can materially change your outcome.
Mitigating bad terms

While these steps can help with future fundraising, there are many founders who have already agreed to bad terms (either through necessity or ignorance), and aren't sure what to do about it. This is tough, because it will depend on whether or not the investor inserted the bad term knowing it was bad for the company, or if they thought it wasn't so bad. As a founder, you should find out, and try to remove it. There's no perfect way to do this, but the first step is to ask the investor to get rid of the term. Say that you were talking to your lawyer or friend and that they pointed out that you signed a term you didn't understand. Ask the investor if you can remove it so that you don't have to worry about it. This will get rid of some portion of these bad terms.[2]

If the investor refuses, your options are more limited. If you have a strong network of other investors or advisers, you can ask them to pressure the investor to change. We've done this a number of times for our companies at YC. Remember that startups, and investing in them, is a long term bet. Reputation matters and smart investors - whether or not they are “good” - will know that screwing a company will end up hurting them down the road. You can make clear that you'll let other founders know about the bad terms you signed. An investor can probably sustain this happening once, but if that investor acted badly towards you, they've likely done it to a lot of companies. If many companies start talking about how bad that investor is, the investor will cease to be able to invest in companies and will have to find a new profession.

The investors that force these terms on unsuspecting founders fail to realize that the big outcomes in investing don't come from clever terms, they come from outliers. Even more than that, asking for these terms is a direct signal that the investors isn't a good investor. I'd avoid those investors asking for these terms, and I tell founders to do the same. In fact, inserting bad terms into funding documents is a good way to limit the number of chances investors have to invest in those black swans because adding those terms will destroy their reputations - it's just a question of how long it will take.
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[1] Here's a good explanation of how this has actually played out recently: https://www.cooley.com/files/TechIPOsTriggeringMore'Ratchets'InShakyMarket.pdf
[2] This will probably only work for early stage rounds and investors. Later stage investors are more hard nosed, and will hew tightly to caveat emptor.

Thanks Geoff Ralston, Andy Weissman, Dalton Caldwell, and David Tisch for your help on this.
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Aaron Harris
tag:www.aaronkharris.com,2013:Post/1006168 2016-03-03T16:56:49Z 2016-05-09T22:22:12Z Utopia Bets / Apocalypse Bets

I think that it is nearly impossible to figure out the exact changes that new technologies will create in the world. That's problematic because investing in startups is largely about figuring out whether or not a team with a new technology - or application of existing technology - will create a change large enough to support a big new company.

Not only is it hard to figure out what changes will happen, it's hard to figure out what changes will happen over given periods of time and if those changes are good or bad. In fact, it's probably safe to assume that any given technology will create badness over certain periods of time even if the long term impact is highly positive. Computers are a good example of this. During WWII, IBM punch card machines (not quite computers, but getting there) were used by the Nazis to organize aspects of the Holocaust. At the same time, Alan Turing was building the foundation of modern computing to crack Enigma. Internal combustion engines gave us mobility and trade on a previously unimagined scale, but also led to anthropogenic climate change.

Since there's no way to know every change that a piece of technology will produce, I think there are two ways of evaluating what to build and invest in. I think of these as Utopia Bets and Apocalypse Bets. The most extreme example of this dynamic comes from AI. In one framing, AI creates a world in which all of our hard problems are solved and humanity devotes itself to exploration, art, and generally being good. In the other extreme, the AI wipes us out.

I've found that many people like to talk about their Apocalypse Bets. There is something emotionally satisfying about being cynical and painting a dark version of the future. I think one of the reasons people do this is because they don't want to look stupid and they want to hedge against bad outcomes. If you predict something will go well, and it doesn't, not only does a bad thing happen, but, worse, you are humiliated for being wrong! If you predict something will go badly, and it does, at least you were right. If it goes well, your life is better, and everyone forgets about you being wrong.

Certainly, Apocalypse Bets are popular in the public imagination and press these days, as you can see by looking at books and movies where technology gets away from man and destroys us. Turning on the news or reading the paper, you can find any number of talking heads discussing why our love of technology gave us unstoppable pollution, weapons we can't control, and epidemics ready to wipe out half of humanity.

Add into this that whenever the market starts going down or volatility picks up, talk about how much worse everything is going to get becomes more common because people are scared. There are investors that have made a lot of money off betting that things will get much worse, mostly in the form of shorting the market in one way or the other.[1] No matter what the talking points are, though, I've never actually met someone who makes venture investments in Apocalypse Bets, regardless of how bearish they are about everything else.
I think this is because capitalism is a bet on the future. Investing over the long run has a positive expected return because markets believe, overall, that the economy will grow.[2] If you didn't believe this, you'd never invest. If that's true, then I think venture investing is an exercise in optimism.

The whole process of betting on future return is magnified by startups. In startups, the founders and the investors are betting that a small number of people can change the way the world works, and make a lot of money in the process. It seems that most of the changes that founders are trying to create improve the world. I can't think of ever hearing a pitch where the founders argued that the world getting worse would be a net positive for their business. This might be an argument made by arms manufacturers, but I don't know as I've never been pitched by one.

Startups, then, are making Utopia Bets. It is rare to find a founder who argues that their company will, by itself, bring about Utopia[3], but they mostly believe that the aggregate force of technological change is pushing humanity to a much better place.[4] This makes sense, seeing as how spending your life working towards making the world a worse place would be depressing for anyone that isn't a supervillain.

The best investors I know look for Utopia Bets as the direct rationale for investing in a given company. Investors rarely pick a specific solutions which they think will bring about a better future and then finding a company to do that thing. Instead, they'll often start with a question similar to: “In the future, cities will have 40mm people. What needs to be built to make those cities function well?” This leads to branches of sub-questions and hypotheses. The investor would probably need to think about transportation, communications, logistics, etc. Each of those areas gives rise to a potential set of companies, towards which those investors will be receptive.

This thought process can be useful to investors in two ways. On one side, having a distinct view of how the future will be better gives investors a way to publicly talk about what interests them. If they say intelligent things, founders who are thinking about the same ideas will reach out to talk about those problems. Some of those founders will be really good, and may end up building companies which the investors can put money into. There are also many people who have thought deeply about these problems, but didn't think anyone would fund the crazy ideas they had to bring about a better world. When those people come out of the woodwork and build companies, not only would the investor likely the first opportunity to invest, but, even if the investor passed, there's a net good of new interesting ideas being tried in the real world.[5]

The other good thing that happens through this thought process is trickier. Thinking deeply about certain problems can be a really helpful filter when deciding to invest in ideas, but it can also be misleading. On the one hand, thinking deeply about a given set of ideas can help differentiate what is good and what is bad. Conversely, it can also create significant bias towards funding ideas that seem like a perfect Utopia Bet, without considering the founders. From this perspective, any bet is great if it stands even a tiny chance of making the world better.

That usually leads to funding companies that only seem good. It's much better to consider whether or not the founders are actually good and likely to build the company that will help make the Utopia Bet come true. You can get a read on this by working through how deeply those founders have thought through the idea as it relates to the way the world is going to change. In fact, the best Utopia Bets are about the founders and their views on how the world will change, rather than the a priori assumptions of the investor. These a priori assumptions can actually end up creating throwing false negatives,[6] because the best companies often exploit something in the market that outside experts have dismissed as non-viable.

This fits well with the idea that the best founders should know far more about what they're making, and be far more passionate about it, and be thinking far more originally about it, than anyone else. These founders should continually upend how the investor thinks and the investor should be learning more from the founder than vice versa. If an investor actually knows more about the idea, and is so passionate about it, that investor should build the company!

Founders who find investors whose view of the future echo - but doesn't mirror - their own end up in a relationship that is far more collaborative than those who take money from investors motivated only by returns. When looking for investors, it's important for founders to understand what sort of Utopia Bets individual investors want to make, because it will help frame the conversation and create a real dialogue in which both sides learn. That's a far more effective route to raising money than one sided pitching.

This isn't to say that the relationships formed through this process will always be smooth. In fact, when two people with strongly held visions of the future get together, every difference in that vision can lead to conflict. However if both sides are truly pulling for making the future better, they should be able to find a way forward together to build incredible things.


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[1] John Paulson (https://en.wikipedia.org/wiki/John_Paulson) almost $5B off of one set of linked bets against the rising housing market. George Soros “broke the pound” in 1992: http://www.investopedia.com/ask/answers/08/george-soros-bank-of-england.asp. That felt like an apocalyptic bet, but it also may have helped UK break a recession. He also then bet on the Pound and made more money! (thanks for the info, Elad!) I see these bets as different than shorting a company because of their basis on big macro trends.

[2] This isn't true of short term trades where investors are often betting against temporary pricing imperfections. That reflects a different kind of optimism - confidence that you are smarter than markets.

[3] Though I've met one or two. They're either crazy, working on AI, or both.

[4] Bill Gates talks about this quite a bit, and links it back to his and Paul Allen's original vision for computers: https://www.gatesnotes.com/2015-annual-letter?page=1&lang=en.

[5] We've actually noticed both of these trends in response to our Requests for Startups https://www.ycombinator.com/rfs/.

[6] False negatives are one of the scariest mistakes that investors can make because of the way returns in VC are dominated by the outliers. See: http://paulgraham.com/swan.html

Thanks to Andy Weissman and Elad Gil for helping me think about this.
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Aaron Harris
tag:www.aaronkharris.com,2013:Post/989060 2016-02-11T16:58:52Z 2016-02-11T16:58:52Z Don't focus on the NASDAQ

While thinking about wiggles (Ignoring the Wiggles ), I looked at when the biggest tech cos in the world started relative to NASDAQ. At first, I thought I'd find no correlation between how well the index was doing and when successful companies were founded.



I love looking at this in chart form, which shows just how many market moves these companies have weathered as they've grown.

[1]

I was actually surprised to discover that most of the companies on my list were founded while the market was doing relatively well on a trailing 1, 3, and 12 month bases.

Of course, if the founders of Microsoft, Google, and Cisco had looked at the returns of the NASDAQ in the year leading up their decisions to start their companies, we wouldn't have three of the most successful companies in history. I'm glad they didn't stare at the market wiggles.

There's also an important lesson in here for me as an investor. It's easy to get excited about startups when startups are doing well and when the economy is roaring. It's harder to be as excited when public markets are down and I'm seeing flat and down rounds. The easy sounding lesson to draw is usually along the lines of being aggressive when others are fearful, and conservative when others are aggressive.

But I don't actually think that's right, I think the right answer is to ignore everything else and judge founders and their companies on their fundamentals. That seems clean and easy in principle, but is difficult to put into practice because one of the things investors do is make a bet on the paths of markets over time. When markets seem to be saying bad things about the future, and market pricing is a bet on the future, it can be tough to ignore them or bet explicitly against them. If markets are exuberant, it's almost as difficult to be confident that you're paying an appropriately high price or investing in an actual good company. It takes time to form that confidence on the basis of fact rather than just guessing and justifying it later. I'm still working on that.

