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The Psychology of Entrepreneurial Misjudgment, part 1: Biases 1-6

Charlie Munger is an 80-something billionaire who cofounded top-tier law firm Munger, Tolles & Olson and is Warren Buffett's long-time partner and Vice-Chairman at Berkshire Hathaway, one of the most successful companies of all time.

Some people, including me, consider Mr. Munger to be an even more interesting thinker and writer than Mr. Buffett, and recently a group of Mr. Munger's friends assembled a compilation book of his most interesting thoughts and speeches called Poor Charlie's Almanack, inspired by Ben Franklin's Poor Richard's Almanack. (The Munger book is only available on Amazon in used form, although you can apparently buy a new copy here.)

Mr. Munger's magnum opus speech, included in the book, is The Psychology of Human Misjudgment -- an exposition of 25 key forms of human behavior that lead to misjudgment and error, derived from Mr. Munger's 60 years of business experience. Think of it as a practitioner's summary of human psychology and behavioral economics as observed in the real world.

In this series of blog posts, I will walk through all 25 of the biases Mr. Munger identifies, and then adapt them for the modern entrepreneur. In each case I will start with relevant excerpts of Mr. Munger's speech, and then after that add my own thoughts.

One: Reward and Punishment Superresponse Tendency

I place this tendency first in my discussion because almost everyone thinks he fully recognizes how important incentives and disincentives are in changing cognition and behavior. But this is not often so. For instance, I think I've been in the top five percent of my age cohort almost all my adult life in understanding the power of incentives, and yet I've always underestimated that power. Never a year passes but I get some surprise that pushes a little further my appreciation of incentive superpower.

...We [should] heed the general lesson implicit in the injunction of Ben Franklin in Poor Richard's Almanack: "If you would persuade, appeal to interest and not to reason." This maxim is a wise guide to a great and simple precaution in life: Never, ever, think about something else when you should be thinking about the power of incentives...

One of the most important consequences of incentive superpower is what I call "incentive caused bias." A man has an acculturated nature making him a pretty decent fellow, and yet, driven both consciously and subconsciously by incentives, he drifts into immoral behavior in order to get what he wants, a result he facilitates by rationalizing his bad behavior [like a salesman who harms her customers by selling them the wrong product because she gets paid more for selling it, versus the right product -- see, e.g., the mutual fund industry].

...Another generalized consequence of incentive caused bias is that man tends to "game" all human systems, often displaying great ingenuity in wrongly serving himself at the expense of others. Antigaming features, therefore, constitute a huge and necessary part of almost all system design.

...Military and naval organizations have very often been extreme in using punishment [the inverse of reward] to change behavior, probably because they needed to cause extreme behavior. Around the time of Caesar, there was a European tribe that, when the assembly horn blew, always killed the last warrior to reach his assigned place, and no one enjoyed fighting this tribe.

Human response to incentives is indeed a huge behavioral motivator, and I think Mr. Munger is right that once you think you realize how big it is, you need to assume it's even bigger.

This is why stock options work so well in startups -- and the fewer people in a startup, the better stock options work, since when there are only a few people in a company, it's usually crystal clear to each person how her work will impact the value of the company.

There is a wrong-headed and dangerous theory afoot that restricted stock (grants of fully in-the-money shares of stock) is a more appropriate motivator of employees of tech companies than stock options:

Mr. Gates wanted Mr. Buffett's input on whether to drop options in favor of restricted stock at Microsoft. [Gates] recalls asking: "How will employees respond to getting a lottery ticket that gives them a definite amount instead of one that could amount to nothing or a ridiculous sum?"

Mr. Buffett's reply, according to Mr. Gates, was: "My wife would rather have a ticket for one fur coat, than a ticket that gave her two or nothing."

Overt sexism aside, from an incentive standpoint the result of shifting from stock options to restricted stock should be obvious: current employees will be incented to preserve value instead of creating value. And new hires will by definition be people who are conservative and change-averse, as the people who want to swing for the fences and get rewarded for creating something new will go somewhere else, where they will receive stock options -- in typically greater volume than anyone will ever grant restricted stock -- and have greater upside.

And sure enough, in the wake of shifting towards restricted stock and away from stock options, Microsoft's stock has been flat as a pancake. The incentive works.

Now, against that, it is true that stock options, particularly for public companies, have an often-destructive random component: they tend to increase in value in rising stock market environments and decrease in value (potentially to zero) in falling stock market environments, regardless of whether value is being created inside your particular company.

For that reason, in the long run it probably makes sense for some new approach to stock-based compensation to be developed that both preserves the motivation to create as opposed to preserve value, but factors out the environmental swings of rising and falling stock markets. Some form of indexing against market averages would probably do the trick. This has been tried from time to time, and I expect it to be tried more in the future, at least for public companies.

As a company grows, stock options and other forms of equity-based motivation become less and less useful as an incentive tool, since it becomes harder for many employees in a large company to see how their individual behavior would have any effect on the stock price of the overall corporation. So, more tactical incentives kick in, such as cash bonuses.

The design of tactical incentives -- e.g. bonuses -- is a whole topic in and of itself, and is critically important as your company grows. The most significant thing to keep in mind is that how the goals are designed really matters -- as Mr. Munger says, people tend to game any system you put in place, and then they tend to rationalize that gaming until they believe they really are doing the right thing.

I think it was Andy Grove who said that for every goal you put in front of someone, you should also put in place a counter-goal to restrict gaming of the first goal.

So, for example, if you are incenting your recruiters on the number of new employees recruited and hired, you need to also give them a counter-goal (and tie it to their compensation) that measures the quality of the new hires three months in. Otherwise the recruiters are guaranteed to give you what you don't want: a lot of mediocre new hires.

One of the great unwritten Silicon Valley skewed incentive stories was a major datacenter vendor in the late 90's that incented its salespeople based on bookings of long-term datacenter leases, without sufficient counter-goals tied to revenue collection or the customer's ability to pay. Sure enough, soon the company's reported bookings were heading straight up, revenue was flat, and cash headed straight down, resulting in a truly spectacular bankruptcy. The salespeople got paid, though, so they were happy.

More recently, skewed incentives in the mortgage industry -- mortage issuers getting paid based on quantity of mortgages issued, versus ability to pay -- caused many of the current catastrophic Wall Street financial meltdowns you get to read about every day.

Even engineers need counter-goals: incent engineers based purely on a ship date, and you'll get a shipping product with lots of bugs. Incent based on number of bugs fixed, and you'll never get any new features. And so on.

Especially in smaller companies, peer pressure can be a very effective form of incentive. This is greatly enabled and abetted by transparency. People hate to be embarrassed in front of their peer group, so if it's crystal clear who's performing well and who isn't, poor performers will be highly motivated to improve -- and if they're not, that's good to know, since obviously then you really need to fire them.

Finally, any entrepreneur should be highly attuned to incentives when hiring outside executives, especially a CEO. Hire a CEO and give her a large stock-option grant with four-year vesting, and you can guarantee she will sell the company in year four. Give her a stock-option grant with accelerated vesting on change of control and she will sell the company sooner than that. Founders can get tripped up on this because they naturally have an emotional incentive to see the company succeed that hired executives often do not share.

And of course, never get caught between a venture capitalist and her incentives.

Two: Liking/Loving Tendency

...[W]hat will a man naturally come to like and love, apart from his parent, spouse and child? Well, he will like and love being liked and loved... [M]an will generally strive, lifelong, for the affection and approval of many people not related to him.

One very practical consequence of Liking/Loving Tendency is that it acts as a conditioning device that makes the liker or lover tend (1) to ignore faults of, and comply with wishes of, the object of his affection, (2) to favor people, products, and actions merely associated with the object of his affection (as we shall see when we get to "Influence-from-Mere-Association Tendency"), and (3) to distort other facts to facilitate love.

The application of this principle to entrepreneurs is obvious: entrepreneurs want to be liked just like everyone else, and wanting to be liked can be a major impediment to entrepreneurial success due to at least two major reasons.

First, an entrepreneur, like any CEO, has to make tough decisions about what her company will do, and those decisions will often run counter to the preferences of her employees. You don't have to be involved in that many startups to find one where the entrepreneur knows she needs to make a tough decision -- such as change strategy, or cancel a flawed project -- but can't quite do it because employees won't like it. Of course this always backfires: employees also don't like leaders who don't make the tough decisions that have to be made.

Second, an entrepreneur, like any manager, has to fire people who aren't great or who aren't right for the tasks at hand. This naturally makes people not like you, particularly the people you fire. But again, not doing this backfires: nobody great wants to be in a company populated by mediocre or ill-fitting peers.

I think these pressures are intensified in a small company versus a larger company, because in a small company everyone tends to know everyone else and people naturally form strong personal relationships within the group -- so the desire to be liked is stronger, and the perceived risk from making decisions that people won't like is higher.

A specific form of this dynamic in a startup is when you have multiple founders, of whom one is the CEO. The founder who is the CEO inevitably discovers that it becomes very hard to stay close personal friends with the other founders. As they say, it's lonely at the top -- if you're doing your job right.

Finally, some entrepreneurs have emotional resistance to pursuing a strategy that does not meet with immediate approval from press, analysts, and other entrepreneurs. This is worth watching carefully -- if everyone agrees right up front that whatever you are doing makes total sense, it probably isn't a new and radical enough idea to justify a new company.

Three: Disliking/Hating Tendency

In a pattern obverse to Liking/Loving Tendency, the newly arrived human is also "born to dislike and hate" as triggered by normal and abnormal triggering forces in its life...

As a result, the long history of man contains almost continuous war...

Disliking/Hating Tendency also acts as a conditioning device that makes the disliker/hater tend to (1) ignore virtues in the object of dislike, (2) dislike people, products, and actions merely associated with the object of his dislike, and (3) distort other facts to facilitate hatred.

If this is a problem inside your company, then you have bigger issues than I can help you with.

However, I think this dynamic kicks in for a startup when thinking about competitors.

