Blake Masters

I’m reading through Francis Bacon’s Novum Organum (for this class). It’s a pretty amazing work.

Aphorism 14 from Book 1 stands out:

The syllogism consists of propositions, propositions consist of words, words are symbols of notions. Therefore if the notions themselves (which is the root of the matter) are confused and over-hastily abstracted from the facts, there can be no firmness in the superstructure. Our only hope therefore lies in a true induction.

This reminded me of Thiel’s law from a few days back: 

A startup messed up at its foundation cannot be fixed.  

For Bacon, you have to get your notios (best translated as “notions” or “concepts,” apparently) right. Then you have a chance at getting your sentences right. Which means you have a chance at getting your paragraphs right, and so on and so forth all the way up the chain. Implicit in this is that you can’t fix a flawed notio. It’s doomed.

Similarly, Peter stresses the importance of getting your company’s foundation right. Do that and you then have a chance of, say, raising VC and/or creating a viable product. Which means you have a chance of generating revenue and then profit. And so on, up the chain toward a successful exit. Get it wrong and you’re doomed.

Here is an essay version of my class notes from Class 7 of CS183: Startup. Errors and omissions are mine.

Roelof Botha, partner at Sequoia Capital and former CFO of PayPal, and Paul Graham, partner and co-founder of Y Combinator, joined this class as guest speakers. Credit for good stuff goes to them and Peter. I have tried to be accurate. But note that this is not a transcript of the conversation.

Class 7 Notes Essay—Follow the Money

I.  Venture Capital and You

Many people who start businesses never deal with venture capitalists. Founders who do interact with VCs don’t necessarily do that early on. First you get your founders together and get working. Then maybe you get friends, family, or angels to invest. If you do end up needing to raise a larger amount of capital, you need to know how VC works. Understanding how VCs think about money—or, in some cases, how they don’t think about it and thus lose it—is important. 

VC started in late 1940s. Before that, wealthy individuals and families were investing in new ventures quite frequently. But the idea of pooling funds that professionals would invest in early stage companies was a product of the ‘40s. The Sand Hill road, Silicon Valley version came in the late 1960s, with Sequoia, Kleiner Perkins, and Mayfield leading the field. 

Venture basically works like this:  you pool a bunch of money that you get from people called limited partners. Then you take money from that pool and invest it in portfolio companies that you think are promising. Hopefully those companies become more valuable over time and everybody makes money. So VCs have the dual role of encouraging LPs to give them money and then finding (hopefully) successful companies to back.

Most of the profits go back to LPs as returns on their investment. VCs, of course, take a cut. The typical model is called 2-and-20, which means that the VC firm charges an annual management fee of 2% of the fund and then gets 20% of the gains beyond the original investment. The 2% management fee is theoretically just enough to allow the VC firm to continue to operate. In practice, it can end up being a lot more than that; a $200m fund would earn $4m in management fees under a 2-and-20 structure. But it’s certainly true that the real payout that VCs look for come with the 20% cut of the gains, which is called the carry.

VC funds last for several years, because it usually takes years for the companies you invest in to grow in value. Many of the investments in a given fund either don’t make money or go to zero. But the idea is that the companies that do well get you all your money back and then some; you end up with more money in the fund at the end than LPs put in to begin with.

There are many dimensions to being a good VC. You have to be skilled at coming up with reasonable valuations, identifying great entrepreneurs, etc. But there’s one dimension that is particularly important, yet surprisingly poorly understood. It is far and away the most important structural element of venture capital: exponential power. This may seem odd because it’s just basic math. But just as 3^rd grade arithmetic—knowing not just how many shares you get, but dividing that by the shares outstanding—was crucial to understand equity, 7^th grade math—understanding exponents—is necessary to understand VC.

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Here is an essay version of my class notes from Class 6 of CS183: Startup. Errors and omissions are my own. Credit for good stuff is Peter’s entirely. This class was kind of a crash course in VC financing. I didn’t include all the examples since you can learn more about VC math elsewhere, e.g. here or here. As usual, though, I’ve tried to include all the key insights from the lecture.