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[1] Data is from http://www.macrotrends.net/. Scale is log.
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Aaron Harris
tag:www.aaronkharris.com,2013:Post/946063 2016-01-04T19:30:02Z 2016-10-02T07:18:26Z Exceptionalism

Startups that do well often follow a set of common principles. These principles influence how they develop products, build teams, raise money, and get customers. The most successful startups, though, are exceptional and often seem to go against these principles in various ways. For founders looking to learn from the experiences and paths of other startups, this can cause confusion and lead to bad decisions.

I think this happens because of how hard it is for outside observers to understand the full context of why given decisions are made in other organizations. It is also nearly impossible to separate causation and correlation, even with perfect understanding of the rationale behind a decision. I've spoken with many founders who point to outcomes at other companies as justification for decisions that they are making with their own companies. These founders rarely give enough weight to to factors like timing, luck, and the impact of particularly skilled employees or founders in producing those outcomes.

That creates a paradox. One of the best ways to learn how to succeed is to follow good examples set by others. At the same time, following those examples can often lead to very bad decisions that harm companies. Figuring out which examples to follow, and how to follow them seems hard.

There is, however, a clear framework for figuring out what to do. First, don't do anything just because you see someone else doing it. For instance, there are many successful jerks, but that doesn't mean you should be a jerk. Some companies succeed while spending huge amounts of money, but you should probably spend as little money as possible to achieve your goals.

Second, when you see a successful company doing things that appear to break from sound principles, look at those examples through the lens of your own company and circumstance. If you take the set of things that exceptional companies do, and overlay it on the set of things that make sense for your business and team, you'll end up with the set of things you can learn from exceptional companies and mimic. You can do this even without perfect knowledge of causation, because simply knowing that something is possible is often enough, given the right people, to achieve it.

You can also look at your existing practices and plans to discover whether or not you have to change them. First is to look at the decisions you are making at your company and ask whether or not you've derived them from the logic of your own business, or if you're doing them only because you saw a successful company do something similar. If it's the latter, you then have to figure out if those decisions make sense in the context of your business without the benefit of outside examples. This is especially hard to do because you can't use your own exceptionalism as a reason for doing something. People and companies aren't exceptional because they say they are. They are exceptional because evidence shows them to be so.

What's really happening when you run this exercise is that you're deriving decisions for your company from first principles. Things other companies do may provide some ideas, but the best decisions come from focusing on what will help your company succeed on its own terms.

As your company grows, you may realize that many of the things you do don't line up with the principles you initially thought would govern your company. That's a good thing, because it means that you've figured out the pieces of your business that are exceptional. While you can't copy exceptionalism, proof that it is possible is everywhere. You can use examples of that proof to help make decisions, but ultimately, you'll have to create it yourself. And if you can create it, you have a good shot at building a great startup.


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Thanks, Geoff Ralston, for your help writing this.

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Aaron Harris
tag:www.aaronkharris.com,2013:Post/923634 2015-11-12T17:12:43Z 2016-10-02T07:38:09Z Things that aren't progress

A few months ago, I wrote about things that look like work, but aren't. As I paid more attention to founders doing these things, I started thinking about why they were happening. I realized that the behaviors were largely a function of bad goal setting.

When founders choose bad goals, they create bad metrics around them and try to hit those metrics. This means that those founders are optimizing for things that look like progress, but aren't. This is dangerous for startups because founders that aim for bad goals warp everything they do towards measures of progress that don't help the business grow and succeed.

If you find yourself thinking that these things are progress, you need to examine what you're aiming for.

Things that look like progress but aren't:

  • Conversations with large enterprises - This is a big one for companies that rely on enterprise sales. Usually, these "conversations" are non-binding, low level, and scattered. They rarely lead anywhere. There is a type of conversation that is actually progress, but it is generally paired with a clear sales plan, a list of stakeholders, and clear asks met along the way.
  • Press mentions - This feels so good, which is why it is tricky. External validation is awesome! But it isn't as awesome as engaged users or paying customers. If you're looking to get press as a means of building SEO, then press mentions can constitute progress. That only makes sense if SEO is part of your strategy and you're measuring things properly. Russ D'Souza talked abut how they do this so well at Seatgeek: http://chairnerd.seatgeek.com/how-seatgeek-measures-pr-coverage/.
  • Winning awards - This is another one of those pieces of external validation. Certainly helpful when proving to your mother that you're not wasting your time, but not material to the success of your company. Awards may recognize either the progress you've made, or how good you are at PR. Focus on making progress.
  • Getting retweeted by someone famous - This is similar to press mentions, but even worse. When a founder is trying to do this, they're usually working on their personal brand at the expense of their startup. That's definitely the wrong thing to do.
  • Meeting someone famous - Famous people are really interested in startups these days. It feels good/cool to say you met someone famous. Don't underestimate the value of having great experiences, but don't mistake it for a sign of success.
  • "Getting into" elite conferences, like Davos - This is some strange combination of awards and meeting famous people.
  • Eyeballs - Had to include this because it's part of what drove valuations in the tech bubble. Turned out this wasn't progress. There's a corollary today: uniques. That can be a good measure of progress if you're a media site generating revenue off of impressions, but in almost all other cases, it's a vanity metric.
  • Cumulative registrations - The cousin of eyeballs. People who register for your company but don't use it aren't actually helpful. In fact, this is probably a bad sign because it means that people don't actually want to use your service. (Suggested by Geoff Ralston)
  • Hiring - When you hire for the sake of a world class team, that isn't progress. If you're hiring because you can't handle the load on your service or product, then it probably is a good sign and it is progress. (Suggested by Paul Buchheit)
  • Fundraising - So many founders confuse raising money with success. That's how the press views it, but it's one of the worst things that founders can tell themselves. Fundraising is just a tool to accomplish your real goals, not a goal in and of itself.
  • Getting into an accelerator, even YC - This is a corollary of fundraising and awards. At YC, we'll do our best to help you figure out what your goals are (if you don't already know), and work with you to achieve them, but it's what happens after you get in that counts, not getting in. YC is neither necessary nor sufficient for success.
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Aaron Harris
tag:www.aaronkharris.com,2013:Post/911449 2015-09-30T16:36:21Z 2016-12-16T22:22:05Z I and We

Starting a company is, in large part, an act of ego. When that business is a startup, the ego component is even larger. This is a good thing.

Ego is what gives the founder the confidence to create something new. Ego powers the belief that the new thing the founder creates will be good enough to change the way that tens, thousands, even millions of people live their lives. Maybe we don’t always call this ego -- maybe we call it vision, or confidence, or passion -- but the idea is the same.

But as important as ego is to the founding of a company, it is also corrosive to the creation of a good culture. Unbridled ego becomes arrogance. It doesn’t allow for other people to achieve and contribute. Founders who do not keep their egos in check are unwilling to acknowledge the help given to them by others, and have a hard time building and retaining great teams.

To start a company founders need ego, but to build a great company, founders need to be modest. Modesty is what allows founders to see all the things that contribute to their success, especially the things over which they have no control. With modesty, founders can see the important role of luck in their success. They can recognize, acknowledge, and reward the part played by cofounders, employees, and customers. They’re resilient when things go wrong because they can see beyond themselves.

The interplay between ego and modesty is obvious when you hear founders talk about their companies. As a company grows, the best founders increasingly talk about “We” and not just “I.” Every discussion about the achievements of the company is a chance to highlight the contributions of other people and of the organization overall.

This isn’t to say that the best founders disappear into the background of their own companies. The “I” still plays a strong part. It remains the founder’s job to consistently set the vision and the example for every employee. When that goes away, a company risks moving into stasis or decline.

Perhaps the most important place to use “I” over the life of a company is when things go wrong. When figuring out what happened, and who bears responsibility for fixing a problem, “We” is insufficient and even dangerous. In that case, modesty doesn’t drive the use of “We,” arrogance does. Arrogance won’t allow a founder to admit that he was wrong, so he slides to “We” to cover for it, to blame the organization. But diffuse blame means that no one figures out what actually happened and how to fix it. Do that often enough, and the badness grows until it kills the company.

It’s tough to balance “I” and “We” and it gets harder as a company grows and becomes more successful. As a company does better, the easiest stories for the press to write are those about the genius of the founders. At the same time, as more and more things happen at a company that the founders don’t directly touch, founders may start to feel disconnected from the thing that they created. This is a hard thing to face, and some founders respond to it by claiming sole credit for successes that are the work of many people. From the other side, as the company grows, some founders fade into the background and stop providing the singular vision and leadership that the company needs to succeed.

There doesn’t seem to be an easy answer as to how to strike the right balance, nor is there a single paradigm for what works best. What does seem clear, though, is that founders need to keep these questions in mind, and, if they find themselves only using “I” or only using “We,” to think long and hard about what they might be missing.

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Thank you, Colleen Taylor, for your edits.

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Aaron Harris
tag:www.aaronkharris.com,2013:Post/892088 2015-08-10T14:23:51Z 2016-09-04T01:24:17Z Presumption of stupidity

I've noticed a common bias that shows up in some founders: they believe that their competitors are stupid or uncreative. They'll look at other businesses and identify inefficiencies or bad systems, and decide that those conditions exist because of dumb decisions on the part of founders or employees. 

This is a bad belief to hold. In truth, competitors in the market are usually founded and run by intelligent people making smart and logical decisions. That doesn't mean that all the decisions they make are necessarily the right ones, but they're rarely a function of outright stupidity.

Where companies do things that diverge from what seems smart from the outside, it's a much better idea to ask why those companies are doing things from the presumption of intelligence and logic rather than the presumption of stupidity. If you don't ask these questions, you might find yourself making the same decisions, or ending up in the same place with your own set of rationalizations. I see this all the time.

In fact, we made this mistake when we started Tutorspree. We looked at all the local agencies and the way that they acquired customers and charged for packages of lessons. We assumed they asked for so much money up front because they were greedy and not smart enough to figure out a better system. It turned out that packages of lessons were a logical outgrowth of high upfront acquisition costs and the long term dynamic of tutor/student relationships. A large enough subset of customers appreciated the breaks on pricing and commitment created by booking multiple lessons up front that it made sense to model the business that way. It took longer than it should have to realize this because of our bias.

If, instead, you presume intelligence and analyze the reasons a business looks the way it does, you will often see the challenges you might face ahead of time and, as a result, design a solution that is actually better, as opposed to simply looking new. It is a lot harder to think this way because it means that you can't just dismiss the things other people do and assume you'll be better. You actually have to prove that you know how to be better. That can be really scary because, much of the time, you might not be able to figure out how to be better. Everything you think of might lead you to the same place you see your competitors.

That, though, is no reason to stop working on your company. I think it's actually a reason to keep going, and to keep gathering information and generating new ideas. This is part of what's so cool about starting a company, you get to make up new rules as you go along, and you can toss out old ones as you go along. Two founders looking at the same problem can easily come up with multiple solutions. Each solution might look similar from far away, but the small differences add up. Importantly, if you know that other smart people started in a similar place and ended up with the wrong answer, you'll think a lot more critically about each of your decisions and never get lazy about challenging your own assumptions.