I see two destructive consequences of this bias in startups with competitors:

First, I believe startups often overfocus on their competitors. It's the easiest thing in the world to orient yourself in opposition to another company in the same market, and to plan your actions based on what will cause damage to the competitor or block the competitor from getting business.

In the startup world, that often leads to multiple competitors engaged in a shooting war in a market that's still too small for anyone to succeed.

I think it's much better for a startup to focus on creating and developing a large market, as opposed to fighting over a small market.

So when your startup's competitive juices get flowing -- especially for the first time -- and you find yourself fixated on a competitor, be sure to take a step back and say, is this really what we want to be focused on right now -- is the market we're both in really large enough to warrant this? If so, sure, go for it, guns blazing. But if not, stepping back and thinking about how to focus instead on creating a large market might be more valuable.

A variant on this dynamic is letting your competitor determine your strategy by watching what he does and then making countermoves. The issue here is that it's highly likely that neither one of you actually knows that much about what you are doing yet -- since you are in a new market, by definition -- and while you know you don't know that much about what you're doing yet, you only observe your competitors's deliberate actions as opposed to seeing their equivalent or greater level of internal confusion. So they seem like they know what they're doing, and so you fall into assuming they know more than you do, when they probably don't.

Second, when you are in a truly competitive situation, this bias can easily lead you to underestimate your competitor by, as Mr. Munger says, "ignoring virtues in the object of dislike".

His product sucks, his salespeople aren't as good, his venture capitalists are those morons who backed that large datacenter vendor that went bankrupt -- and so on.

Notably, this attitude can become cultural in your company very quickly. I think that if you're in a shooting war, even if you privately think your competitor is an amoral pinhead, that you establish a tone that says, we'll assume that he's highly competent and has many fine virtues, which we will respect and then systematically target with our own strengths and virtues until we have killed him.

Four: Doubt-Avoidance Tendency

The brain of man is programmed with a tendency to quickly remove doubt by reaching some decision.

It is easy to see how evolution would make animals, over the eons, drift toward such quick elimination of doubt. After all, the one thing that is surely counterproductive for a prey animal that is threatened by a predator is to take a long time in deciding what to do...

So pronounced is the tendency in man to quickly remove doubt by reaching some decision that behavior to counter the tendency is required from judges and jurors. Here, delay before decision making is forced. And one is required to so comport himself, prior to conclusion time, so that he is wearing a "mask" of objectivity. And the "mask" works to help real objectivity along, as we shall see when we next consider man's Inconsistency-Avoidance Tendency...

What triggers Doubt-Avoidance Tendency? Well, an unthreatened man, thinking of nothing in particular, is not being prompted to remove doubt through rushing to some decision. As we shall see later when we get to Social-Proof Tendency and Stress-Influence Tendency, what usually triggers Doubt-Avoidance Tendency is some combination of (1) puzzlement and (2) stress.

This is probably a good one for entrepreneurs. You'd better not have a lot of doubts about what you are doing because everyone else will, and if you do too, you'll probably give up.

Of course, an entrepreneur's doubt avoidance is only a plus right up to the point where it becomes pigheaded stubbornness that interferes with her ability to see reality, particularly when a strategy is not working.

In my view, entrepreneurial judgment is the ability to tell the difference between a situation that's not working but persistence and iteration will ultimately prove it out, versus a situation that's not working and additional effort is a destructive waste of time and radical change is necessary.

I don't believe there are any good rules for being able to tell the difference between the two. Which is one of the main reasons starting a company is so hard.

Five: Inconsistency-Avoidance Tendency

[People are] reluctant to change, which is a form of inconsistency avoidance. We see this in all human habits, constructive and destructive. Few people can list a lot of bad habits that they have eliminated, and some people cannot identify even one of these. Instead, practically every one has a great many bad habits he has long maintained despite their being known as bad. Given this situation, it is not too much in many cases to appraise early-formed habits as destiny. When Marley's miserable ghost says, "I wear the chains I forged in life," he is talking about chains of habit that were too light to be felt before they became too strong to be broken.

[T]ending to be maintained in place by the anti-change tendency of the brain are one's previous conclusions, human loyalties, reputational identity, commitments...

It is easy to see that a quickly reached conclusion, triggered by Doubt-Avoidance Tendency, when combined with a tendency to resist any change in that conclusion, will naturally cause a lot of errors in cognition for modern man. And so it observably works out. We all deal much with others whom we correctly diagnose as imprisoned in poor conclusions that are maintained by mental habits they formed early and will carry to their graves...

And so, people tend to accumulate large mental holdings of fixed conclusions and attitudes that are not often reexamined or changed, even though there is plenty of good evidence that they are wrong...

As Lord Keynes pointed out about his exalted intellectual group at one of the greatest universities in the world, it was not the intrinsic difficulty of new ideas that prevented their acceptance. Instead, the new ideas were not accepted because they were inconsistent with old ideas in place...

We have no less an authority for this than Max Planck, Nobel laureate, finder of "Planck's constant." Planck is famous not only for his science but also for saying that even in physics the radically new ideas are seldom really accepted by the old guard. Instead, said Planck, the progress is made by a new generation that comes along, less brain-blocked by its previous conclusions...

One corollary of Inconsistency-Avoidance Tendency is that a person making big sacrifices in the course of assuming a new identity will intensify his devotion to the new identity. After all, it would be quite inconsistent behavior to make a large sacrifice for something that was no good. And thus civilization has invented many tough and solemn initiation ceremonies, often public in nature, that intensify new commitments made.

This goes hand-in-hand with doubt-avoidance, and again is usually a plus for a startup, since it leads to greater commitment on the part of the entrepreneur and the team. (And yes, I am in favor of blood oaths for startups.)

Perhaps this bias is most relevant to how new markets develop. Sometimes you get lucky -- you bring a new product to market, and the target customers all go, great, we'll take it! However, often you get a level of resistance from the market that can be puzzling -- "can't they see that our new product would be better for them than what they have now?"

This in turn leads to the odd dynamic you often see where a startup will field a new product, nobody wants it, and the startup goes belly up. Then three or four or five years later, another startup launches with a very similar product, and this time the market says, hell yes!

I think this is something that every entrepreneur needs to watch very carefully. Sometimes it's simply a matter of timing -- and if people just aren't ready for a new idea, you usually can't make them ready, and you have to wait for them to change or for a new generation of customers to come along.

My favorite way around this problem is the one identified by Clayton Christensen in The Innovator's Dilemma: don't go after existing customers in a category and try to get them to buy something new; instead, go find the new customers who weren't able to afford or adopt the incarnation of the status quo.

For example, when the personal computer was invented, the desirable market was not the universe of people who were already buying computers -- a.k.a. mainframe and minicomputer buyers -- but rather the universe of the people who couldn't afford a mainframe or minicomputer and therefore had never had a computer before.

Similarly, the desirable market for Hotmail in the early days was not existing email aficionados who were already using sophisticated email desktop software, but rather the universe of people who were coming on the Internet for the first time who didn't even have email yet and for whom web-based email was by far the easiest way to start.

Conversely, one of the reasons that today's consumer Internet companies have the wind at our backs versus our peers 10 years ago is that a whole new generation of consumers has come of age in the last 10 years for whom the Internet is their primary medium -- time and demographics are on our side now. That makes life a lot easier, let me tell you. Meanwhile, the average age of television viewers continues drifting higher and higher...

Six: Curiosity Tendency

This is, frankly, an odd one for Mr. Munger to include, since it's primarily a plus, and he doesn't really identify a downside.

The only important thing I can think to add -- aside from the importance of hiring curious people -- is that lack of curiosity can be a huge danger to a startup in the following way: often, your initial strategy won't quite work, but you can learn as you go based on other things that happen in the market and eventually iterate into a strategy that does work. Obviously, insufficient curiosity can prevent you from seeing the new data and lead you to continue to pursue a losing strategy even when you wouldn't have to.

To be continued...

Silicon Valley after a Microsoft/Yahoo merger: a contrarian view

This post is not about the potential Microsoft/Yahoo merger.

Instead, let's just assume for the moment that Microsoft succeeds in its bid for Yahoo.

What would a Microsoft/Yahoo merger mean for startups in Silicon Valley?

Some smart people whom I respect a great deal believe that a Microsoft/Yahoo merger would be bad for Silicon Valley startups.

Says Bill Burnham, for example: "By swallowing up Yahoo, Microsoft will be removing one of the biggest and most active acquirors of start-ups in Silicon Valley... [making] M&A less competitive in general and [reducing] the # of potential exits... [which is] bad news for Internet [startups] and their VC backers anyway you look at it."

I respectfully disagree; I think that a Microsoft/Yahoo merger would have practically no impact on any high-quality Silicon Valley startup.

And here's why:

First, Yahoo has simply not been all that active in buying Silicon Valley Internet startups -- nor, for that matter, has Microsoft and Google -- contrary to popular perception.

Since Terry Semel's arrival as CEO, and continuing since his departure, Yahoo has become quite conservative when it comes to buying startups.

Yahoo only bought a relative handful of companies in 2007. The big ones were Right Media and Blue Lithium in the advertising space -- where Yahoo was highly motivated to make progress -- and Zimbra in the email space. The small number of other acquisitions (three in the US, I believe -- Mybloglog, Rivals, and Buzztracker) were tiny enough that Yahoo didn't even have to disclose the purchase prices.

Similarly, Microsoft bought surprisingly few companies in 2007. aQuantive was the big dog, and Microsoft was similarly motivated by a high degree of urgency to get on the advertising bus. Apart from that, you're looking at a very small number of very small deals, such as Screentronic and Jellyfish -- fine companies, I am sure, but tiny deals.

And even Google, which did more deals than Microsoft and Yahoo combined in 2007, only did a coule of sizeable ones -- Doubleclick (again that advertising thing), and Postini in email. And, Feedburner got a fine exit from Google given that it hadn't raised much equity funding. But most of the other companies Google bought largely to acquire engineers, and perhaps nascent products that hadn't yet shipped -- not doubles or triples or even necessarily singles from the perspective of venture-funded Valley startups.