CS183: Startup—Notes Essay—Thiel’s Law

I.  Origins, Rules, Culture

Every company is different. But there are certain rules that you simply must follow when you start a business. A corollary of this is what some friends have (somewhat grandiosely) called Thiel’s law: A startup messed up at its foundation cannot be fixed.  

Beginnings of things are very important. Beginnings are qualitatively different. Consider the origin of the universe. Different things happened then than what we experience in everyday life. Or think about the origin of a country; it necessarily involves a great many elements that you do not see in the normal course of business. Here in the U.S., the Founders generally got a lot of things right. Some things they got quite wrong. But most of the time they can’t really be fixed.  Alaska has 2 senators. So does California. So Alaska, despite having something like 1/50^th of California’s population, has equal power in the Senate. Some say that’s a feature, not a bug. Whatever it is, we’re likely to be stuck with it as long as this country exists.

The insight that foundings are crucial is what is behind the Founders Fund name. Founders and founding moments are very important in determining what comes next for a given business. If you focus on the founding and get it right, you have a chance. If you don’t, you’ll be lucky at best, and probably not even that.

The importance of foundings is embedded in companies. Where there’s a debate or controversial claim at Google, one says, “The Founders have scientifically determined that x is true,” where x is his preferred position. If you think that certain perks should be extended since happy people are the most productive, you say that Larry and Sergey have already settled the matter. The point is that all the science is done at the founding. No new data can interfere with the founding moment.

Foundings are obviously temporal. But how long they last can be a hard question. The typical narrative contemplates a founding, first hires, and a first capital raise. But there’s an argument that the founding lasts a lot longer than that. The idea of going from 0 to 1—the idea of technology—parallels founding moments. The 1 to n of globalization, by contrast, parallels post-founding execution. It may be that the founding lasts so long as a company’s technical innovation continues. Founders should arguably stay in charge as long as the paradigm remains 0 to 1. Once the paradigm shifts to 1 to n, the founding is over. At that point, executives should execute. 

There is, of course, a limit to how much you can do with rules. Things can and will break down even with perfect rules. There is no real chance of setting things up correctly such that the rest unfold easily. But you should still get the early stuff as right as possible.

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Here is an essay version of my class notes from Class 5 of CS183: Startup. Errors and omissions are mine.

Stephen Cohen, co-founder and Executive VP of Palantir Technologies, and Max Levchin of PayPal and Slide fame joined this class as guest speakers. Credit for good stuff goes to them and Peter. I have tried to be accurate. But note that this is not a transcript of the conversation.

CS183: Startup—Notes Essay—The Mechanics of Mafia

I. Company Cultures

Everybody knows that company culture is important. But it’s hard to know exactly what makes for an ideal culture. There are obviously some things that work. Even though they didn’t necessarily look like a winning investment at the time, the early Microsoft team clearly got something right.

Then there are some things that don’t work so well. A cult is perhaps the paradigmatic version of a culture that doesn’t work. Cults are crazy and idealistic in a bad way. Cult members all tend to be fanatically wrong about something big.

And then there is what might be called anti-culture, where you really don’t even have a culture at all. Consulting firms are the classic example here. Unfortunately, this is probably the dominant paradigm for companies. Most of the time, they don’t even get to the point of having culture. People are mercenaries. People are nihilistic.

Picture a 1-dimensional axis from consultant-nihilism to cultish dogmatism. You want to be somewhere in the middle of that spectrum. To the extent you gravitate towards an extreme, you probably want to be closer to being a cult than being an army of consultants.

Good company culture is more nuanced than simple homogeneity or heterogeneity. On the homogeneity side, everyone being alike isn’t enough. A robust company culture is one in which people have something in common that distinguishes them quite sharply from rest of the world. If everybody likes ice cream, that probably doesn’t matter. If the core people share a relevant and unique philosophy about something important, you’re onto something.