Of course, just because you presume intelligence doesn't mean that every decision made was smart. People and organizations make bad decisions for all kinds of reasons. The thing is, you don't learn much by understanding that a call was bad, you learn by understanding the inputs and the organization that enabled the bad decisions.

Even with this framework, there's no guarantee that you'll end up in the right place, no matter how much you analyze those whose decisions have left you with an opportunity. At the end of the day, there's only so much you can learn from looking at competitors. Truly great businesses aren't built as counterpoints to existing companies. They become great because they meet a deep need that isn't being satisfied. That usually requires the kinds of creative and cognitive leaps that no amount of market analysis could possibly give you.

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Aaron Harris
tag:www.aaronkharris.com,2013:Post/886966 2015-07-27T17:23:40Z 2015-10-26T16:18:06Z Private infrastructure

When infrastructure is built, it usually starts out as a large scale project that can only be accomplished by government. It can be built in undeveloped areas for a fairly large amount of money, or in developed areas with massive amounts of cash and even more political capital. That's hard to do in democracies, though seems to work well in places like China.

This dynamic means that we'd expect infrastructure to fail over time as the inertia arrayed against repairs and new construction grows. That seems to be what's happening in the US.

When infrastructure decays and fails, though, it creates a lot of opportunities. Citizens who were meant to be served by the infrastructure become unhappy and are when that unhappiness is great enough, they will spend their own dollars on alternatives. This is a more direct process  than funding infrastructure through tax dollars, though it can produce different types of outcomes.

In the United States today, these opportunities are being exploited by a range of startups and companies who are essentially building private infrastructure, mainly for the relatively wealthy.

Food

Instacart is building new infrastructure to deliver food to homes. In most early use cases, this looks like pure convenience, however, over the long run it could impact and start to eliminate food deserts. By making food available in more places, Instacart has the power to change where people want to live. That process will reshape how cities grow and, eventually, are built. I'll also say that in a place like NY, where supermarkets are small, crowded, and overpriced, it seems clear that the current system only exists because there's no better alternative. Instacart is that alternative.

Transportation

This process is also starting to play out on our roads. Most of our highway system was created by a single gigantic bill, the Federal Aid Highway Act of 1956. It would be hard to imagine today’s Federal government getting its act together or finding enough money to repair roads on a national scale. Harder still would be believing that a place like the Bay Area would figure out a way to install effective and efficient public transportation to ease the stress on our roads and highways which are nearly always gridlocked. Technology is starting to provide ways to bypass those problems by improving throughput on existing systems without changing the physical plant.[1]

Self driving cars are the most extreme example of this trend. If we do actually arrive in a world where self driving cars are ubiquitous and built on the same standard such that they can communicate with one another at long range, congestion gridlock should largely vanish as the cars plan miles ahead and subtly change speeds to clear up slow downs before they start. Even before that future, though, apps like Waze help drivers plan better routes and alleviate some stress on the most crowded points in the system.

Energy

I think the trend is also impacting power generation and consumption in the US. Companies such as  Solar City will install your own power plant on your roof which means you're no longer subject to brownouts or price increases at peak times. In most of the US, this is more of a ‘nice to have’ and cost saving measure, but in the third world, solar power could provide a viable and efficient alternative to the construction of large power plants and electric delivery systems. These systems would be a fraction of the price of the old way of doing things and be significantly more reliable thanks to their distributed architecture.[2]

Private can’t mean wealthy

There is, however, an underlying tension in the rise of this new infrastructure in that the first segments of the population to get it are generally the wealthier ones who can afford to use it. Two tiered systems may be fine when they exist in non-essential parts of our lives. However, when there are two tiers, determined by wealth, for services as basic as energy, we're in a dangerous place.

That's part of why infrastructure exists the way it does. No single piece of the population would spend enough money to build services and systems useful for everyone. I think that's always going to be true for certain projects, such as bridges. But, as technology drops the cost of delivering the types of services we traditionally associate with infrastructure, I think we'll see the market extend its reach farther and farther. There's a huge amount of money to be made by ensuring universal coverage, but it won't be easy to unlock all of it.

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[1] At best, though, this is a partial solution. Throughput is well and good, but if the roads actually start to collapse, we'll need other solutions.

[2] Even though this seems like a good idea, there are still quite a few hurdles, not the least of which would be figuring out the right financing structure to make the installations profitable for the companies doing them. This is harder than it might seem for developing countries without sufficiently developed/ubiquitous banking systems.


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Aaron Harris
tag:www.aaronkharris.com,2013:Post/871315 2015-06-24T15:45:24Z 2016-01-31T11:36:13Z We need to rethink employee compensation

I think that the way that employees are getting compensated at startups is starting to break. The old model of relatively low salary and "high" equity only works when there's a healthy public market for that equity in the not too distant future. If IPOs are getting significantly delayed and are potentially at risk of not happening at all,[1] we need to change how compensation is structured.

Options only make sense as compensation when you can draw a clear line from the point at which you get the options to the point at which those options are equivalent to cash. This happens when two conditions are met: 1) the stock price is enough above the strike price on the options to make exercising worthwhile to the employee and 2) there is someone willing to quickly buy the stock. This tends to happen with access to liquid markets, which traditionally means public ones. That's the only place where an employee can sell whenever she wants and can know the price she'll get with a high degree of certainty. It's also the only place where an employee can really hedge out some or all of the risk of her options.[2] That hedging is important if the value of the options rise significantly and lead to an employee having 99% of her net worth in a single illiquid asset.

When shares can only be sold in private transactions on secondary markets, and, increasingly can only be sold with the consent of the company, the options are actually worth less. This is true for three reasons.

The first reason is that control is an important factor in asset pricing. Think about this in a situation where an employee would like to sell stock to fund the purchase of a home. In a public company, that employee could exercise the options, sell the stock quickly and use the cash to buy that home. If that employee instead wants to sell stock in a private company, and the company does not let the employee do so, the employee cannot get the cash to buy the house. Because that employee cannot do what they want with the equity, that employee should discount the value of the options they hold.

The second reason that options are worth less in the absence of robust public markets is that the terms of sale of stock in the future are unclear. An employee being granted options has no idea under what conditions he will be allowed to sell stock in the future. The future sale might be subject to board approval, there might be a heavily restricted set of buyers, the employee could be told that no sales are allowed whatsoever for a variety of reasons. Each of these possibilities adds uncertainty which makes the options harder to value and worth less.

Founders need to account for this change in the value of options when giving them, and employees need to account for the change when evaluating their offers and negotiating. This is, however, hard to do in the absence of information. Without a liquid public market to value stock, it's hard to say what the options are worth. The best guess an employee has in this scenario is to go by the most recent valuation given to the company during a fundraise. The further from that fundraise an employee is, the less relevant the price. Furthermore, without the ability to compare how different employers control and handle the sale of private stock, it's nearly impossible for an employee to know what is standard.

The third reason for why individual options are probably worth less now than they used to be is that both employer and employee need to account for the fact that the time until IPO or liquidity is longer than it used to be. This is a big issue. To get the true value of offered comp, employees need to add their offered salary to the present value of the options offered. When calculating that, the further out the payout, the less it is worth today.[3]

This is an especially important calculation when trying to hire employees away from larger companies who are already public or can offer larger cash packages to employees. Those offers also tend to include options or stock grants which have known price and sale terms. Because of their easy to understand high dollar value, these offers are hard to compete with. Options in early stage startups are much harder to value even without all these new factors. Given uncertainty around the final value of those options, the time until they can be exercised and sold is hugely important. As you move further out on the curve, not only does the discount factor become a larger lever, uncertainty over the final value gets more extreme. You can be pretty sure that a company currently worth $10mm won't be worth $1b in 3 months, so you have a reasonable band of expectation. Once that value calculation moves to years out, nearly anything is possible and needs to be factored into the calculation.

I'm not the only one thinking about this, and, indeed, there are instruments available that let employees take immediate advantage of long term options. Some banks or private investors will provide loans collateralized by options. This can be good, but debt is very different than having cash. Taking advantage of this kind of strategy could also lead to potentially tricky situations where, if the option value as determined by secondary transactions falls (which could happen quickly and dramatically given the lack of liquidity in the system), the creditor could claim the assets before the term is up. Even if the price then recovers, the employee is out of luck and money.

Founders need to deal with these issues, and given how fierce the competition for good employees is, I think someone will do so soon. One response would be to increase overall options packages to account for the fact that they are now less valuable.

Another path would be to create an internal liquidity pool capable of buying shares from employees at predetermined trigger points. Maybe this could be funded by existing investors, or maybe by other employees or existing shareholders. Because the sale points are predetermined and don't provide an open market, the value of options would still be discounted, but not as much as a scenario with no guaranteed access to liquidity.

It may make sense for some companies to start creating revenue share programs as standard practice - especially for companies that never plan to going public (of which there appears to be a rising number). This could be a powerful means of retention, though would only work with companies throwing off enough cash.

I think that something even more basic needs to happen first: companies need to standardize their secondary sale and options repurchase practices. We're living in the wild west right now - each company and each employee is doing things on their own. An employee that wants to sell shares on the secondary market generally starts asking friends if they know anyone who wants to buy those options. Generally, they'll find a broker who offers to matchmake and who then gets a cut of the overall sale in exchange for their work. The price that gets set isn't shared from one deal to another, and the rules around whether or not the company can block the sale aren't standardized. This isn't fair to employees, and will lead to confusion and bad outcomes.

Maybe what we need is two things. The first is a founder pledge that they will do everything in their power to let common holders sell into secondary markets above a certain valuation, say, $500mm. The second is that founders of highly valued private companies need to participate in a robust, standardized, secondary market to allow for the clearance of those shares.

My guess, though, is that there will be a number of different solutions with the market choosing the best one as evidenced by the quality of talent hired and retained by the company using them. Founders should be watching for that and be willing to adopt best practices as soon as they arise.

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[1] There have been a lot of articles and blog posts about this recently, but Andreessen Horowitz's recent "US Tech Funding - What's Going On" is the best analysis I've seen. They note that the average time to IPO is now 11 years vs. 4 in 99, and that the overall number of tech IPOs is plummeting as privately funded companies raise huge late stage private rounds instead.

[2] You can do this a number of different ways and hedge out either your exposure to the company itself or do the overall market. Hedging out this risk probably deserves an entire post as it can get complicated. And, while nearly impossible to do it perfectly, is important to significantly reduce risk.

[3] We'd do this as a lump sum calculation for simplicity. You can play with that calculation here: http://www.calculatorsoup.com/calculators/financial/present-value-investment-calculator.php

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Aaron Harris
tag:www.aaronkharris.com,2013:Post/857721 2015-05-18T21:17:04Z 2015-05-30T23:31:52Z Party (round) all the time?