Microsoft, Yahoo, and Google are only buying a relatively small number of smaller companies at all today -- so given that, taking Yahoo, or even Microsoft for that matter, out of the M&A races isn't going to reduce the number of deals going down each year by very much.

Second, the spectrum of companies that are doing Internet M&A is surprisingly broad, and, drawing from lists of deals from just 2005-2007, includes names like:

• Akamai
• Amazon
• American Greetings
• AOL
• CBS
• Cisco
• CNet
• Comcast
• Digital River
• Disney
• eBay
• Expedia
• HP
• IAC
• Jupiter Media
• Liberty Media
• Marchex
• MercadoLibre
• Monster
• Motricity
• NBC Universal
• New York Times
• News Corp
• Omniture
• Priceline
• Publicis
• Real
• Sabre
• Scripps
• Shutterfly
• Sony
• Valueclick
• Viacom
• WPP

So the base of buyers for Internet startups is considerably more diversified than you might think.

Third, consider what's likely to happen next.

Many of the traditional media companies -- in the US and overseas -- are looking at their core businesses today and seeing either rapid or imminent deterioration. This is certainly true for television, radio, music, newspapers, and magazines, and quite possibly also true for movies (given the decline in ticket sales and the recent apparent stalling out of the DVD market). And this is also true -- or will be true -- for a pretty broad range of various other businesses that are getting touched by the Internet.

For historical reasons -- skepticism about the potential of the Internet, combined with the false hope presented to many traditional businesses by the dot com crash of 2000-2002 -- many of these traditional companies are not yet appropriately positioned for an Internet-dominated future.

And now, if the Microsoft/Yahoo deal does go through, those same companies in many cases will be looking down a very scary double-barreled shotgun of an ascendant Google and an armored-up Microsoft, aimed right at their lunch, if you know what I mean.

I'm pretty confident guessing that the level of concern and even panic among many traditional companies -- particularly media companies -- is only going to escalate from here, as traditional non-Internet businesses in various sectors deteriorate and consumers continue moving en masse to the Internet.

And from there, it's not hard to guess that Internet M&A is likely to heat up considerably over the next several years, compared to the last several years, across a very interesting and surprisingly diverse cross-section of buyers.

Fourth, new buyers appear on a regular basis.

It wasn't that long ago that Google would not have gone on anyone's list as a significant buyer of other companies.

In the meantime, Facebook has emerged as a company with considerable financial firepower and is already starting to do M&A.

If past is prologue, several new buyers of one form or another will pop up over the next five years, and one or two of them will probably be on the "top buyers" list in 2010 or 2012 -- when you'd be selling a company you start today -- even though we probably haven't even heard their names yet.

Think also about the telecom companies, the mobile carriers, the Japanese consumer electronics companies, the Korean conglomerates, the mobile handset makers -- Nokia is ramping up their Internet M&A efforts right now, European media companies... not to mention the Chinese Internet companies. Any of these could emerge as meaningful buyers of Silicon Valley Internet companies of various forms in the years ahead.

After all, in a world where Cisco is buying social networking startups, anything is possible.

Fifth, building your startup with a goal of getting acquired is foolishness anyway, in my opinion. Smart people disagree with me on this, but I'll make my case in two points:

• Big companies don't want to buy startups that want to get bought. Instead, big companies buy startups that have built something of value that they decide is important to them.
• You can't possibly guess what things of value big companies are going to want to own in one or two or three years. The world is changing too fast -- witness the Microsoft hostile bid for Yahoo itself! -- and besides, big companies are Moby Dick and you can't understand the reasoning behind their decisions anyway.

Combine those two points with the fact that no big company buys that many startups each year anyway, and it's easy to see that the odds of you successfully anticipating something that a big company is going to want in the future and then actually selling your company to them -- as your strategy -- is a very risky proposition that is highly prone to failure.

And in fact, in my experience, most startups that start with the goal of getting bought, fail.

The formula for success in startups is the same today as it's always been, and it will be the same post-Microsoft/Yahoo:

Build something of value -- something that people want, and something that will be profitable at the appropriate point -- and the world is yours.

Successful companies -- companies that have built something of value -- have many options. They can stay private and throw off dividends. They can go public. They can get acquired by big companies who suddenly decide, hey, that looks really valuable, let's buy that. They can sell minority stakes to big investors or strategic partners at very high valuations. All options that are typically not open to the startup that started with the goal of getting bought and didn't build something of independent value.

Or, reduced to a phrase: the best way to get bought is to not be for sale.

Because of this, even if Microsoft, Yahoo, and Google stopped doing M&A completely, the strategy of any high-quality startup in the valley would not change one bit.

Sixth, I believe that a Microsoft/Yahoo merger would actually be a net positive for many high-quality Silicon Valley Internet startups, for a completely different reason.

Again, suppose the takeover bid succeeds. You're looking at probably a year of government approvals, followed by at least a year of integration.

You can't speed up the first part, because that's up to the government, and they don't react well when you scream "hurry up!" at them. And you don't want to speed up the second part, because integrating two companies of the scale and scope of Microsoft and Yahoo is an absolutely enormous undertaking and you want to make sure you do it right, or you're not going to get any of the benefits.

In practice, that will be two years in which both Microsoft and Yahoo will most likely be considerably less aggressive on rolling out new products and new initiatives -- because the key people at both companies will be consumed with the merger.

And, just think, if they are buying fewer companies as a consequence, that also means they're less likely to buy one of your competitors and come after you while you are building your thing of value.

I think this merger, if it happens, will help clear the field for a whole new generation of Silicon Valley Internet startups to create and scale the next set of killer consumer services that will go mainstream and be used by hundreds of millions of people worldwide.

Where does that leave us?

The Microsoft/Yahoo deal, if it happens, means very little for the entrepreneurial climate in Silicon Valley, or the opportunities available to you and your startup.

Your job is exactly the same as before: build something people want, scale it up, make sure it's defensible, and make sure you can make money with it.

Build a company you are proud of.

If you do those things, you'll do just fine; if you don't, neither Microsoft nor Yahoo nor any other big company were going to rescue you anyway.

Nobody ever said this was easy, but in a world moving this fast and this much in flux, it certainly is fun!

Great talk by Stephen Wolfram on starting companies

From Stephen Wolfram, one of my entrepreneurial heroes, who (unlike me) was able to start and run a successful high-tech company in Champaign, Illinois...

A great talk on how to start and run companies. Worth reading the whole thing, but here are my favorite parts.

Motivation for starting Wolfram Research, the maker of Mathematica:

[As a physicist,] I'd been used to using all sorts of separate programs -- and custom software -- for things I wanted to do. But I had the idea that perhaps I could make one really general computational system that I could just use forever.

And that lots of other people would find useful too.

Well, that was what launched me on building Mathematica. I was pretty definite and determined about it.

And I knew I needed to start a company.

Starting focused, but learning and adapting as you grow:

I had made a little money by then. And quite a few of the first people I collected were basically moonlighters. So I didn't need any outside money.

And pretty soon I started making deals with companies like NeXT and Sun and IBM to pay up front to have our software for their machines.

And after a year and a half -- June 1988 -- Version 1 of Mathematica was released, and made a nice splash.

I think I had about 15 employees by then. I hoped I could keep the company really small. A pure R&D company. With the sales and marketing -- or at least the sales -- left to the hardware companies.

Well, despite lots of good intentions, that didn't work out. There were too many cultural impedance mismatches. And pretty soon I realized I was just going to have to build everything directly in my company.

And I'm happy to say that that worked out really well. The company's been going for more than 18 years now. And been consistently profitable.

I've been the CEO all the time. I've kept the company small. The core of it is still only about 350 people.

On the value of tapping a rich vein of potential development and expansion from a deep core idea:

You know, Mathematica is really based on fairly deep ideas about computation. That particularly come out in the notion of symbolic programming. That lets one unify all sorts of constructs and operations. And manipulate the structure as well as the content of data.

That's been at the core of Mathematica for 18 years. But it's a difficult idea, that takes a long time to get absorbed.

But it's what's let us build the huge web of algorithms and things in Mathematica.

And over the last ten years we've gradually realized that it lets us build some pretty major other things. Which are going to be really exciting when they're finally out. I think a bigger step even than when Mathematica Version 1 came out.

Why start a company, and why not start a company:

Well, of course, people are all different. And I think what's crucial is to understand one's own capabilities, and one's own motivation.

A lot of what goes into starting companies is turning nothing into something. Starting with a blank slate, and just inventing all kinds of stuff.

You'll never know if it's ultimately correct. You just have to use your judgement, make decisions, and move on.

To some people, that's pretty scary. Not to have any answers to look up in the back of the book. Just to do stuff.

People have different motivations, of course. A lot of people think the big thing with companies is money.

Yes, if you luck out, you can make a lot of money. But it's really rare that money carries people as a motivation.

You have to actually care about what you're doing.

For some people, like me, it's the actual creative content that they care most about. For other people, it's the act of building the company. For others, it's making deals. Or winning against competition.

But there has to be something you really care about.

Why the CEO should be a founder:

And I think it's important that if you're the one who cares, you should be the one pushing things forward. If you're smart, there's a good chance you can learn the detailed skills to run a company. But to make the company really work, you need someone leading it who really cares about it.

You can't delegate the core motivation.

On the role -- or non-role -- of business plans, and the sources of real value:

But in the things I've done -- and all the various CEOs I've counseled over the years -- I'm not sure if writing a detailed business plan would ever once have been worthwhile. I'm as analytical as anyone. But somehow there are always variables one doesn't know. That can just turn numbers and things upside down.

Now of course there's a certain discipline to writing a business plan. And seeing whether someone can actually put together a logical plan can be a good way to assess them.

It's like whether one has a good website. That looks nice, and is well organized. Or has some educational degree that proves one can finish something.

Well, OK, I could go on for ages about things to do and not to do with companies.

After a while one gets a certain intuition for what's going to work, and what's not. I'm always trying to test my intuition, by watching how things actually play out, and comparing with what I expected.