Similarly, differences qua differences don’t matter much. In strong company cultures, people are different in a way that goes to the core mission. Suppose one key person is on an ice cream only diet. That’s quirky. But it’s also irrelevant. You want your people to be different in a way that gives the company a strong sense of identity and yet still dovetails with the overall mission. Having different kinds of problem-solvers on a team, for example, can make for a stronger culture.

II. Zero Sum vs. Not

A. To Fight or Not To Fight

Generally speaking, capitalism and competition are better seen as antonyms than as synonyms. To compete isn’t what you should set out to do. That doesn’t mean you should slack off. To succeed you probably need to work intensely. But you should work on something that others aren’t doing. That is, focus on an area that’s not zero-sum.

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Here is an essay version of my class notes from Class 4 of CS183: Startup. Errors and omissions are my own. Credit for good stuff is Peter’s entirely. 

CS183: Startup—Notes Essay—April 11—The Last Mover Advantage

I. Escaping Competition

The usual narrative is that capitalism and perfect competition are synonyms. No one is a monopoly. Firms compete and profits are competed away. But that’s a curious narrative. A better one frames capitalism and perfect competition as opposites; capitalism is about the accumulation of capital, whereas the world of perfect competition is one in which you can’t make any money. Why people tend to view capitalism and perfect competition as interchangeable is thus an interesting question that’s worth exploring from several different angles.

The first thing to recognize is that our bias favoring competition is deep-rooted. Competition is seen as almost quintessentially American. It builds character. We learn a lot from it. We see the competitive ideology at work in education. There is a sense in which extreme forms of competition are seen as setting one up for future, non-competitive success. Getting into medical school, for example, is extremely competitive. But then you get to be a well-paid doctor.

There are, of course, cases where perfect competition is just fine. Not all businesses are created to make money; some people might be just fine with not turning a profit, or making just enough to keep the lights on. But to the extent one wants to make money, he should probably be quite skeptical about perfect competition. Some fields, like sports and politics, are incredibly and perhaps inherently competitive. It’s easier to build a good business than it is to become the fastest person alive or to get elected President.

It may upset people to hear that competition may not be unqualifiedly good. We should be clear what we mean here. Some sense of competition seems appropriate. Competition can make for better learning and education. Sometimes credentials do reflect significant degrees of accomplishment. But the worry is that people make a habit of chasing them. Too often, we seem to forget that it’s genuine accomplishment we’re after, and we just train people to compete forever. But that does everyone a great disservice if what’s theoretically optimal is to manage to stop competing, i.e. to become a monopoly and enjoy success.

A law school anecdote will help illustrate the point. By graduation, students at Stanford Law and other elite law schools have been racking up credentials and awards for well over a dozen years. The pinnacle of post law school credentialism is landing a Supreme Court clerkship. After graduating from SLS in ’92 and clerking for a year on the 11^th Circuit, Peter Thiel was one of the small handful of clerks who made it to the interview stage with two of the Justices. That capstone credential was within reach. Peter was so close to winning that last competition. There was a sense that, if only he’d get the nod, he’d be set for life. But he didn’t. 

Years later, after Peter built and sold PayPal, he reconnected with an old friend from SLS. The first thing the friend said was, “So, aren’t you glad you didn’t get that Supreme Court clerkship?” It was a funny question. At the time, it seemed much better to be chosen than not chosen. But there are many reasons to doubt whether winning that last competition would have been so good after all. Probably it would have meant a future of more insane competition. And no PayPal. The pithy, wry version of this is the line about Rhodes Scholars: they all had a great future in their past.

This is not to say that clerkships, scholarships, and awards don’t often reflect incredible accomplishment. Where that’s the case, we shouldn’t diminish it. But too often in the race to compete, we learn to confuse what is hard with what is valuable. Intense competition makes things hard because you just beat heads with other people. The intensity of competition becomes a proxy for value. But value is a different question entirely. And to the extent it’s not there, you’re competing just for the sake of competition. Henry Kissinger’s anti-academic line aptly describes the conflation of difficulty and value: in academia at least, the battles are so fierce because the stakes are so small.