There are a lot of party rounds happening right now in early stage investing. Definitions vary, but calling a round with greater than 10 investors a party seems about right. My thought is that party rounds tend to leave companies without an investor who cares enough or has pockets deep enough to bridge the company when necessary. Some rounds do actually have a strong lead, along with a syndicate of smaller, useful investors. Those generally have different dynamics.

What I've been trying to figure out is whether or not party rounds are increasing in frequency or not. Anecdotally, it feels like they are. Has something changed in the valley that party rounds should become preferred? The JOBS Act made it easier for large numbers of small investors to back companies in a way that was not previously legal. Platforms like Angel List reduce the friction required to find investors by creating a central, easily accessibly clearing house for companies looking for money and investors looking to give it to them. Or maybe the growing size and frequency of Demo Day type events (YC's included) have created an environment where party rounds are the new normal.

I took a look at Crunchbase, expecting to see that the overall number of party rounds has been rising uncontrollably. Interestingly, that's not what I found.

What's actually happening is that there are more startups getting funded, and the number of party rounds going to those companies is rising roughly in tandem. What's really surprising is that party rounds as a % of overall rounds actually fell from a peak of 3.7% in 2010 to 2.2% in 2012, though it's now back up to 3.42%.

So it seems that we're not seeing a new normal when it comes to early stage investing. We're actually seeing an overall stable pattern ticking up in the last year after a drop. The real story here is the one about the overall number of startups getting funded as the economy has come out of the Financial Crisis. That number is clearly rising, though 2014 tailed off a bit[1]. More startups mean more innovation, and that's great.

The structure and composition of a single round of funding isn't the most important factor in a startup's success or failure. It's just another piece of the story, and one that doesn't seem to be changing much.[2]

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[1] Not sure why the number would have dropped in 2014. Might be a function of the data available to Crunchbase when this run of the db was pulled on April 3, 2015.

[2] I am still curious about whether or not party rounds are a positive or negative influence, but don't yet have an answer.

Title inspired by: 

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Aaron Harris
tag:www.aaronkharris.com,2013:Post/852509 2015-05-07T15:34:07Z 2016-07-04T02:35:36Z Things that aren't work

Recently, I've had a few conversations with founders who, after YC is over, feel a bit lost about what to do next. During YC, the answer of what to do is pretty simple - we tell them to write code and talk to users. Intellectually, they know the answer after YC is to keep building their businesses, but all of a sudden they're faced with a lot of different opportunities, needs, and demands on their time.

This is a tricky time for founders because it can be easy to confuse things that look like work with actual work. Work may mean more than just writing code and talking to users, but it should only encompass things that make your company grow and get better. It can be easy to convince yourself that doing these other types of things make your company better, but that's wrong. These things are mostly for recreation. Treat them that way if you want to, but don't confuse them with what will actually help your startup.

Things that look like work but aren't:

  • Writing blog posts about running startups - This feels good. If it gets onto Hacker News and gets a lot of views, you'll feel really flattered and proud. But don't confuse people reading your post with people knowing and caring about your company.
  • Speaking on panels at startup conferences - If your customers are other startups, and the panel is about something specific you do, great. If not, this is a waste of time.
  • Going to fancy conferences hosted by investors or media - Feels great because  you get to talk to people about how well you're doing. If you were doing that well, you'd be in your office or talking to customers. Simple test for conferences: Are your customers or users there? If yes, could be worth going, if not, then it isn't.
  • Advising other founders - If you know enough to genuinely help, this is a really nice thing to do. It's good to help other founders, but it isn't likely to help your company grow. Make sure you are careful about this and don't let it take up too much time.
  • Investing in other startups - Definitely not work, though it might make (or more likely lose) you some money. This is on personal time.
  • Being a venture partner for a VC - Opposite of work. This is probably taking time away from your startup because now you're working for someone else.
  • Attempting to fix the plumbing in your office - I've done that. Not work. Not the best way to save money. My former cofounders would probably tell me not to insulate the windows myself either.
  • Networking happy hours hosted by investors - This is an opportunity to drink free beer. Great to do in moderation.
  • Having coffee with investors - This can be confusing, because sometimes you need to meet with investors. If you're gearing up to raise money or need specific advice, this is work. Most of the time, though, this isn't work.

Things that don't look like work but are:

  • Writing updates for your investors and meeting with them one on one - I've written about investor updates. These relationships are important, and can be incredibly helpful as you grow. Maintain them.
  • Talking to your cofounders and team - Sometimes, this looks like having coffee or grabbing a beer. Invariably, you'll be talking about work and how things are going. This is work because you need to know what's going on, and need to care about how your team is feeling and doing.
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Aaron Harris
tag:www.aaronkharris.com,2013:Post/804402 2015-01-29T16:43:29Z 2017-01-14T19:52:56Z Cofounder management

It turns out that before founders ever have to manage employees, they have to manage one another. In fact, at the earliest stages of a company, when it's just two or three founders, bad management generally leads to the death of the startup. This kind of management also happens to be really hard.

Despite how important and difficult managing your cofounders is, most of the management advice I've seen is about managing employees or superiors. That's useful, but not at first. What I have read about this stage of management is structured as "treat this as a relationship." That's true, but also general enough as to be only somewhat helpful.

Managing cofounders is hard for a number of reasons:

  1. Initially, there are no clear lines of direct reporting amongst cofounding teams. One cofounder may be the CEO, but that doesn't mean that that person is the best manager or the best suited to lead engineering, sales, or product.
  2. Cofounders rarely have experience managing anyone or anything. They're learning at the same time as running a startup. There are a lot of good ways to manage, but they take time to learn and practice.
  3. Cofounders often think they don't need management because they're all on the same team, working towards the same goals.
  4. Startups are high pressure, and pressure makes people make bad decisions and lose their tempers. Small mistakes get magnified 
  5. Communication is much harder than you'd expect, even when there's just two people.
  6. Deciding to start a company from scratch with the goal of building a billion dollar business takes ego. As a result, founders often have large egos. With every success or piece of publicity, egos get inflated. Failures, public and private can deflate egos, and beat people up emotionally. That roller coaster creates tension, frayed nerves, and fighting.
  7. Divisions of responsibility are often unclear. That can result in turf wars, feelings of encroachment and micromanagement.
  8. Decision making in small teams of equals can be hard, especially when there are disagreements, which are often passionate.

There are many other factors that can introduce difficulties into cofounder management. Fortunately, the set of solutions is significantly smaller than the problem set. These problems stem from root causes which can be dealt with more simply than addressing the various expressions of those causes.

Open communication is the single most important factor in creating a good working atmosphere and provides the scaffold for everything else. It's significantly more important than cofounders liking one another. It is not enough for cofounders to agree to communicate, and generally inadequate for them to talk when the need arises. Cofounders need to establish regular check ins with one another to talk about issues at the company and with one another.

It is often helpful to have these types of conversations away from the office, especially once there are employees. Moving these conversations away from the office limits interruptions and also takes a lot of the psychological tension out of the conversations, especially the difficult ones. My cofounders and I were lucky here. We had a coffeeshop next door, a restaurant downstairs, and a bar across the street. Each came in handy, depending on the intensity of the conversation. We did, however, realize (a bit later than we should have) that disappearing from a tiny office too frequently during the day was a bad idea and hurt morale for the rest of the company. If you find that you can't have these types of honest talks with your cofounders, even out of the office, you're in trouble.

At the earliest stage of a startup, when an idea is morphing into a company, you'll probably have the first of your difficult conversations: you and your cofounders need to divide responsibilities and assign ownership of goals and the tasks that need to be accomplished to achieve those goals. Final decision authority has to be established for individual areas and for company wide decisions. Some of this will rest with the CEO, some of it with the head of product, engineering, or sales. Those roles might be filled by the the same person, but the responsibility flows through the role, not the person.

Remember that this conversation can get contentious if people feel they are being cut out of decisions they believe they should own. It is really hard to cede authority, but it has to happen in order to create a manageable strucutre.

Talk about these issues early, write down your decisions, and regularly review them.

Part of the reason you need to divide ownership of responsibilities early is to set expectations for yourself and your cofounders. Managing cofounders isn't easy, and you shouldn't expect it to be. When you're fighting over who has final say on product decisions, you'll discover just how hard it can be. One of my cofounders and I used to have shouting matches when I acted unilaterally on product without informing him. While he agreed that I had final say, I had failed to convincingly communicate my reasoning to him, and failed to set the right expectation of how product decisions would be made.

The truth is, finding out just how hard managing can be is one of the biggest shocks of working with other people. Having a reasonable set of expectations about it will help. Knowing, ahead of time, that you'll fight, get pissed off, and struggle, puts each of those events in a context that makes sense. Having strategies to work through each of those events means that those events (hopefully) won't destroy your company.

While you'll find some of your own strategies, it's a waste of time to come up with them completely on your own. Management is as much a repeatable and proven process as it is an expression of personal style. The process aspects can largely be adapted from general management literature, but I've always found it more useful to engage with a trusted mentor. In the best case scenario, this mentor is trusted by all the cofounders so that they're learning the same lessons and can use the mentor as an impartial arbiter when needed.

Finding a good mentor is tricky. Doing YC will give you access to some great ones, but certainly isn't the only way. Ideally, you want to find someone who has been through the situations that you're going to experience. You should also expect to need several mentors at different points in your career. The mentor advising you at the earliest stages might not be the person you want when each founder is responsible for dozens or hundreds of employees. The challenges you'll face will be different, as will the advice.

Even with this framework in place, managing your cofounders is rarely easy and invariably gets harder as the company grows and pressures rise. The pressures get amplified even more when things start going wrong, as they always do. You'll fight about important things, and you'll fight about seemingly inconsequential things. That's all ok and quite mundane. Just make sure you keep talking about it, adapting, and moving your company forward. Your goal shouldn't be to make your relationship with your cofounders easier. Your goal is to make the relationship manageable.


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Aaron Harris
tag:www.aaronkharris.com,2013:Post/792244 2015-01-06T23:45:03Z 2016-01-31T11:38:40Z Someone else had your idea first

"I liked Jimi Hendrix's record of this and ever since he died I've being doing it that way..."

- Bob Dylan, on Jimi Hendrix's cover of All Along the Watchtower

Most people are very lazy. They don't want to take the time to think through new ideas or look at them in a new light. Once they've made up their minds about something, they don't change them. That's generally why most people don't come up with ideas for new or great things.

This is also true for many venture capitalists. In fact, it's at the root of a very common question that founders get asked: "Well, isn't so and so doing this?" To be fair, this question isn't necessarily sparked by laziness. It's also sparked by ego - the VC wants to show how familiar they are with the market. They say "Look! I know about things and there's someone else who had the same idea you had." The implicit criticism here is that, because someone else had the idea first, your idea is somehow worse.

I think part of the reason that people ask this question as a way of putting founders down is that they assume that startups are zero sum. That's an assumption born in certain models of markets, but it's completely wrong when looking at startups. Because startups create new value, the idea that someone else has done or is doing something similar to what you're doing often acts to broaden or prove the market you're attacking.