There are certain constants. Get-rich-quick schemes almost never work. Even if they sound really clever. It takes actual hard work to build things. And usually at the core of anything successful is something difficult. It may not be what people talk about. It might be something technical. It might be a business structure. But there'll be something there that's sort of a hard idea. It's always a good exercise to see if you can figure out what it is.

You know, sometimes there are things in business that just don't seem to make sense. Some deal that's too good to be true. Some magic solution to a problem. But somehow those never really seem to work out. Somehow in the long run things always arrange themselves to sort of be fair. To get out what gets put in.

Finally, check this out. Wow.

Rebuilding Hollywood in Silicon Valley's image

Last week I posted a rather pointed polemic titled "Suicide by strike" in which I argued that the big entertainment companies were acting suicidally in picking a fight with the writers at precisely the wrong time.

In this post, I more dispassionately outline my theory of why that's the case, and what I think may happen next.

The writers' strike, and the studios' response to the strike, may radically accelerate a structural shift in the media industry -- a shift of power from studios and conglomerates towards creators and talent.

First, some context. In Hollywood, the talent -- actors, directors, writers -- is unionized, and those unions engage in old-fashioned collective bargaining with the studios, also known as "the Man". That collective bargaining establishes the economic framework by which most of the talent gets paid.

Last week, the writers' union -- technically unions, but I'll use the singular form for simplicity -- went on strike for the first time since 1988 after an acrimonious breakdown in negotiations with the studios over a new deal.

Significantly, the actors' and directors' unions are due to renegotiate their deals with the studios soon as well; some people in Hollywood believe that the studios are being deliberately hostile to the writers in order to send a signal to the actors and directors to not expect much.

The writers are on strike primarily over the terms by which they get paid "residuals", or ongoing payments, for various forms of distribution of television shows and movies. In a simplified nutshell:

• Due to amazing historical circumstances around the birth of the VCR in the early 1980's, television and movie writers are currently paid approximately 4 cents for each DVD sold -- bearing in mind that the average sale price for a DVD is over $10, and the cost of manufacturing a DVD is less than 50 cents. The writers want that residual rate doubled to 8 cents per DVD, and the studios are refusing.
• Currently, writers are not paid for Internet downloads via online video stores like iTunes and Amazon Unbox. The studios want to extend the current 4-cent DVD residual formula to Internet downloads; the writers are holding out for more.
• The studios are refusing to pay residuals on Internet streaming of television shows and movies -- even when that streaming comes from their very own web sites and contains revenue-bearing commercials. The studios call all such streaming "promotional". The writers are howling with outrage that if the studios themselves are streaming complete TV shows containing commercials, that's clearly not just "promotional". The writers have a good point.

Taken on their own, these issues are most likely negotiable and solvable. However, trust between the two sides seems nearly nonexistent; the writers feel like they have been repeatedly burned by the studios over the last few decades; and the studios may well have a vested interest in beating up the writers in order to motivate the actors and directors to not push too hard in their upcoming negotiations.

And so, the writers are on strike.

How long will the strike last?

Nobody knows. The strike of '88 lasted for up to five months. Some people in Hollywood think this strike could last until June 2008 or beyond. Or perhaps it gets settled tomorrow.

What happens if the strike continues for months?

Movie production will apparently be largely unaffected for quite a while; the movie studios have stockpiled scripts and are continuing to shoot new films.

Television, however, is a very different picture.

Scripted television production is already all but shut down. Most late-night talk shows are shut down. Most remarkably, many comedy and drama series are either already shut down or will be within the next several weeks. Why? Two reasons: first, television shows often don't have scripts in hand for more than a few weeks of filming at any given time. Yes, Virginia, the writers of "24" really don't know how it's going to end when they start filming a new season. Second, many television shows are run by so-called showrunners who serve as both writers and producers; many showrunners are now refusing to work altogether -- and the studios are already threatening to sue them for refusing to honor their producing contracts, further fraying relations.

If the strike continues into next spring, you won't see new episodes of most scripted TV shows past Christmas -- you'll see reruns, and reality TV. Some people on Hollywood think this could permanently kill many of the shows currently on network TV -- i.e. they may never start back up. (MTV's "A Shot At Love with Tila Tequila" will, however, be unaffected.)

If the strike continues too far into next spring, it will also disrupt the production of pilots, which will mean that there won't be any new shows for the fall 2008 TV season, which means you might not see new TV programming other than reality shows until 2009. 2008 may be, quite literally, a dead year for TV.

OK, now let's get into my theory of how this may play out...

What are the probable long-term consequences of an extended strike?

First, ongoing alienation of a new generation of TV viewers.

The music industry's war on digital distribution over the last 10 years, starting with their assault on Napster and continuing to all the present-day RIAA fiascos, has permanently alienated an entire generation of consumers, who are now voting with their wallets and not buying music. They're still going to concerts, buying artist merchandise, buying video games that contain lots of music, even voluntarily paying Radiohead directly for free album downloads -- but mainstream recorded music revenue is dropping like an anvil in a Bugs Bunny cartoon, with virtually no hope of recovery.

The TV and movie industry has already been conducting their equivalent war on digital distribution; as a result, most of the new consumers -- kids, college students, young professionals -- view iTunes and Amazon Unbox downloads as "too little, too late" when it comes to giving them the ability to watch what they want, when they want, on whatever device they want.

I think the TV and movie industry is at a turning point where things could go either way -- they could repeat the critical error of the music industry and permanently alienate their customer base; or they could get it together and create viable models for the future that make consumers happy and make money.

The situation already wasn't looking too good, but the one even more effective way to alienate viewers than attacking their viewing options is to actually kill the programs they are watching.

Which is what an extended strike will do.

Second, driving consumers even faster to the new range of activities they can engage in.

We all know the list: the Internet, social networking, user-generated content, blogging, video games, mobile phones, you name it. All the activities that consumers have discovered and adopted since the last writers' strike in 1988, that they just love, and that have already been siphoning away time, attention, and money from TV and movies even without a strike.

Obviously, the less scripted television and film content that's being produced, the more alienated consumers will shift over to all the new activities -- and the less likely they will ever go back.

Third, and most significantly: catalyzing faster development of new business models for entertainment media.

Here's where things get really dramatic.

The Internet has already been forcing a rethink of the structure of the media industry, particularly for entertainment. The strike is kicking that rethink into high gear. Here's why:

The classic Hollywood economic model is built around the existence of a few very large companies -- studios -- that dominate production, marketing, and distribution. This has been the economic model since the birth of the entertainment industry, for fundamental reasons.

• Historically, marketing and distribution of entertainment properties has been extremely expensive. Running big nationwide ad campaigns and getting distribution into TV networks or movie theater chains is expensive. And production has also been very expensive. Only a small number of very large companies can afford to be in the business.
• Because of that, those few very large companies -- studios -- have been bottlenecks. If you are talent -- writers, actors, directors -- you have to deal with the studios because otherwise you can never bring anything to market.
• The studios have rationally exploited their bottleneck status to demand ownership of the creative product. Writers, actors, and directors don't own their output; the studios do.
• As a consequence, talent gets paid like hired guns, not owners.
• As a consequence of that, talent bands together to form unions -- actors', directors', and writers' unions -- and engage in adversarial collective bargaining to try to extract a share of the ongoing economics of their output. Hence the residual system that's in dispute today: 4 cents per DVD.

Let's contrast all of that to the Silicon Valley model.

In Silicon Valley, there are many companies, large and small, that create, market, and distribute products -- and more such companies all the time. In fact, there is a whole industry -- the venture capital industry -- devoted to creating as many new such companies as possible, as rapidly as possible.

• In Silicon Valley, creation, marketing, and distribution of a compelling new product is not very expensive. And with the Internet, marketing and distribution costs drop nearly to zero. Most successful Internet companies, large and small, use free viral marketing techniques and never run ads. And the whole concept of distribution costs goes away when everything is digital -- the next set of bits costs nothing to manufacture.
• Therefore, there are no bottlenecks. Many companies, large and small, can afford to be in business -- can afford to develop new products and bring them to market, market them and distribute them. And nobody can really block you.
• In Silicon Valley, the creators of the product -- the talent -- are owners: owners of their product, and owners of their company. In fact, the entities that finance the companies -- venture capitalists, private equity funds, the public stock market -- want the creators to be owners: in a world where there can be many companies, the best creative talent will be drawn to the situations in which they will be owners, and will be compensated as owners.
• Because of that, in technology, creators get paid like owners.
• Therefore, there are no unions. There is no reason for the creators to unionize -- they would be negotiating with themselves. The concept of residuals does not exist -- they'd be paying themselves. And alignment of interests between creators and financiers is near-perfect.

I believe the entertainment industry is in the early stages of being rebuilt in the image of Silicon Valley.

What would a new entertainment media company, producing original content, look like in the age of the Internet?

• Starting from the end of the process: you know distribution is now nearly free. Put it up on the Internet and let people stream or download it.
• Marketing is also free, due to virality. Let people email your content to their friends; let people embed your content in their blogs and on their social networking pages; let your content be searchable via Google; let your content be easily surfaced using social crawlers like Digg. All free.
• Production is very cheap. Handheld high-definition video cameras cost nearly nothing. You can do almost every aspect of production and post-production on any Mac. Hell, you can even score an entire movie for free -- there are hundreds of thousands of bands on the Internet who would love to have their music embedded in a new entertainment property as promotion for the bands' concerts and merchandise.
• The creators of the content are the owners of the company. The writers, actors, directors -- they are the owners. They have a direct, equity-based economic stake in the company's success. They get paid like owners, and they act like owners.
• Financing is straightforward: venture capital, just like a high-tech startup. We live in a world in which financing a high-quality startup is simply not difficult -- not for a high-quality technology startup, and increasingly not for a high-quality media startup. Modern financiers love being co-owners of a new company with the talent that will make the company successful -- and that's how it will happen here.