That seems true, but it also seems odd. If the stakes are so small, why don’t people stop fighting so hard and do something else instead? We can only speculate. Maybe those people just don’t know how to tell what’s valuable. Maybe all they can understand is the difficulty proxy. Maybe they’ve bought into the romanticization of competition. But it’s important to ask at what point it makes sense to get away from competition and shift your life trajectory towards monopoly.

Just look at high school, which, for Stanford students and the like, was not a model of perfect competition. It probably looked more like extreme asymmetric warfare; it was machine guns versus bows and arrows. No doubt that’s fun for the top students. But then you get to college and the competition amps up. Even more so during grad school. Things in the professional world are often worst of all; at every level, people are just competing with each other to get ahead. This is tricky to talk about. We have a pervasive ideology that intense, perfect competition makes the best world. But in many ways that’s deeply problematic.

One problem with fierce competition is that it’s demoralizing. Top high school students who arrive at elite universities quickly find out that the competitive bar has been raised. But instead of questioning the existence of the bar, they tend to try to compete their way higher. That is costly. Universities deal with this problem in different ways. Princeton deals with it through enormous amounts of alcohol, which presumably helps blunt the edges a bit. Yale blunts the pain through eccentricity by encouraging people to pursue extremely esoteric humanities studies. Harvard—most bizarrely of all—sends its students into the eye of the hurricane. Everyone just tries to compete even more. The rationalization is that it’s actually inspiring to be repeatedly beaten by all these high-caliber people. We should question whether that’s right.

Of all the top universities, Stanford is the farthest from perfect competition. Maybe that’s by chance or maybe it’s by design. The geography probably helps, since the east coast doesn’t have to pay much attention to us, and vice versa. But there’s a sense of structured heterogeneity too; there’s a strong engineering piece, the strong humanities piece, and even the best athletics piece in the country. To the extent there’s competition, it’s often a joke. Consider the Stanford-Berkeley rivalry. That’s pretty asymmetric too. In football, Stanford usually wins. But take something that really matters, like starting tech companies. If you ask the question, “Graduates from which of the two universities started the most valuable company?” for each of the last 40 years, Stanford probably wins by something like 40 to zero. It’s monopoly capitalism, far away from a world of perfect competition. 

The perfect illustration of competition writ large is war. Everyone just kills everyone. There are always rationalizations for war. Often it’s been romanticized, though perhaps not so much anymore. But it makes sense: if life really is war, you should spend all your time either getting ready for it or doing it. That’s the Harvard mindset.

But what if life isn’t just war? Perhaps there’s more to it than that. Maybe you should sometimes run away. Maybe you should sheath the sword and figure out something else to do. Maybe “life is war” is just a strange lie we’re told, and competition isn’t actually as good as we assume it is.

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Here is an essay version of my class notes from Class 3 of CS183: Startup. Errors and omissions are my own. Credit for good stuff is Peter’s entirely.  Please note that I actually missed this class (I was on my honeymoon!). Thanks to @erikpavia and @danrthompson for sending me their notes to work from.

CS183: Startup—Notes Essay—Value Systems

 The history of the ‘90s was in many ways the history of widespread confusion about the question of value. Valuations were psychosocial; value was driven by what people said it was. To avoid herd-like confusion of decades past, we need to try and figure out whether it’s possible to determine businesses’ objective value and, if it is, how to do it.

As we discussed back in Class 1, certain questions and frameworks can anchor our thinking about value. The questions are necessarily personal: What can I do? What do I think is valuable? What do I see others not doing? A good framework might map globalization and technology as the two great axes of the 21^st century. Synthesizing all this together forges the higher-level question: What valuable company is nobody building? 