That's not to say that directly cloning another company is a great idea. If you have no differentiation and no original thinking on a problem, then you have to fall to one of two arguments: a) the market for a given idea is so large that there's room for multiple players executing well or b) the other company is so bad at executing that they'll self destruct. They're both potentially valid, but they're hard cases to make - especially at the early stages of a company.

Even though the question might seem dumb, it's one of my favorites. It's also a great question to get as a founder. I ask it of almost every founder I meet, because it's very rare to find a truly new idea. The answer I'm looking for is nearly always "of course someone else has tried this before." But that's not enough. The question begs for a deeper answer, one that talks about why, even though other people have tried the same idea, they're still leaving billions of dollars on the table. It's an opportunity to demonstrate depth of thought and originality. It's that framework of thinking and level of insight that makes greatness.

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Aaron Harris
tag:www.aaronkharris.com,2013:Post/789357 2014-12-30T18:56:28Z 2015-03-26T12:30:17Z We're all communication hoarders

In April of 2004, Google announced that its Gmail product would give users 1 gigabyte of free storage. At the time, Hotmail offered users 2 megabytes and Yahoo offered 4 megabytes. I'm guessing I initially accessed my invite via PINE, and found the idea of using a full gig of storage for email to be crazy. Unsure what I'd ever do with all that space, I initially used it as a remote backup for my thesis.[1]

Ten years later, I have nearly 12 gigs of saved email - and I delete quite a lot. Like a family in a too large home, I hold on to messages I'll never need again for two reasons: 1) the cognitive energy to decide to destroy something forever is greater than the energy needed to put it out of sight for the time being and 2) Gmail's UX actively pushes me to archive rather than to delete. This principle extends across nearly all the communication mediums with which I interact. It is more difficult to delete pictures than to upgrade storage, more difficult to delete texts rather than keep them, and to accept social connections than deny them. In each case, my desire to save against the future wins out against the knowledge that, in all likelihood, the vast majority of what I save will never be useful to me.

This is a strange place in which to find myself. I don't like keeping extraneous items around. To be sure, part of that is a function of living in a NYC apartment with little room to spare. As opposed to my apartment, though, I can assume that my storage space is effectively infinite. Yahoo already offers infinite storage to its mail customers, and it's likely that the other players will follow suit over time. This makes sense when you consider two factors. First: how cheap storage space has actually become.[2]

Second: the data contained in my communication is more valuable to my email provider than what I'd pay for the space.[3] It is unsurprising that I'm given an ever larger shoebox to fill. With no obvious cost to keeping everything around, that's exactly what I start to do.

And that leads to a paradox. The more of my communication I keep, the less each piece means to me. It feels like I'm losing something as a result, even as I gain a trove with massive potential meaning. My wife's grandfather was in Paris during WWII with the US Army. In the two years he was away, his wife had their first child - an event he only discovered weeks later via mail. The letters they wrote one another are unbelievable historical artifacts that shape their and our understanding of them and the world.[4] Of all the things they could have saved throughout 73 years of marriage (and counting), they made the conscious decision to save these items. That decision is a key part of how we know their importance.

My kids and grandkids won't have the experience of reading letters that my wife and I have saved in the same way, because we save everything by default. It's entirely possible they'll have nothing since my email account will most likely be locked when I die. That doesn't mean that all this communication I generate has no value or meaning. It is hugely valuable, in aggregate, to Google and Apple and Facebook. They'll continue to have access to my information long after I die, and it will continue to feed their algorithms.

I don't properly know what I'm losing by gaining so many individual pieces of communication. I do know, however, that the pace at which we communicate continues to accelerate, and that the forms through which we communicate continue to evolve.[5] The ways that expanding body of communication gets mined for information are proliferating at the same pace, but so far, they're almost entirely geared towards the companies that make money off our data.

I think that leaves something on the table. There's a class of product yet to be successfully created that can sift through all of my communication, across all platforms, that finds what is actually meaningful. I don't just want the first message that said "I love you" to my wife, I want the letter or email that led to that conversation. I want to be able to find the text which, on the surface, was meaningless, but in another time I would have set aside as an important life marker. While I can manipulate my inbox search to find some of these things, I can't really find the meaningful things. Maybe Google already does this to serve me ads, but that doesn't really help me.

Then again, maybe I'm thinking about communication all wrong. Maybe it should only have meaning in the instant it is made because that's a better fit for our brains. Or maybe we haven't figured it out yet. That feels more accurate to me, and I'm looking forward to seeing what comes next.

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[1] Pretty sure I wasn't thinking of "cloud storage" at the time.

[2] Chart courtesy of ZDNent. "Thailand Hard Drive Crisis" is my new favorite chart annotation.

[3] I've talked about this cost/persona data trade off before: http://www.aaronkharris.com/tanstaafl

[4] We're lucky enough to still have Pops and Grandma Lil telling us stories. Grandma Lil also still has some of the perfume Pops bought her with bartered champagne and cigarettes.

[5] I recall being in Scotland in 2005 and being confused at the popularity of texting. It seemed so strange and foreign at the time. Considering the average American 18-24 was sending 3200 texts a month in 2011, I think I got that one really wrong.

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Aaron Harris
tag:www.aaronkharris.com,2013:Post/766377 2014-11-07T19:00:09Z 2014-12-31T02:45:19Z TANSTAAFL

At some point the internet tricked us into thinking we could get something for nothing.

More than any other company, Google is responsible for fooling us. It was the first free and legal service to gain ubiquity.[1] Google told us that we didn't have to pay anything for amazing services. It seemed to good to be true. It was and is, in fact, too good to be true.

What Google doesn't come out and say is that you're paying, a lot, just not with cash. Your data is valuable. Apparently, it's more valuable than charging you for services because you cannot choose to pay for personal Google services and avoid the sale of your data.

This means data, at least what we contribute when properly sifted, aggregated, and analyzed, is more valuable than the cash we'd be willing to pay for access to the same services. When the world is based on networks, as ours increasingly is, then the greatest network is the most valuable asset there is. By making network access look free, Google managed to capture a huge user base. Once it had the network, it started to charge. It cleverly adapted an existing model - advertising - but did it by selling data + access, rather than just access (which is the best radio and tv and newspaper essentially could really do).

If that's true, we need to ask if we're getting a fair deal. But most of us won't ask that question[2], and if we do, we have no alternatives of the same quality. The deal also keeps getting re-traded, without our truly informed consent.[3] Every time Google offers a new service, it collects more data about it's users. That data is valuable on it's own, and makes existing data more profitable. Users could get some sense of the data collected and how it will be used by scrutinizing ever longer legal documents - but that's hugely unlikely. And, again, even if users did just that and found the trade wanting, there's not much recourse.

And if we did want to pay? Mary Meeker's 2014 Internet Trends Report tells us how much our favorite services should cost. Google revenues wouldn't change if we each paid $45 for all of our free services.[4] To grow revenue, Google would have to release new services and charge for them.

That probably sounds crazy, but it isn't - it's roughly how Apple works.[5]

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[1] Napster is another important player in this story. It largely convinced a huge portion of internet users that piracy was ok because it was so easy.

[2] There are a lot of causes: laziness, ignorance, fear of complexity or awareness.

[3] Clicking "yes" on new terms and conditions hardly seems to suffice.

[4] This number is broadly indicative though likely skewed by the differences in data value between spenders with different geographies, socio-economic brackets, and histories.

[5] I've been thinking a lot about the way these two businesses work at the opposite ends of this spectrum. It's a fascinating dichotomy.

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Aaron Harris
tag:www.aaronkharris.com,2013:Post/762169 2014-10-29T17:48:48Z 2014-11-25T19:25:24Z Pet Theories

All investors have pet theories. They may call these theories "theses" or "themes," but they boil down to the same thing - closely grouped sets of ideas which the investors want to be true. Investors will usually fund companies that seem to stand a chance of making these ideas real. At YC, we have quite a lot of pet theories, which end up getting expressed through our RFS.

Knowing the pet theories of the investors with whom you're talking is helpful. They may be more likely to fund startups that fit into pet theories and are likely to know a lot more about those theories than they do about other fields. That's great if you know what you're doing, but dangerous if you're half-assedly working on something. Let's assume you're in the first camp, because the second group shouldn't be talking to investors anyway.

You can learn a lot about the pet theories of investors by reading what they've written or spoken about in the past. Some investors - Fred Wilson, Andy Weissman, Chris Dixon - make this easy by writing blog posts that frequently reference what they think about and why they make the investments that they do. Other investors work at firms dedicated exclusively to particular pet theories. You can learn still more looking at an investor's career and past investments.[1] These are all pieces of information that can teach you about how an investor thinks, which will allow you to prepare better for actually meeting them.

Knowing an investors' pet theories can also help you get a meeting. An email directly referencing something near and dear to an investor's heart will get a response much more easily than something generic.[2] At the same time, the hurdle for getting a meeting on a pet theory is going to be high because the investor has likely seen many teams and ideas in the space.[3]

The really cool thing about meeting with someone who has a pet theory about what you're working on is that you won't really pitch them, you'll have a real conversation focused on the heart of what you're doing. These investors will be unlikely to ask simple, surface level questions. You'll be engaged and thinking the whole time, which should lead to better answers, and the best demonstration of how good you are.

Things will start to get really interesting when you begin to challenge the preconceived notions that an investor has as a result of how much he's thought about a given problem. Chances are that if you're doing something new, this is going to happen. It's where you'll be able to evaluate the quality of the investor. The best of them are flexible. They'll adapt their frameworks in response to new information and knowledge. The worst will be dismissive of ideas they hadn't considered before.[4]

There are also plenty of situations in which someone hasn't thought that deeply about a theory they discuss at length. Maybe they want to sound smart or look cool. Regardless, you should be able to figure that out pretty quickly and move on.

You should learn about an investor's pet theories when deciding if you should talk to them, and when preparing to actually meet. In the end, this is just one of the pieces of information you should have. It isn't as important as building a great business, but understanding the picture will help you pitch better, so spend some time on it.

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[1] Keep in mind, though, that investors generally don't only invest in their pet theories.

[2] This seems so basic, yet I get enough generic emails that I'm convinced it has yet to sink in.

[3] As always, warm intros are an even better bet.

[4] True in all situations, not just those related to pet theories.

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Aaron Harris
tag:www.aaronkharris.com,2013:Post/761055 2014-10-27T17:06:28Z 2015-08-11T12:02:43Z Taking advice

I ask for a lot of advice. Maybe too much. Sometimes the advice is great, sometimes it ends up seeming worthless and wrong. Invariably, I attributed the outcome of following advice to the giver - following advice from good people led to good outcomes, and vice versa. In the last few years, I've found myself giving a lot of advice and have realized how wrong I was in attributing cause and effect.

There are two axes that determine the goodness of advice. The first is the obvious one: the quality of the person giving advice. This it the part which most often get discussed. We're told to seek out high quality mentors and advisors. These should be people who think clearly, have experience, have the time to think through problems and help.