This is not a difficult thing to envision. And in fact, it's already happening. Will Ferrell's Funny Or Die, in which I am a minority investor, is one early existence proof of this model. And there are a ton of other such new companies either already underway, or currently being incubated, or currently being negotiated.

And in fact, there are a lot of historical precedents even in the media industry for the model of talent as owners, going all the way back to the original United Artists in 1919. Some of those precedents worked great -- George Lucas, for example. Some flamed out. Of course, they were all up against the bottlenecks.

But here we are, living in a world in which the bottlenecks have suddenly become irrelevant.

I don't think there's any question that this is the logical model to pursue in the age of the Internet -- the age of free distribution and marketing.

Suppose the writers' strike continues for months to come -- and even beyond that, suppose the actors or the directors also go on strike. In such a scenario, it is hard to see how many companies based on this new model won't be created extremely quickly -- after all, if you really can't work for the Man, why not start your own company, if you can?

And if you are a primary creator in Hollywood, the model for starting your own company is suddenly becoming very clear.

Which brings me full circle to why I'm even writing about this topic in the first place.

As consumers -- even alienated consumers -- it would be sad to see the TV shows and movies we love not get made during a protracted strike. And certainly many people throughout the extended ecosystem of the entertainment industry -- most of them not rich and not famous -- will suffer financially.

However, in the event of a long-term strike, out of the ashes of the traditional model would -- I believe -- come the birth of certainly dozens, maybe hundreds, and possibly even thousands of new media companies, rising phoenix-like into the global entertainment market, financed by venture capital, creating amazing new properties, employing large numbers of people, and rewarding their creators as owners.

As an entertainment consumer, I'm ready for it, and I suspect you are too.

Hollywood, rebuilt in Silicon Valley's image.

Serial entrepreneurs and today's Silicon Valley

Several days ago, Gary Rivlin of the New York Times called me about a story he was writing about the brilliant Max Levchin of Paypal and Slide, and the general topic of serial entrepreneurs in Silicon Valley. The story came out yesterday; below are the notes I prepared for my conversation with Gary.

In a nutshell, Gary's question to me was: what makes serial entrepreneurs tick? Why do people like Max keep going and start new companies when they could just park it on a beach and suck down mai tais?

First, in my experience, Silicon Valley entrepreneurs are all over the map when it comes to personality and motivation. Some are purely mercenary -- one hit and they're out. Others just love the technology, and the business is a side effect. Still others are like Chauncey Gardiner in Being There. And some just love starting and building companies.

Second, there were serial entrepreneurs in the past, but there are certainly more now than ever before. There are many factors that lead to this -- here are the big ones:

• There are simply more entrepreneurs now -- due to the amazing surge in venture capital and the culture of startups over the last 10-15 years -- so you'd expect more serial entrepreneurs just based on that.
• A lot of new companies simply develop faster these days than they did in the past. Microsoft and Oracle, for example, both put in 10 years of incredibly hard work before going public (both founded in '76, IPO in '86), and they only had a few hundred employees each when they went public -- and those were the two biggest software successes of their era.

  Versus these days, when many companies are founded, built, scaled up, and sold (or, yes, taken public!) in a few years.

  The process can happen so fast that people are freed up much faster; therefore, upon being freed up they are younger and tend to have more raw energy than people who in the past would have spent 10 or 20 or 30 years building a single company -- and by the time they freed up, they maybe didn't want to put that level of effort into something again.

• Also because of the faster cycle time, when you start company #2 you can assume that it won't necessarily consume the next 10-20-30 years of your life -- you can probably build something successful over say 5 years, maybe 8 years max, and so you're not committing the rest of your life.

  This makes it easier for people to say, OK, hey, it worked once, I'll try it again.

• The culture of startups in the Valley is clicking on all cylinders -- everything from fundraising to hiring to building out a management team to signing up lawyers and accountants and bankers is simply easier than ever before. I'm talking in a macro sense -- over the last 10 years, versus prior decades, even considering the early 2000's bust.

  So it's just easier to start the next company that it was the past -- the "pain in the ass" factor is lower.

• In terms of exit, there are some IPO's, but the big thing is that M&A is a widely accepted and viable exit. Big companies in and related to the Valley have actually become quite good, in general, at acquiring small companies -- not perfect, but quite good. They do it frequently, in order to build out their product families or grow market share. This of course inspires more companies to be started and tends to compress the time cycles further.

Third, all that said, it is striking how many of the truly revolutionary companies are started, at least in part, by people who haven't done it before. Google (Brin and Page), Yahoo (Yang and Filo), Facebook (Zuckerberg), Apple (Jobs and Wozniak), etc.

When you see one of those really revolutionary companies and there's some young kid with the idea, of course, they often are linked up with one or more seasoned, experienced people -- Google (Schmidt, Doerr, Moritz), Yahoo (Moritz, Koogle), Facebook (Thiel, Breyer), Apple (Markkula). So even there you see a kind of a serial entrepreneur (or VC or executive) effect which is another form of what you're talking about.

Fourth, drilling deeper into the motivations of the great serial entrepreneurs I know, the dominant themes are:

• Desire to prove oneself -- either "I can do it again -- it wasn't a fluke the first time", or "I was the junior partner last time, now I'll be the senior partner", or "I got fired from my last company, I'll show those f****** VCs", or something like that.
• Desire to continue working and being productive -- "I'm 26 or 30 or 34, I have a lot of energy, I have to keep moving, and I'm certainly not going to go to work for some boring big company or be another hack VC... obviously I need to start another company".
• In love with the technology or a new idea -- there's more of this than cynical people think.
• A feeling that we're in a unique time and place where it's possible for us to start, build, and be successful with multiple companies -- it'd be a shame to walk away from the opportunity to continue to be a part of such a magical time and place. This is a big motivator for me, by the way. Growing up, I would have never dreamed that an industry like this would exist or that I would get to be a part of it. I pinch myself every day.
• Money, but not just "I can buy a fancier cashmere car cover" kind of thing (although there is some of that) -- just as often I think it's money as a way to keep score (often in the form of something like, "I can't believe Mark Cuban is a billionaire and I'm not; I can do that too"), or money as a way to have an impact on the world philanthropically -- the more you make, the more you can give away. That last one is certainly becoming a bigger and bigger motivator for me.

With any given serial entrepreneur, it's probably a mix of these.

Fifth, a sharply related topic to all of this is that the opportunities are bigger than ever before. It's not an accident that companies like Google or Facebook or Paypal just get huge, and apparently overnight.

For the first time in history, you have a global market of 1+ billion people, all connected over an interactive network where they're all a click away from you. That's amazing.

And 100 million new people are being added to that count every year, and that will continue for the next 30 years.

A huge and growing market makes all kinds of magical things possible, and I think that's what we're seeing now.

You have to love this industry

I know I do!

October 2:

Steve Ballmer, the Microsoft chief executive, believes that the craze for individual social networks such as Facebook risks being exposed as a "fad"...

"I think these things [social networks] are going to have some legs, and yet there’s a faddishness, a faddish nature about anything that basically appeals to younger people," Mr Ballmer told Times Online yesterday...

[Ballmer] added that there was little in the way of technology to justify the lofted valuation attached to a site expected to achieve revenues of only $150 million this year.

"There can’t be any more deep technology in Facebook than what dozens of people could write in a couple of years. That’s for sure," he said.

October 24:

Microsoft Corp. agreed to invest $240 million for a 1.6% stake in Facebook Inc. that values the social-networking site at $15 billion, beating Google Inc. in a closely watched contest.

As part of the deal, the two companies expanded their existing advertising agreement. Microsoft, which previously handled Facebook's U.S. ad sales, will now also sell the site's international advertising.

OK, you're right, it IS a bubble

[IMPORTANT WARNING: What follows is satire. I'm NOT being serious. Except for one paragraph at the very end. See if you can spot that one.]

When I first started this blog four months ago, one of the first substantive posts I wrote was called "Bubbles on the brain".

In it, I attempted to use "logic" to explain the reasons we are most likely not in another dot com bubble.

Since that time, talk of a new dot com bubble or Web 2.0 bubble or Internet bubble has only escalated in volume and intensity.

OK.

You're right.

It's a bubble.

A huge, massive, inflating bubble.

We're all doomed.

Doomed, I say!

DOOMED!

It can't last.

It won't last.

It can't won't not last.

Here we sit, with over $7 billion in venture funding this year chasing exactly zero good ideas.

Paid keyword ads? All BS. Once users figure out those things on the side of the page aren't natural search results, that's it, no more click-throughs. Pop goes the souffle.

Ad targeting? Snort. The creme de la creme for Internet advertising, so to speak, is those acne cream banner ads you see all over Facebook. That's it. That's the best Internet advertising will ever be. Get used to the bottom of the barrel, suckers.

Subscription fees? Premium services? Ecommerce? Sponsorships? Mobile advertising? Mobile fee-based services? New hosting models? Video advertising? Music subscription services? In-game advertising? Massively multiplayer games? Digital gifts? Affiliate bounties? HA! Don't make me laugh. Oh, wait -- YOU JUST DID.

So people everywhere are flocking to these newfangled trendoid web sites by the tens of millions and spend hundreds of millions or billions of hours on them every month. So what. It's all a big fad. Think hula hoops. Pet rocks. The macarena. The clock is ticking, and the 15 minutes is almost up.

Move along, move along, nothing to see here.

These are not the droids you're looking for.

Venture capitalists? All stupid, and unnecessary to boot. Everyone knows that you shouldn't need to raise more than $5.37 in loose change to start a new web business. I mean, c'mon.

Entrepreneurs? Smoking dope. What are they thinking? Why aren't they all working for Apple, helping to build a fatter Nano? What's wrong with them? Potsmoking, mussed-hair, rooftop party-going, trendy glasses-wearing, sandal-clad, Red Bull-snorting, laid-getting wankers, the lot of 'em. The sooner they realize the world never changes and there are no new opportunities to pursue, the better.

Facebook apps? Good God. So they spread virally to millions of users in a matter of weeks. Not worth anything. Everyone knows that. Can't possibly build a business. I mean, don't you realize what else can spread to millions of people in a matter of weeks? Do you want to catch any of those? I don't think so!