A somewhat different perspective on technology—going from 0 to 1, to revisit our earlier terminology—is the financial or economic one. Since that perspective can also shed considerable light on the value question, it’s worth covering in detail now.

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Here is an essay version of my class notes from Class 2 of CS183: Startup. Errors and omissions are my own. Credit for good stuff is Peter’s entirely. 

CS183: Startup—Notes Essay—Party Like It’s 1999?

I.  Late to the Party

History is driven by each generation’s experience. We are all born into a particular culture at a particular time. That culture is like an extended dinner conversation; lots of people are talking, some lightly, some angrily, some loudly, some in whispers. As soon as you’re able, you listen in. You try to figure out what that conversation is about. Why are people happy? Why are they upset? Sometimes it’s hard to figure out.

Take someone born in the late 1960s, for instance. There was a lot going on then, culturally. But a toddler in the late ‘60s, despite having technically lived through them, essentially missed the debates on civil rights, Vietnam, and what the U.S. was supposed to look like. The child, being more or less excluded from the dinner table, would later find it hard to get a sense of what those discussions were like.

There is a keen analogue between the cultural intensity of the ‘60s and the technological intensity of the 1990s. But today’s college and perhaps even graduate students, like the toddler in 1969, may have been too young to have viscerally experienced what was going on back in 1999. To participate in the dinner table conversation—to be able to think and talk about businesses and startups today in 2012—we must get a handle on the history of the ‘90s. It is questionable whether one can really understand startups without, say, knowing about Webvan or recognizing the Pets.com mascot.

History is a strange thing in that it often turns out to be quite different than what people who lived through it thought it was. Even technology entrepreneurs of the ‘90s might have trouble piecing together that decade’s events. And even if we look back at what actually happened, it’s not easy to know why things happened as they did. All that’s clear is that the ‘90s powerfully shaped the current landscape. So it’s important to get as good a grasp on them as possible.

II. A Quick History of the 90s

Most of the 1990s was not the dot com bubble. Really, what might be called the mania started in September 1998 and lasted just 18 months. The rest of the decade was a messier, somewhat chaotic picture.

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Here is an essay version of my class notes from Class 1 of CS183: Startup. Errors and omissions are my own. Credit for good stuff is Peter’s entirely. 

CS183: Startup—Notes Essay—The Challenge of the Future

Purpose and Preamble

            We might describe our world as having retail sanity, but wholesale madness. Details are well understood; the big picture remains unclear. A fundamental challenge—in business as in life—is to integrate the micro and macro such that all things make sense.

            Humanities majors may well learn a great deal about the world. But they don’t really learn career skills through their studies. Engineering majors, conversely, learn in great technical detail. But they might not learn why, how, or where they should apply their skills in the workforce. The best students, workers, and thinkers will integrate these questions into a cohesive narrative. This course aims to facilitate that process.

I.          The History of Technology

            For most of recent human history—from the invention of the steam engine in the late 17^th century through about the late 1960’s or so— technological progress has been tremendous, perhaps even relentless. In most prior human societies, people made money by taking it from others. The industrial revolution wrought a paradigm shift in which people make money through trade, not plunder.

              The importance of this shift is hard to overstate. Perhaps 100 billion people have ever lived on earth. Most of them lived in essentially stagnant societies; success involved claiming value, not creating it. So the massive technological acceleration of the past few hundred years is truly incredible.

             The zenith of optimism about the future of technology might have been the 1960’s. People believed in the future. They thought about the future. Many were supremely confident that the next 50 years would be a half-century of unprecedented technological progress.

              But with the exception of the computer industry, it wasn’t. Per capita incomes are still rising, but that rate is starkly decelerating. Median wages have been stagnant since 1973. People find themselves in an alarming Alice-in-Wonderland-style scenario in which they must run harder and harder—that is, work longer hours—just to stay in the same place. This deceleration is complex, and wage data alone don’t explain it. But they do support the general sense that the rapid progress of the last 200 years is slowing all too quickly. 

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