While these things might be hard to find in a single person, they're not typically that hard to evaluate. What's much harder, and probably more important, is the other axis: how good you are at describing reality to someone with much less context than you have. It turns out, this is really hard to do for a number of reasons.

  1. Honesty is difficult, especially about issues we're facing. When you ask for advice, you are implicitly saying you don't know how to do something. That's hard, but seems to be accepted. What's much tougher is making sure you know the reasons you're having the issues you're having. Often, figuring this out is the point of advice (even if you started asking for something much more surface level).
  2. Context is hard because it is vast. Think about how much you know about your company. Think about how little anyone else knows, no matter how involved they've been. At best, they see a series of snapshots and can construct a reasonable amount of context themselves. This is nowhere near what you have rattling around in your head. Being able to rapidly construct necessary context is important for an advisor, but they rely on you to give them relevant details.

If you can't pull off these two inputs when asking for advice, you'll get bad advice no matter how good the person on the side is.[1]

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[1] Yes, this does constitute advice, but I'm pretty sure this is of the type that's good in all situations.

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Aaron Harris
tag:www.aaronkharris.com,2013:Post/735445 2014-09-05T14:01:41Z 2016-07-08T13:42:11Z The importance of honoring pro-rata agreements

I've recently heard about a number of fundraises in which the company raising has refused to honor pro-rata agreements with early, small investors.[1] The most frequent reason seems to be that newer, larger investors demand a certain percentage in a funding round, and tell founders that it can either come from the founder stake, or by locking out earlier investors. Sometimes they just say "lock out the early investors."

This is bad behavior on a number of levels.

It's bad for the founders to do this because they're violating an existing legal agreement. As a founder, your word is your bond, and going back on a deal is a great way to destroy trust. Unfortunately, there's rarely an immediate/obvious impact because the small investors are unlikely to sue or cause a big stink. They don't want to piss off the big investors or get a reputation for being "troublesome," so they're stuck.

For the early investors, this is really bad. When an early investor negotiates for pro-rata, the money they invest buys equity now, and the opportunity to maintain that equity later. This is critical for early stage investors, especially those investing out of a fund. The cumulative impact of dilution is material and their models and expectations are built with that in mind. Investors would not/should not make certain deals if they knew they were going to get screwed out of their rights. Take a look at this model for a sense of just how important pro-rata rights are to early stage investors.

For the later investors, the behavior is actually pretty smart on several levels. By getting the stake they want from early investors and not the founders they can insure that the founders retain skin in the game (or are given opportunities to sell secondary). They can also weaken the ability of early investors to have a say in the company's future by reducing their combined voting power. Finally, this type of behavior may hasten the end of "super-angel" funds by handicapping their returns. Less competition is a good thing for those left standing.

Given how much competition there is around fundraising at the moment, it's unlikely that this behavior will stop any time soon. At the end of the day, the founders have to make the decision. If you find yourself in this situation, stand up for the agreements you made. If you'd like to discuss how, please reach out.

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[1] Dave McClure recently tweeted that he's seeing the same.

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Aaron Harris
tag:www.aaronkharris.com,2013:Post/726599 2014-08-13T19:02:14Z 2016-08-29T21:03:18Z Advice on pitching

We're currently getting ready for demo day at YC, which means quite a lot of pitch practice. Here are the main points of feedback we tend to give to teams. This advice works for almost any kind of presentation you might give.

Speaking

  • Speak slowly and enunciate
  • Be excited. Your pitch should not sound memorized. Intonation, cadence, and projecting help a lot
  • Be specific and concise
  • Look at the audience. You don't have to make eye contact with individuals, just with areas of the crowd. People in those areas will think you've made eye contact with them
  • Don't use generic phrases as transitions ("so...")
  • Actually explain what you do, and do it quickly
  • If you make a large transition, be very clear about it and explain why
  • Don't be "cute" with your points, be declarative
  • If you make a joke, telegraph it. If you're not sure the joke will land, cut it
  • Don't hide the big good things because you are modest, highlight them specifically early on
  • Use natural language and simple sentences, i.e. no sentences with three verbs
  • Don't use words you wouldn't use in normal conversation
  • If an example is a real person, make it clear that you're talking about a real person, not a user model
Charts/metrics
  • Charts should be easy to understand - make one point with any graphic or chart. Don't make people read charts - they'll stop listening to you.
  • If you put up a graph that confuses people, they will feel stupid and stop listening
  • Line graphs are better than bar graphs when showing growth
  • Label your axes and use real numbers - even if they are small. The shape of the graph matters, not the absolute numbers
  • Explain anomalies
  • If you should be generating revenue and then show a different metric, investors will be suspicious
  • TAM should be bottom up, not top down
Slides
  • Titles should describe the slide
  • Slides should be reentrant - each should make sense and make your case individually
  • Remember that minds wander, and people check phones. When they look up, they should immediately be able to pick up the thread
  • Don't use pretty, but thin, fonts. This isn't a time for subtlety, make sure your slides are legible from far away
  • Coolness and legibility are not orthogonal, they're diametrically opposed[1]
  • Screenshot slides are typically bad

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[1] This feels like something PG might have said directly, but I can't honestly remember.

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Aaron Harris
tag:www.aaronkharris.com,2013:Post/709591 2014-07-01T16:37:12Z 2017-04-19T20:51:27Z Investor Updates

At YC, we get lots of updates from our alums. There seems to be a correlation between quality and frequency of updates and the goodness of the company and founders. I strongly doubt there's a causal relationship, but I do think it makes sense that the best founders would write good and frequent updates because it reflects their own processes and attention to metrics and consistent growth.

While the act of sending updates is itself valuable, the quality of the update is critical. Writing a good update forces a founder to focus on the right things and keeps your investors engaged and helping.[1] A bad update can reflect the fact that a founder is thinking about the wrong things. When an update is just poorly executed, it doesn't get read, which removes a lot of the value, i.e., getting your investors engaged and staying at the top of their minds when relevant opportunities arise..

Here are some of the most common pieces of advice I give when I see updates that could be improved:

  • Figure out what you're going to report each month - this should probably be your growth (in revenue or users)[2], your cash/burn, what you need from investors and a qualitative measure of how things are going. As your business matures, these metrics may grow and shift, but stay consistent.[3]
  • Send updates monthly. It's a hell of a forcing function, a bit like writing  your growth on the whiteboard every month for everyone to see.
  • Lead with the key metrics and growth rates you defined.
  • Make requests of your investors after you report your key metrics. You could just as easily lead with this.[4]
  • Put the asks higher up so that the investors defintely see them. Key metrics and asks should be front and center to improve your hit rate.
  • Make it shorter. You want your investors to read the whole update and remember what they can do to help, and why they should do it.[5]
  • Charts are nice. They're hugely effective at showing progress in a way words can't.
  • When you finish an update, go back and read it. Does it have relevant data? Does it have your asks? Is it short? If not, rewrite it.

If you hit those points, you're probably all set.It doesn't matter if the update is in a fancy newsletter template or in a plain text email. The act of thinking about it and sending it is what is important, so just get in the habit.

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[1] If your investors think about you positively and frequently, they'll not only help you with specific requests but point serendipitous opportunities your way. That's one way you can "manufacture" luck.

[2] Avoid using "proxy metrics" without the necessary context. For instance, if you report GMV as your core metric, you should report your rake and action revenues. Otherwise, your investors are going to immediately wonder what's going on.

[3] Adding new things because they're important is good. Removing things because you can't hit your milestones is bad.

[4] Pretty sure this is how Chris Dixon advised me to write them.

[5] This can get hard when you have lots of good things to say. If you must include them, put it in an appendix or save it for quarterly or semi-annual updates.

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Aaron Harris
tag:www.aaronkharris.com,2013:Post/687969 2014-05-07T22:20:32Z 2014-08-13T20:41:44Z How to create good outcomes when negotiating

When I watch my nieces and nephew negotiating with my siblings, I'm consistently amazed at how good they are. They have an innate grasp of leverage, relevant terms, and they know what they want. That, or they're completely unreasonable and illogical, which frequently amounts to the same thing - they win more frequently than they lose. Near as I can tell this is true of all children.

Founders don't have the same luxury as kids. The stakes are usually higher, the terms are less familiar, and the other party less willing to forgive tantrums. Based on what I've seen, a lot of founders (especially first time founders) don't really know how to negotiate. There's a whole section of the library devoted to negotiating tactics. From what I've seen, the problems founders run into are a lot more basic.

Some advice to avoid the mistakes I've seen:

  1. Know what you want - It's shocking how frequently parties enter into negotiations without a clear understanding of what they each want. If you don't know what you want, it's impossible to know what you can give up and what you need to hold onto.
  2. Understand the terms - This is basic, but generally ignored. If you're signing a document, you need to read it and understand it. If you're going to use terms in negotiations, make sure you know how to use them. This applies to financing terms ("pre", "pro-rata", "control"), employment terms ("vesting", "cliff", "at will"), and essentially anything else you say to the other party.[1]
  3. Do not leave anything to ambiguity - Turns out this is one of the hardest things to do, especially in "friendly" negotiations with investors you know or friends you might be hiring. Don't assume that something you think is implied is agreed upon. Every point that you negotiate should be made explicitly. Which leads to...
  4. Document everything - If you agree to something, confirm it in writing. This can be as simple as an email saying "Thanks for meeting Aaron. As agreed, we're excited to have you investing 100k in our round at $5mm valuation." If the other side confirms, great. Do this immediately because if there's disagreement on what was actually agreed in person, this is how you'll find out. Importantly, silence doesn't count as consent.
  5. Just because the other party is your friend... - Doesn't mean they're going to give you everything you want, or that you should give them everything they want. This is where mixing business and friendship get tricky, so keep in mind that deals are about business. Negotiating with friends is also where ambiguity is most likely to arise, so be extra cautious.
  6. You don't get points for being a jackass - There's a popular misconception that mean people are better negotiators. That's not true. People who are formidable are good negotiators. They're tenacious about the important points, and gracious about the things that don't matter. The key here is to remember that a negotiation tends to be the start of a relationship. You don't want to start that relationship on a bad foot.[2] In most cases, you're also operating in a surprisingly small world. You're going to see the same people again and again, so being on good terms with them is going to be productive.[3]
  7. Your word is your bond - Probably the most important rule there is. If you agree to something, don't break that agreement. Don't even let yourself fall into a place where you might break an agreement. If you agreed to something, whether with a handshake or in writing, the negotiating on that point is done. Reneging is the fastest way to destroy your reputation and any trust that you've built up. If you find yourself unclear if you agreed to something, refer to point 3. This is not the place to get cute or try to re-interpret after the fact. You can be forgiven being confused (up to a point) but not for breaking an agreement you knowingly made.

If you find yourself raising money from an experienced VC or negotiating a contract with an experienced business development lead, keep in mind that they negotiate for a living and are probably better at it than you. They know how to push your buttons to get what they want. This isn't malicious (usually), but it is effective. These are good times to ask a more experienced advisor for advice. Ultimately, you'll have to run the negotiation yourself, but it doesn't hurt to get an outside opinion. If you stick with these guidelines, you'll do alright.