Call off the dogs.

It's all over.

Stick a fork in it.

It has ceased to be.

The metabolically-differenced lady has sung.

Right now this industry is just like Wile E. Coyote in the old Road Runner cartoons, ran out over the edge of the cliff, hanging in midair, gravity just about to kick in.

Think Acme servers.

Where's it all going from here?

Now that I've raised a monster Series C round for my own company, all other funding of all other startups will immediately cease. No new competitors to my company need be started. There's certainly no major opportunity in what we're doing; why go after your fair share of a $0 dollar market?

Further, now that my company is in a rapid viral growth loop, will all the users please stop using anything new that comes along. And while you're at it, stop using most everything else also, please. Cut it out with the fads already. Posthaste. Chop chop.

Venture capitalists, I don't think I need to tell you what to do. OK, I do. Hand back the money you've raised from LPs. Quickly. Quietly. OK, now step away. Don't make any sudden moves. Back out of the office park, slowly, slowly. Hey, look at the bright side -- carried interest finally getting taxed properly won't affect you anymore! And now you will have time to play 250 rounds of golf a year instead of just 225, and you can focus on getting your Porsche 911's retrofitted to run on ethanol.

All you other startups funded in the last three years? Punt. Now. Liquidate the company -- get whatever cash you can for the Aeron chairs and the foosball tables and the lava lamps and the RAID arrays and shut down now, hand the cash back to the investors, preferably on fire, and leave town, head down, in shame. All those young programmers and product managers can go get jobs in retail footwear where they belong.

You big companies -- you eBays, you Yahoos, you Googles, you Amazons? Yes, and you, Microsoft? Think the new new B2B -- back to boring. What's with all these new products? The world is confusing enough. Shut 'em down and let's go back to the good old days: Windows ME, Mac OS 9, dialup modems, and 640 megabytes ought to be enough for everyone. You're just screwing us all over with all this new fancy broadband video-enabled phone-call-making wifi web-based lightweight touch-interface gorgeous long-battery-life flimflam -- just look at how you keep dropping the damn prices. I knew I'd be better off not buying any of it, ever. The class action lawsuits are in the mail. And for God's sake, raise your dividends -- what, you think there's any growth left in this industry? Fools. When the great shareholder revolt comes, you'll be first up against the wall.

You wanton scribblers of what will now once again be referred to as the "press", as everyone suddenly goes back to reading the news on smudgy-inked paper -- start cranking up the I told you so stories. You know you've been wanting to tell 'em -- here's your big chance! Pulitzer is waiting.

The sooner we all get back to 2003, when the few surviving companies had huge giant markets all to themselves, with no competition anywhere in sight, because everyone knew the world had come to an end, the better.

I will accept your applause and gratitude in the form of immediate compliance.

Thank you.

Quote of the week: Filmmaker Ridley Scott on his first three creative projects

[E]very time you do a movie, in fact, the more experience you get, you can almost say, the less you know. Because the more you know, the more can go wrong. So that can also make you more insecure. But I guess I don't really worry about much. I just try and do the best I can on the set.

[At the time I made Blade Runner], I'm in three movies. I mean [Blade Runner] is my third movie. My first movie is pretty good actually, called The Duellists. And that was criticized for being too beautiful, and you know, I took that to heart. So the next one was Alien, and that was less beautiful but more impressive and more grungy. I was criticized for a lack of character development. I said, "What fucking character development do you need when you've got that son of a bitch on board?"

So I started getting defensive, then realized actually I was in fairly good shape in terms of being a film director, because for the kind of movies that I will do, I will be always very visual. And I won't push it in your face, but I know it's an advantage. I've got a good eye, and I don't know what a good eye means, but I've got a good eye, I think. I can align and see way beforehand, imagine way beforehand, what's going to be. That's good, that's very useful. Because some people don't have that, they [need to have] other talents.

I've had to evolve my capabilities in developing material... Alien I was sent, and I read it and thought, "I know what to do with this," and didn't want to change anything. Because they kept saying, "Want to change anything?" "Nope." They said, "No?" I said, "No. That's it. Let's go." So that was great, because that flew.

And then Blade Runner was the play, which then evolved for eight months every day. [The writer] and I and [the producer] every day talked, talked, talked, talked. As [the producer] was trying to get the financing, the film was growing. And that was interesting because that was a real evolution of working alongside a writer that I really respect. And it was hard for him because sometimes he'd say "Oh fuck." I'd suddenly have this brain wave that comes from a visual notion. We'd get a lot of, "Oh God, I thought we had that worked out." I said, "Yeah, but wouldn't this be great?" And he'd say, "Yeah, but that will mean this, this, this, and this." [And] then there's a domino effect...

From Wired.

I think I can, I think I can

...but if I think I can too well, maybe I can't...

From a new paper in the Journal of Economic Psychology:

High failure rates and low average returns suggest that too many people may be entering markets as entrepreneurs. Thus, anticipating how one will perform in the market is a fundamental component of the decision to start a business.

Using a large sample obtained from population surveys conducted in 18 countries, we study what variables are significantly associated with the decision to start a business.

We find strong evidence that subjective, and often biased, perceptions have a crucial impact on new business creation across all countries in our sample.

The strongest cross-national covariate of an individual’s entrepreneurial propensity is shown to be whether the person believes herself to have the sufficient skills, knowledge and ability to start a business.

In addition, we find a significant negative correlation between this reported level of entrepreneurial confidence and the approximate survival chances of nascent entrepreneurs across countries.

Our results suggest that some countries exhibit relatively high rates of start-up activity because their inhabitants are more (over)confident than in other countries.

Counterpoint: Ben Horowitz on micromanagement

[This is a guest post from my business partner Ben Horowitz, reacting to my recent post about hiring, managing, promoting, and firing executives. I have italicized the parts where he really tears into me for your added humor value.]

While I enjoyed Marc's post on hiring and firing executives, I think that he unfairly dissed micromanagement.

Here's why.

Everyone knows that the hyper-controlling manager with the severe personality disorder who micromanages every crummy decision is no fun to work for. However, it is wrong to condemn the practice of micromanagement on that basis.

Specifically, there are times and situations where micromanaging executives is not just ok, but also the right thing to do. Andy Grove has an excellent explanation of this in his classic book High Output Management, where he describes a concept called "Task Relevant Maturity". Andy explains that employees who are immature in a given task require detailed training and instruction. They need to be micromanaged. On the other hand, if an employee is relatively mature in a task, then it is counterproductive and annoying to manage the details of their work.

This is also true when managing executives. Marc might think that he hires an executive because she has the experience and know-how to comprehensively do her job, so any detailed instruction would be unwise and unwarranted. Marc would be wrong about that. It turns out that even -- and maybe especially -- executives are also immature in certain tasks.

It is almost always the case that a new executive will be immature in their understanding of your market, your technology, and your company -- its personnel, processes, and culture. Will the new head of engineering at Ning walk in the door with Marc's understanding of the development process or the technology base? Would it be better for this new head of engineering to make guesses and use her own best -- not so good-- judgment, or for Marc to review the first say 20 decisions until the new exec is fully up to speed?

In reality -- as opposed to Marc’s warped view of reality -- it will be extremely helpful for Marc [if he were actually the CEO, which he is not] to meet with the new head of engineering daily when she comes on board and review all of her thinking and decisions. This level of micromanagement will accelerate her training and improve her long-term effectiveness. It will make her seem smarter to the rest of the organization which will build credibility and confidence while she comes up to speed. Micromanaging new executives is generally a good idea for a limited period of time.

However, that is not the only time that it makes sense to micromanage executives. It turns out that just about every executive in the world has a few things that are seriously wrong with them. They have areas where they are truly deficient in judgment or skill set. That’s just life. Almost nobody is brilliant at everything. When hiring and when firing executives, you must therefore focus on strength rather than lack of weakness. Everybody has severe weaknesses even if you can’t see them yet. When managing, it’s often useful to micromanage and to provide remedial training around these weaknesses. Doing so may make the difference between an executive succeeding or failing.

For example, you might have a brilliant engineering executive who generates excellent team loyalty, has terrific product judgment and makes the trains run on time. This same executive may be very poor at relating to the other functions in the company. She may generate far more than her share of cross-functional conflicts, cut herself off from critical information, and significantly impede your ability to sell and market effectively.

Your alternatives are:

(a) Macro-manage and give her an annual or quarterly objective to fix it, or...

(b) Intensively micromanage her interactions until she learns the fundamental interpersonal skills required to be an effective executive.

I am arguing that doing (a) will likely result in weak performance. The reason is that she very likely has no idea how to be effective with her peers. If somebody is an executive, it's very likely that somewhere along the line somebody gave her feedback -- perhaps abstractly -- about all of her weaknesses. Yet the weakness remains. As a result, executives generally require more hands-on management than lower level employees to improve weak areas.

So, micromanagement is like fine wine. A little at the right times will really enhance things; too much all the time and you’ll end up in rehab.

The Pmarca Guide to Startups, part 9: How to hire a professional CEO

Don't.

If you don't have anyone on your founding team who is capable of being CEO, then sell your company -- now.

The Pmarca Guide to Startups, part 8: Hiring, managing, promoting, and firing executives

One of the most critical things a startup founder must do is develop a top-notch executive team. This is a topic that could fill a whole book, but in this post I will provide specific guidelines on how to hire, manage, promote, and fire executives in a startup based on my personal observations and experiences.

For the purposes of this post, definitions: An executive is a leader -- someone who runs a function within the company and has primary responsibility for an organization within the company that will contribute to the company's success or failure. The difference between an executive and a manager is that the executive has a higher degree of latitude to organize, make decisions, and execute within her function than a manager. The manager may ask what the right thing to do is; the executive should know.