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[1] Maybe it's because I'm married to a lawyer, but I'm continually shocked at how many people sign legal documents without understanding what those documents actually mean. This is how people end up with unexpected board observers, losing voting control, or taking unexpected dilution.

[2] This isn't exactly true when it comes to corporate raiders...

[3] Despite the best intentions, negotiations can get incredibly heated and parties will sometimes feel wronged. That's unavoidable, but it can be mitigated.

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Aaron Harris
tag:www.aaronkharris.com,2013:Post/656748 2014-02-21T00:55:45Z 2014-06-26T09:33:32Z Uber's Economics vs. Its Users

It's rare that I find a service or tool that changes the way I go about my day to day life. It's much more common to find something that seems really interesting/cool, have it go into regular rotation, and then see it drop. In order for something to stay in frequent rotation, it has to fit into one of several categories:

  1. It has entertainment value beyond pure novelty. Instagram seems to have cleared that hurdle.
  2. It allows me to do something hugely useful that I'd not been able to do before. Cellphones certainly did that.
  3. It materially reduces the friction of doing something I already do/want to do. Dropbox does that.

At the same time, something that meets one of these hurdles can still fail because the cost of using it is too high. For me, that cost has always broken down simply to one of two factors:

  1. The dollar cost.
  2. The cost in time/frustration due to poor user experience.

If either of those cross a hard to define threshold, I'll give up. That line is hard to predict, because there's rarely a clear equivalency in the units by which I measure the value and the cost. Still, I know it when I see it.[1]

Recently, though, I've been thinking about a different dynamic, one that describes my relationship with Uber. Given the frequency with which I use Uber, I should love it. The design is great, and it really does make ordering a car easy in most circumstances. However, I hate using Uber. In fact, I only use it because it is currently the best option for me to get to and from the airport.[2]

I only realized recently how deeply I dislike using Uber. A few weeks ago, I pulled out my phone to call an Uber to my apartment in NYC. As I did so, I realized I had tensed up - stressed about what I was about to discover. Would the fare be normal? 1.5x? 3x? If surge pricing was in effect, I knew that I'd have to start calculating trip costs in my head to compare the different options, which surge at different rates. Then I started considering what the surge curve would look like throughout the approximately 30 minute window I give myself to leave. Would it rise throughout and sharply fall? Would it stay flat? When, exactly, would my optimal time to call a car? The service basically has me thinking incredibly hard to figure out whether or not I want to use it.[3]

What Uber has done is forced me to trade inconvenience and transparency for convenience and a total lack of transparency plus a huge amount of uncertainty. I can't recall another time I've been forced into such a stark and extreme choice in order to use an application that trumpets its own usability so heavily.

The source of my frustration lies with Uber's embrace of a clinical application of supply/demand methodology. On the surface, I actually agree with their argument that more demand should yield higher prices.[4] However, the more I think about their logic, the less it makes sense. Uber prides themselves on their control of the data of trips. They claim that that data feeds complex algorithms that spit out the surge pricing levels. However, if their data is so incredible, they should be significantly better at predicting surges before they happen, thereby mitigating the overall level of surges and the rapidity with which they appear and dissipate. Maybe they even are doing this on some level, but if they are, it certainly isn't apparent to users.[5]

It strikes me that Uber is playing a very dangerous game. Travis and his team have proven themselves to be incredibly good at execution. I worry, though, that their focus on that execution and their near religious belief in the power of economics will lead them to continue doing things that make users very angry. Uber has been successful because they made something people wanted, and made that thing accessible. They're currently skirting the edge of making that thing people want very distasteful to use.  At this stage, I would drop Uber in a heartbeat if another service offered similar access with increased transparency, even at a higher price point.[6] Anecdotally, I don't appear to be the only person that feels that way.

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[1] I'll never forget my 12th grade AP History teacher, Mrs. Broder, teaching us about Potter Stewart's use of that phrase in reference to obscenity.

[2] This is a really big factor in their favor, but it also feels incredibly temporal.

[3] This might be one of the biggest violations of Steve Krug's "Don't make me think" mantra I've yet encountered with a consumer application.

[4] Which mitigates my frustration only very slightly.

[5] For instance, they know I typically take a car on Monday mornings, and could easily text me a warning that, if I was planning a trip the next day, I should be aware that a surge is likely. Alternatively, they could make pricing out the different options transparent and simple to find.

[6] And there many trying: Instantcab (now Summon), Lyft, Hailo, Sidecar, etc.

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Aaron Harris
tag:www.aaronkharris.com,2013:Post/654563 2014-02-14T15:03:59Z 2014-02-14T18:30:29Z Making Mistakes

At 10 years old, I lost a trillion dollar bet to my older brother. I bet him it was Wednesday. It was actually Thursday. I was very sure of myself (for reasons I can't recall), and saw a good opportunity to shave off some of the debt I owed him. Luckily, he has yet to call the debt. At the time, all I felt was keen embarrassment at my stupidity. As time went on It became clear I had learned a valuable lesson about taking deals that seem too good to be true.

Though mistakes that I make can be painful in the near term (and sometimes in the long term), I've found that they're a critical part of how I learn. I'm fairly certain that the mistakes I made which led to the end of Tutorspree taught me far more about how startups work than immediate success would have.

Success feels good

Success is usually idiosyncratic. Strategies that lead to success are self-validating. We build narratives around the cause and effect of success based on incomplete information and our own biases [1]. This makes it very easy to falsely attribute success to the factors that are easily seen without doing the work necessary to properly understand what happened. This tendency gets even stronger when we're looking at our own successes. At that point, ego starts to discount things like luck, which are frequently a huge part of success. Because success makes us feel good, it lulls our faculties for critical thinking, which almost by definition means it is harder to learn deep lessons [2].

Making mistakes doesn't give us the same kind of happy feelings that success does. Because the mistakes hurt, we investigate them more closely. Because we're thinking critically and comparing causal chains leading up to and flowing from mistakes, we're more likely to consider complexity and examine why things really happened as they did. That doesn't necessarily mean that each time I make a mistake I learn a critically important lesson about myself, but by thinking hard enough, I generally do learn something useful [3].

Mistakes vs. Failure

Near as I can tell, I'm not alone in believing that mistakes are a valuable tool for learning. In fact, in Silicon Valley, there's a tendency to talk about failure as a point of pride. But there's a disconnect between how we talk about Failure (intentional big "F") and how we talk about mistakes. While the internet is littered with post-mortems on failed companies, it's rare to find founders or investors who will freely admit to being wrong about a public comment or investment [4].

That doesn't make sense given what we know about mistakes. It does, however, start to make more sense with the addition of two other factors. The first is the increasing permanence and public nature of all media. It's relatively easy for me to admit mistakes to small and trusted groups because I don't fear malicious repercussions.[5] As that circle expands, the difficulty of admitting the mistake increases because I don't trust the intentions or actions of everyone in it. In the competition between wanting to learn by admitting mistakes and wanting to not be perceived as stupid or attacked for the same, not looking stupid wins.

This directly informs the second factor: increasing obsession with "personal brand." Personal brand isn't a new concept, but it has become increasingly important to more people because of the pressure to constantly tell the story of your life in public through social media. That publicity + the expanded circle again leads back to wanting to present a perfect image. Through that lens, each instant broadcast that is inconsistent with that narrative and "off-brand" appears to be a public failure in front of an untrusted circle. Not only do we look stupid for making a mistake; the mistake jeopardizes the narrative we've built about ourselves. [6]

Even if "building a brand" isn't something we consciously think about, knowing how public everything is makes being honest about mistakes hard. So how do we get as comfortable looking at recent mistakes as we are looking at the ones in the distant past? We probably can't - there's too much baggage. But I think there are ways to start moving in the right direction. Recognizing the cycle that makes it hard to admit mistakes is a good start. Developing a close friend, set of friends, or mentor, with whom you can speak honestly is another step. Most importantly, I think we probably need to take it easy and remember that no mistake, public or private, is likely to be the defining moment of our lives [7].  At the same time, cutting some slack for others who make mistakes will likely do a lot to ease the culture of recrimination/fear that has built up around making mistakes.[8] Really, we just need to be decent and thoughtful. Hard, but important.

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[1] Fitting facts into a story is a common trap that seems to go the base of how our brains are built.

[2] If you happen to be watching the success of someone you dislike, the reverse might be true. Your critical thinking faculties might be working just fine, though your conclusions and avenues of investigation might get clouded by envy or jealousy.

[3] That might be "be careful when stopping with your new clipless pedals." Maybe small, but better to learn the lesson than assume it was easy.

[4] Interestingly, you'll see more evidence of VCs admitting to investments they missed than investments they should not have made. See Bessemer's Anti-Portfolio

[5] That certainly wasn't always easy. I've had to work on being able to admit my mistakes. The benefits I've reaped by doing so have made it easier and easier.

[6] Truth is, I haven't prioritized my personal brand that much. I firmly believe that trying to build a brand is the best way to get the reputation of just being a scenester. I think I should be judged on the things I actually do with and for the people around me. That, however, is a completely different topic.

[7] With the possible exception of Bill Buckner in and around Boston.

[8] That may mean you lose the chance to show Twitter how clever and snarky you can be. That's a good trade in the long run.

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Aaron Harris
tag:www.aaronkharris.com,2013:Post/638474 2014-01-06T16:44:13Z 2016-01-31T13:11:15Z When SEO Fails: Single Channel Dependency and the End of Tutorspree

Although we achieved a lot with Tutorspree, we failed to create a scalable business. I've been working through why. In doing so, I’m trying to avoid the sort of hugely broad pronouncements I often see creep into post mortems that I’ve read: “don’t hire people!”; “hire people faster!”; “focus on marketing at all costs”; “ignore marketing, focus on product” etc.

I’ve focused here on the strategic causes of our failure. While I learned a huge amount about operations, managing, and team building; mistakes made in those areas were not the ultimate cause of failure just as the many things we got right within the company did not ultimately lead to success. I also recognize that this doesn’t cover every detail, even on the strategy side.

SEO: Too good to be true

Tutorspree didn’t scale because we were single channel dependent and that channel shifted on us radically and suddenly. SEO was baked into our model from the start, and it became increasingly important to the business as we grew and evolved. In our early days, and during Y Combinator, we didn’t have money to spend on acquisition. SEO was free so we focused on it and got good at it.

That worked brilliantly for us. We acquired users for practically nothing by using the content and site structure generated as a byproduct of our tutor acquisition. However, that success was also a trap. It convinced us that there had to be another channel that would perform for us at the level of SEO.

In our first year, that conviction drove our experiments with a series of other channels: PPC, partnerships, deals, guerilla type tactics, targeted mailings, craigslist posting tools, etc. Each experiment produced results inferior to those from SEO. The acquisition costs through those channels were significantly higher than what was allowable based on our revenue per customers. We also found that potential customers coming through PPC were converted at a lower rate than those originating through SEO. Even as we sharpened our targeting, experimented with messaging, and sought advice and consulting from more experienced parties, we found that paid channels just weren’t good enough to merit real focus.

That dynamic put us in a strange position. On the one hand we had a channel bringing in profitable customers. On the other hand, we did not have the budget within our model and product to push hard enough on other channels.

The AirBnb Head Fake

At the end of our first year, the divergence between our success with SEO and our failure with other channels dovetailed with a whole set of lessons we drew from analyzing user behavior on Tutorspree. We realized that there were fundamental problems with the product of Tutorspree which both prevented us from converting visitors to customers at optimal rates and from having enough capital to spend on acquiring more visitors/potential customers.

We had modeled ourselves on AirBnB, believing we were a clear parallel of their model for the tutoring market. What we were seeing in terms of user behavior, however, was fundamentally different. Parents simply didn’t trust profiles and a messaging system enough to transact at the rate we needed. Our dropoff was too high, and the number of lessons being completed was too low. We realized that we were wrong in how we thought about the entire market, and radically altered our model to suit in March of 2012. Looking back, it is also apparent that we were able to ignore our error for as long as we did precisely because SEO worked as well as it did. The dynamics of our marketing provided air cover for any other issues we had.

We called the new model Agency as we pulled in aspects of a traditional agency’s hands on approach and combined it with our matching system and our customer acquisition channel – SEO. Within a month of the change, we doubled revenue. Six months after the shift, our revenue had increased another 3x and we’d increased margins from 15% to 40%. The new model gave us our first profitable month, and put us within striking distance of consistent profitability. It looked like we had cracked the product problem. Our conversion rates were way up and per user revenue was climbing rapidly. Those factors gave us the budget we needed to more productively experiment with other channels.

Virtually all of our customers came from SEO.

New and Better Model; Same Old Channel

By December of 2012, we had virtually infinite runway and were at the edge of profitability. We still wanted to swing for the fences, and, given the radically shifted economics presented by our new model, we made the decision to retest all the marketing channels we had tried with our initial model and then some. We knew that only having a single scaling channel – SEO – would not let us become huge, so we began pushing for another scalable channel.

Given the strength of where we were and the challenges we saw, we raised another round with the explicit purpose of finding the right marketing channels. While we considered raising an A, we played conservatively, deciding that we wanted to find the repeatable channels, then raise an A to push them hard rather than raise too much money too early.

We finished that fundraise in January, began a much needed redesign of the site to fit with our significantly more high touch model, hired a full time growth lead and began to push rapidly into content marketing, partnerships. Then, in March of 2013, Google cut the ground out from under us and reduced our traffic by 80% overnight. Though we could not be 100% certain, the timing strongly indicated that we had been caught in the latest Panda algorithm update.

With our SEO gone, we took a hard look at our other channels. While content may have played out in the long run, and in fact showed signs of the beginning of a true audience, the runway it needed was far too long without the cushion provided by SEO. PPC - mainly through Adwords (though also through FB) – was moving in the direction of being ROI positive, but the primary issue turned out to be one of volume rather than cost. Because of our desire to focus heavily on the markets in which we had the highest tutor density (and therefore the greatest chance of filling requests), we had to carefully target our ads in terms of geography and subject. Given that dynamic, we simply couldn’t find a way to generate enough leads, no matter the price. In the end, that calculus applied to nearly every paid channel we could identify.

Common Thread

Our reliance on SEO influenced nearly every decision we made with Tutorspree. At the beginning, it influenced our decisions to allow tutors to sign up anywhere, for almost any subject. On the one hand, that brought in leads we could never have specifically targeted. On the other hand, it spread our resources out across too many verticals/locations. That problem was compounded by our move into Agency. While we were converting at a higher rate and price than ever, we were also forced to spend too much time and money on completely unlikely leads. When you build your brand on incredible service, it becomes very hard to simply ignore people.

When our SEO collapsed, we routed virtually all of our technical resources to fixing it. In that effort, we had significant amounts of success. We regained most of the traffic that we lost with the algorithm switch in June. We regained a significant portion of our rankings. However, the traffic that we were getting at that point was not as high quality as that which we had been getting beforehand.[1]

Because of how successful SEO was, it was the lens through which we viewed all other marketing efforts, and masked the issues we were having in other channels along with important realities of how the tutoring market differed from how we wanted to make it work. We were, in effect, blinded by our own success in organic search. Even though we saw the blindness, we couldn’t work around it.

Lessons Learned

Tutorspree taught me a lot of lessons. I learned about product, users, customers, hiring, fundraising, managing, and firing. I made some bad hires because of my own blind spots and desire to believe in how people operate. There were periods of time where I avoided conflicts within our team too much – decisions that were always the wrong ones for the business and that I regretted later. Those mistakes were not ultimately what caused our failure.

Nor is the largest lesson for me that SEO shouldn’t be part of a startup’s marketing kit. It should be there, but it has to be just one of many tools. SEO cannot be the only channel a company has, nor can any other single channel serve that purpose. There is a chance that a single channel can grow a company very quickly to a very large size, but the risks involved in that single channel are large and grow in tandem with the company.[2] 

That’s especially true when the channel is owned by a specific, profit seeking, entity. Almost inevitably, that company will move to compete with you or make what you are doing significantly more expensive, something Yelp gets at well in their 10K risks section: “We rely on traffic to our website from search engines like Google, Bing and Yahoo!, some of which offer products and services that compete directly with our solutions. If our website fails to rank prominently in unpaid search results, traffic to our website could decline and our business would be adversely affected.”

For me, this is a lesson about concentration risk and control. In this case, it played out on the surface in our only truly successful marketing channel. That success wound its way through everything we did, pulling all that we did onto a single pillar that we could not control.

By necessity we had to concentrate risk on certain decisions (something likely true of most small startups). I did not have the time or resources to do everything I wanted or needed to do. I never will. But I need to be cognizant of the ways in which that concentration is influencing everything I do. I need to make sure that it doesn’t dig me into holes I can’t work out of on my own.

Ultimately, this post mortem is about the single largest cause I can identify of why we failed to scale Tutorspree. In examining our SEO dependence, I was surprised at how deeply it influenced so many different pieces of the company and aspects of our strategy. It powered a huge piece of our success, and ultimately triggered our failure. There’s a symmetry there that I can’t help but appreciate, even though I wish to hell it had been otherwise.

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[1] This is a whole other issue I explored in the Tutorspree blog at the time. It seems that Google is increasingly favoring itself in local transactional search.

[2] RapGenius recently ran into this issue, but were able to overcome their immediate problems through some impressively fast and thorough work.

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Aaron Harris
tag:www.aaronkharris.com,2013:Post/634779 2013-12-26T17:39:15Z 2015-04-15T01:29:30Z The Cap Trap

Why convertible notes exist

Convertible notes beat equity as the financing of choice for early stage startups largely because they were faster. While later stage companies can afford the time necessary to negotiate long sets of terms, early stage companies don't have that luxury. Not only are prices for such early stage entities nearly impossible (and therefore time consuming) to determine, time is itself the most limited resource a startup has - it's critical to raise quickly and get back to work. Though equity financings can be standardized up to a point, there's always a huge sticking point for negotiations: price. Rather than try standardizing, convertibles notes simply got rid of price as a term.

While the notes eliminated price, they needed structures to govern what the investment would be worth when a price finally did come into play. Price was replaced with two other mechanisms - a discount rate and a cap.[1] While each of these was a negotiable point, they were each and cumulatively less meaningful than price, because they deferred the core pricing question to the next round of financing. Ideally, that meant shorter negotiations on less significant terms. With a priced financing meant to take place within the year (based on the note's maturity), investors were willing to punt on pricing while founders were willing to roll their risk a bit further down the road and get back to work.

The cap trap

But a funny thing happened on the way to this ideal state - caps became implied prices. It isn't all that surprising that this happened. The best founders know that setting goals based on real numbers is critical to sustained growth. They're also incredibly competitive. By removing real prices from fundraising, the convertible note nullified a part of the fundraising game that was important to the egos of founders (and investors). Without a number on which to hang their success, startups lost a public way to "prove" how good they were. At that point, the cap became an obvious choice for an approximation of price: It was a hard number, it could/should reflect something about the note holder's expectations of the price at which the company would next raise money, and it is typically not that well understood.[2]

This introduced several unintended problems. The most extreme of these issues was the advent of the "uncapped" note. To some founders, this was the holy grail. In a very naive sense, this implied an infinite valuation - companies were so hot that investors were saying they'd accept any price at some point in the future just to get in. Practically speaking, this scenario - paired with not having a discount - creates a misalignment of incentives between the investor and the startup. Rather than trying to help the startup move as fast and far as possible prior to the next round of financing, investors are actually incentivized to get as low a price on the first equity as possible so that they are able to convert in at a reasonable price. Conversely, the startup wants to move as fast as possible - as all startups should - and give up as little as the company as possible. While that tension always exists on some level, the dynamic is particularly extreme in these cases.

The second problem came from startups who raised too little money with too high a cap. Convertible notes are debt. They accrue interest and have maturity dates. As a result, it tends to be a bad idea to raise too much money through them. While investors rarely call the notes, the accrued interest can become a significant dilutive factor. But, since founders decided that high caps = good caps, startups would do crazy things like raise $1mm on a $20mm cap with one year maturity.[3] The hurdles set for a company in that scenario were almost unimaginable - and contradictory! Inside of a year, that company would have to grow to a point where raising money at above a $20mm valuation was not just possible, but likely. Otherwise, again because of the common misperception that cap = price, they'd have to raise a "down round". However, if by some miracle they raised above the cap, the investors would get the same % they initially agreed to, but would also get higher liquidation preference.[4]

Ironically, while convertible notes were initially designed to allow good companies to raise money quickly and get back to work, the best companies are precisely the ones that most frequently fell into these cap traps.

Being smarter when raising money

Recently, Y Combinator released a new financing instrument, called the safe, designed to eliminate parts of these problems. By removing interest and maturity dates, the safe makes it easier for companies to raise larger amounts than on notes while avoiding putting themselves in impossible situations. However, the ultimate responsibility for restraining the temptation to raise at ever higher caps rests with founders. Understanding how and why convertible notes and safe exist is the first step. That's easy, it's just reading. The second step is much harder, but equally worth it - founders need to overcome their egos. That might be impossible, but it's well worth the effort.

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[1] Notes also have elements of debt: interest rates and maturity.

[2] I've had conversations with both founders and investors in which it has been apparent that this is one of several terms that are commonly misconstrued. Those misunderstandings lead to different actors using caps as placeholders for different things, which complicates the picture.

[3] I'm being extreme, but have heard of crazier.

[4] David Hornik explores this more in his post Just Say No To Capped Notes. He rightly points out that the capped note is an at times awkward compromise, but I disagree that the resolution should be all uncapped notes or all equity financings. 

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Aaron Harris