The general theory of executives, like managers, is, per Andy Grove: the output of an executive is the output of her organization. Therefore, the primary task of an executive is to maximize the output of her organization. However, in a startup, a successful executive must accomplish three other critical tasks simultaneously:

• Build her organization -- typically when an executive arrives or is promoted into her role at a startup, she isn't there to be a caretaker; rather she must build her organization, often from scratch. This is a sharp difference from many big company executives, who can spend their entire careers running organizations other people built -- often years or decades earlier.
• Be a primary individual contributor -- a startup executive must "roll up her sleeves" and produce output herself. There are no shortage of critical things to be done at a startup, and an executive who cannot personally produce while simultaneously building and running her organization typically will not last long. Again, this is a sharp difference from many big companies, where executives often serve more as administrators and bureaucrats.
• Be a team player -- a startup executive must take personal responsibility for her relationships with her peers and people throughout the startup, in all functions and at all levels. Big companies can often tolerate internal rivalries and warfare; startups cannot.

Being a startup executive is not an easy job. The rewards are substantial -- the ability to contribute directly to the startups's success; the latitude to build and run an organization according to her own theories and principles; and a meaningful equity stake that can lead to personal financial independence if the startup succeeds -- but the responsibilities are demanding and intense.

Hiring:

First, if you're not sure whether you need an executive for a function, don't hire one.

Startups, particularly well-funded startups, often hire executives too early. Particularly before a startup has achieved product/market fit, it is often better to have a highly motivated manager or director running a function than an executive.

Hiring an executive too quickly can lead to someone who is really expensive, sitting there in the middle of the room, doing very little. Not good for the executive, not good for the rest of the team, not good for the burn rate, and not good for the company.

Hire an executive only when it's clear that you need one: when an organization needs to get built; when hiring needs to accelerate; when you need more processes and structure and rigor to how you do things.

Second, hire the best person for the next nine months, not the next three years.

I've seen a lot of startups overshoot on their executive hires. They need someone to build the software development team from four people to 30 people over the next nine months, so they hire an executive from a big company who has been running 400 people. That is usually death.

Hire for what you need now -- and for roughly the next nine months. At the very least, you will get what you need now, and the person you hire may well be able to scale and keep going for years to come.

In contrast, if you overhire -- if you hear yourself saying, "this person will be great when we get bigger" -- you are most likely hiring someone who, best case, isn't that interested in doing things at the scale you need, and worst case, doesn't know how.

Third, whenever possible, promote from within.

Great companies develop their own executives. There are several reasons for this:

• You get to develop your best people and turn them into executives, which is great for both them and you -- this is the single best, and usually the only, way to hold onto great people for long periods of time.
• You ensure that your executives completely know and understand your company culture, strategy, and ethics.
• Your existing people are the "devil you know" -- anyone new coming from outside is going to have flaws, often really serious ones, but you probably won't figure out what they are until after you've hired them. With your existing people, you know, and you minimize your odds of being shocked and appalled.

Of course, this isn't always possible. Which segues us directly into...

Fourth, my list of the key things to look at, and for, when evaluating executive candidates:

• Look for someone who is hungry and driven -- someone who wants a shot at doing "their thing". Someone who has been an up and comer at a midsized company but wants a shot at being a primary executive at a startup can be a great catch.
• Flip side of that: beware people who have "done it before". Sometimes you do run into someone who has been VP Engineering at four companies and loves it and wants to do it at a fifth company. More often, you will be dealing with someone who is no longer hungry and driven. This is a very, very big problem to end up with -- be very careful.
• Don't disqualify someone based on ego or cockiness -- as long as she's not insane. Great executives are high-ego -- you want someone driven to run things, driven to make decisions, confident in herself and her abilities. I don't mean loud and obnoxious, I mean assured and determined, bleeding over into cocky. If a VC's ideal investment is a company that will succceed without him, then your ideal executive hire is someone who will succeed without you.
• Beware hiring a big company executive for a startup. The executive skill sets required for a big company vs a startup are very different. Even great big company executives frequently have no idea what to do once they arrive at a startup.
• In particular, really beware hiring an executive from an incredibly successful big company. This is often very tempting -- who wouldn't want to bring onboard someone who sprinkles some of that IBM (in the 80's), Microsoft (in the 90's), or Google (today) fairy dust on your startup? The issue is that people who have been at an incredibly successful big company often cannot function in a normal, real world, competitive situation where they don't start every day with 80% market share. Back in the 80's, you often heard, "never hire anyone straight out of IBM -- first, let them go somewhere else and fail, and then hire them". Believe it.
• This probably goes without saying, but look for a pattern of output -- accomplishment. Validate it by reference checking peers, reports, and bosses. Along the way, reference check personality and teamwork, but look first and foremost for a pattern of output.

Fifth, by all means, use an executive recruiter, but for sourcing, not evaluation.

There are some executive recruiters who are actually really good at evaluation. Others are not. It's beside the point. It's your job to evaluate and make the decision, not the recruiter's.

I say this because I have never met a recruiter who lacks confidence in his ability to evaluate candidates and pass judgment on who's right for a given situation. This can lull a startup founder into relying on the recruiter's judgment instead of really digging in and making your own decision. Betting that your recruiter is great at evaluation is not a risk you want to take. You're the one who has to fire the executive if it doesn't work out.

Sixth, be ready to pay market compensation, including more cash compensation than you want, but watch for red flags in the compensation discussion.

You want someone focused on upside -- on building a company. That means, a focus on their stock option package first and foremost.

Watch out for candidates who want egregious amounts of cash, high bonuses, restricted stock, vacation days, perks, or -- worst of all -- guaranteed severance. A candiate who is focused on those things, as opposed to the option package, is not ready to do a startup.

On a related note, be careful about option accceleration in the event of change of control. This is often reasonable for support functions such as finance, legal, and HR where an acquirer would most likely not have a job for the startup executive in any of those functions. But this is not reasonable, in my view, for core functions such as engineering, product management, marketing, or sales. You don't want your key executives focused on selling the company -- unless of course you want them focused on selling the company. Make your acceleration decisions accordingly.

Seventh, when hiring the executive to run your former specialty, be careful you don't hire someone weak on purpose.

This sounds silly, but you wouldn't believe how often it happens. The CEO who used to be a product manager who has a weak product management executive. The CEO who used to be in sales who has a weak sales executive. The CEO who used to be in marketing who has a weak marketing executive.

I call this the "Michael Eisner Memorial Weak Executive Problem" -- after the CEO of Disney who had previously been a brilliant TV network executive. When he bought ABC at Disney, it promptly fell to fourth place. His response? "If I had an extra two days a week, I could turn around ABC myself." Well, guess what, he didn't have an extra two days a week.

A CEO -- or a startup founder -- often has a hard time letting go of the function that brought him to the party. The result: you hire someone weak into the executive role for that function so that you can continue to be "the man" -- consciously or subconsciously. Don't let it happen to you -- make sure the person you hire into that role is way better than you used to be.

Eighth, recognize that hiring an executive is a high-risk proposition.

You often see a startup with a screwed up development process, but "when we get our VP of Engineering onboard, everything will get fixed". Or a startup that is missing its revenue targets, but "when we get our VP of sales, reveue will take off".

Here's the problem: in my experience, if you know what you're doing, the odds of a given executive hire working out will be about 50/50. That is, about 50% of the time you'll screw up and ultimately have to replace the person. (If you don't know what you're doing, your failure rate will be closer to 100%.)

Why? People are people. People are complicated. People have flaws. You often don't know what those flaws are until after you get to know them. Those flaws are often fatal in an executive role. And more generally, sometimes the fit just isn't there.

This is why I'm so gung ho on promoting from within. At least then you know what the flaws are up front.

Managing:

First, manage your executives.

It's not that uncommon to see startup founders, especially first-timers, who hire executives and are then reluctant to manage them.

You can see the thought process: I just hired this really great, really experienced VP of Engineering who has way more experience running development teams than I ever did -- I should just let him go do his thing!

That's a bad idea. While respecting someone's experience and skills, you should nevertheless manage every executive as if she were a normal employee. This means weekly 1:1's, performance reviews, written objectives, career development plans, the whole nine yards. Skimp on this and it is very easy for both your relationship with her and her effectiveness in the company to skew sideways.

This even holds if you're 22 and she's 40, or 50, or 60! Don't be shy, that will just scare her -- and justifiably so.

Second, give your executives the latitude to run their organizations.

This is the balancing act with the previous point, but it's equally important. Don't micromanage.

The whole point of having an executive is to have someone who can figure out how to build and run an organization so that you don't have to. Manage her, understand what she is doing, be very clear on the results you expect, but let her do the job.

Here's the key corollary to that: if you want to give an executive full latitude, but you're reluctant to do so because you're not sure she can make it happen, then it's probably time to fire her.

In my experience it's not that uncommon for a founder or CEO to be uncomfortable -- sometimes only at a gut level -- at really giving an executive the latitude to run with the ball. That is a surefire signal that the executive is not working out and probably needs to be fired. More on that below.

Third, ruthlessly violate the chain of command in order to gather data.

I don't mean going around telling people under an executive what to do without her knowing about it. I mean, ask questions, continually, at all levels of the organization. How are things going? What do you think of the new hires? How often are you meeting with your manager? And so on.

You never want the bulk of your information about a function coming from the executive running that function. That's the best way to be completely and utterly surprised when everything blows up.

Here's the kicker: a great executive never minds when the CEO talks to people in her organization. In fact, she loves it, because it means the CEO just hears more great things about her.

If you have an executive who doesn't want you to talk to people in her organization, you have a bad executive.

Promoting:

This will be controversial, but I am a big fan of promoting talented people as fast as you can -- promoting up and comers into executive roles, and promoting executives into bigger and broader responsibilities.

You can clearly overdo this -- you can promote someone before they are ready and in the worst case, completely screw up their career. (Seen it. Done it.) You can also promote someone to their level of incompetence -- the Peter Principle. (Seen it. Done it.)

However, life is short, startups move fast, and you have stuff to get done. You aren't going to have the privilege of working with that many great, talented, high-potential people in your career. When you find one, promote her as fast as you can. Great for her, great for the company, and great for you.

This assumes you are properly training and managing her along the way. That is left as an exercise for the reader.

The surest sign someone is ready for promotion is when they're doing a great job running their current team. Projects are getting done, team morale is good, new hires are top quality, people are happy. Time to promote some people into new challenges.

I'm a firm believer that most people who do great things are doing them for the first time. Returning to my theory of hiring, I'd rather have someone all fired up to do something for the first time than someone who's done it before and isn't that excited to do it again. You rarely go wrong giving someone who is high potential the shot.

This assumes you can tell the high potential people apart from everyone else. That too is left as an exercise for the reader.

Firing:

First, recognize the paradox of deciding to fire an executive.

The paradox works like this:

It takes time to gather data to evaluate an executive's performance. You can't evaluate an executive based on her own output, like a normal employee -- you have to evaluate her based on the output of her organization. It takes time for her to build and manage her organization to generate output. Therefore, it takes longer to evaluate the performance of an executive than a normal employee.

But, an executive can cause far more damage than a normal employee. A normal employee doesn't work out, fine, replace him. An executive doesn't work out, it can -- worst case -- permanently cripple her function and sometimes the entire company. Therefore, it is far more important to fire a bad executive as fast as possible, versus a normal employee.

Solution? There isn't one. It's a permanent problem.

I once asked Andy Grove, one of the world's all-time best CEOs, about this. He said, you always fire a bad executive too late. If you're really good, you'll fire her about three months too late. But you'll always do it too late. If you did it fast enough that it wasn't too late, you wouldn't have enough data, and you'd risk being viewed as arbitrary and capricious by the rest of the organization.

Second, the minute you have a bad feeling in your gut, start gathering data.

Back to the point on ruthlessly violating the chain of command -- get to it. Talk to everyone. Know what's going on. Unless you're paranoid -- and, shockingly, I have met paranoid founders and CEOs, and not counting Andy Grove -- you need to gather the data because you're going to need to fire the executive -- if you're good, in about three months.

In the meantime, of course do everything you can to coach and develop and improve the executive. If it works out, that's great. If not, get ready.

A few specific things I think are critical to look for:

• Is the executive hiring? If there are open headcount slots and nobody's coming in the door, you have a problem. Just as bad is when the new hires aren't very good -- when they're bringing down the average quality of the organization.
• Is the executive training and developing her people? Often in a startup, an executive is hired to take over a function that's already been started, at least in rudimentary form. The people in that function should be noticeably better at their jobs, and highly respectful of the executive's skills, within the first several months at the very least. If not, you have a problem.
• What do the other executives think? Great executives are often imperfect but their peers always respect them. If your other executives are skeptical of a new executive after the first few months, you have a problem.
• Is it painful for you to interact with the executive? Do you try to avoid or cancel your 1:1's? Does talking to her give you a headache? Do you often not understand what point she's trying to make or why she's focused on such an odd issue? If the answer to any of these questions is yes, you have a problem.

Third, fire crisply.

Firing an executive sucks. It's disruptive to the organization. It creates a lot of work for you -- not least of which is you'll have to go find someone else for the job. And, it risks making you look bad, since you're the one who hired the person in the first place.

And it always seems to happen at a critical time in your startup's life, when the last thing you need is a distraction like this.

Nevertheless, the only thing to do is do it, do it professionally, make clear to the organization what will happen next, and get on down the road.

In my opinion the two most common mistakes people make when they fire executives both fall in the category of pulling one's punches, and I highly recommend avoiding them:

• Long transition periods -- tempting, but counterproductive. Confusing, demoralizing, and just plain weird. Instead, make a clean break, put a new person in charge -- even if only on an acting basis -- and get moving.
• Demotion as an alternative to firing (or, alternately, "I know, we'll hire her a boss!"). Hate it. Great people don't deal well with getting demoted. There is an occasional exception. Unless you are positive you have such an exception, skip it, and move directly to the conclusion.

Fourth, don't feel guilty.

You're not beheading anyone.

Anyone who got a job as an executive at a startup is going to have an easy time getting the next job. After all, she can always paint you as a crazy founder, or inept CEO.

More often than not, when you fire an executive, you are doing her a favor -- you are giving her a chance to find a better fit in a different company where she will be more valued, more respected, and more successful. This sounds mushy, but I mean it. And if she can't, then she has a much deeper problem and you just dodged a huge bullet.

And on that cheery note, good luck!

Luck and the entrepreneur, part 1: The four kinds of luck

In the last few weeks, I've been reading huge stacks of books on the psychology of creativity and motivation -- which is the reason for the relative scarcity of substantive blog posts. Said post situation will be remedied shortly, by a series of posts on -- surprise! -- the psychology of creativity and motivation.

But first, to complement my post on age and the entrepreneur from a few days ago, this post begins a series of occasional posts about luck and the entrepreneur.

Luck is something that every successful entrepreneur will tell you plays a huge role in the difference between success and failure. Many of those successful entrepreneurs will only admit this under duress, though, because if luck does indeed play such a huge role, then that seriously dents the image of the successful entrepreneur as an omniscient business genius.

Moreover, some of those people would shrug and say that luck is simply out of your hands. Sometimes you have it, sometimes you don't. But perhaps there's more to it than that.

Dr. James Austin, a neurologist and philosopher (!), wrote an outstanding book called Chase, Chance, and Creativity -- originally in 1978, then updated in 2003. It's the best book I've read on the role of luck, chance, and serendipity in medical research -- or, for that matter, any creative endeavor. And because he's a neurologist, he has a grounding in how the brain actually exerts itself creatively -- although there is more recent research on that topic that is even more illuminating (more on that later).

In the book, Dr. Austin outlines his theory of the four kinds of luck -- or, as he calls it, chance; I will use the terms interchangeably.

First, he defines chance as follows:

Chance... something fortuitous that happens unpredictably without discernable human intention.

Yup, that's luck.

Chance is unintentional, it is capricious, but we needn't conclude that chance is immune from human interventions. However, one must be careful not to read any unconsciously purposeful intent into "interventions"... [which] are to be viewed as accidental, unwilled, inadvertent, and unforseeable.

Indeed, chance plays several distinct roles when humans react creatively with one another and with their environment...

We can observe chance arriving in four major forms and for four different reasons. The principles involved affect everyone.

Here's where it helps to be a neurologist writing on this topic:

The four kinds of chance each have a different kind of motor exploratory activity and a different kind of sensory receptivity.

The [four] varieties of chance also involve distinctive personality traits and differ in the way one particular individual influences them.

OK, so what are they?

In Chance I, the good luck that occurs is completely accidental. It is pure blind luck that comes with no effort on our part.

Yup.

In Chance II, something else has been added -- motion.

Years ago, when I was rushing around in the laboratory [conducting medical research], someone admonished me by asking, "Why all the busyness? One must distinguish between motion and progress".

Yes, at some point this distinction must be made. But it cannot always be made first. And it is not always made consciously. True, waste motion should be avoided. But, if the researcher did not move until he was certain of progress he would accomplish very little...

A certain [basic] level of action "stirs up the pot", brings in random ideas that will collide and stick together in fresh combinations, lets chance operate.

Motion yields a network of new experiences which, like a sieve, filter best when in constant up-and-down, side-to-side movement...

Unluck runs out if you keep stirring up things so that random elements can combine, by virtue of you and their inherent affinities.

Sounds like a startup!

Chance II springs from your energetic, generalized motor activities... the freer they are, the better.

[Chance II] involves the kind of luck [Charles] Kettering... had in mind when he said, "Keep on going and chances are you will stumble on something, perhaps when you are least expecting it. I have never heard of anyone stumbling on something sitting down."

OK, now here's where it gets interesting:

Now, as we move on to Chance III, we see blind luck, but it tiptoes in softly, dressed in camouflage.

Chance presents only a faint clue, the potential opportunity exists, but it will be overlooked except by that one person uniquely equipped to observe it, visualize it conceptually, and fully grasp its significance.

Chance III involves involves a special receptivity, discernment, and intuitive grasp of significance unique to one particular recipient.

Louis Pasteur characterized it for all time when he said, "Chance favors the prepared mind."

I thought that was Eric Bogosian in Under Siege 2: Dark Territory, but OK.

...The classic example of [Chance III] occured in 1928, when Sir Alexander Fleming's mind instantly fused at least five elements into a conceptually unified nexus [when he discovered penicillin -- one of the most important medical breakthroughs ever].

He was at his work bench in the laboratory, made an observation, and his mental sequences then went something like this: (a) I see that a mold has fallen by accident into my culture dish; (2) the staphylococcal colonies residing near it failed to grow; (3) therefore, the mold must have secreted something that killed the bacteria; (4) this reminds me of a similar experience I had once before; (5) maybe this new "something" from the mold could be used to kill staphylococci that cause human infections.

Actually, Fleming's mind was exceptionally well prepared. Some nine years earlier, while suffering from a cold [you can't make this stuff up], his own nasal drippings had found their way onto a culture dish. He noted that the bacteria around his mucous were killed, and astutely followed up the lead. His experiments then led him to discover... lysozyme... [which] proved inappropriate for medical use, but think of how receptive Fleming's mind was to the penicillin mold when it later happened on the scene!

OK, what about Chance IV?

[Chance IV] favors the individualized action.

This is the fourth element in good luck -- an active, but unintentional, subtle individualized prompting of it.

Please explain!

Chance IV is the kind of luck that develops during a probing action which has a distinctive personal flavor.

The English Prime Minister, Benjamin Disraeli, summed up the principle underlying Chance IV when he noted: "We make our fortunes and we call them fate."

Chance IV comes to you, unsought, because of who you are and how you behave.

...Chance IV is so personal, it is not easily understood by someone else the first time around... here we probe into the subterranean recesses of personal hobbies and behavioral quirks that autobiographers know about, biographers rarely.

[In neurological terms], Chance III [is] concerned with personal sensory receptivity; its counterpart, Chance IV, [is] involved with personal motor behavior.

Please continue!

[You] have to look carefully to find Chance IV for three reasons.

The first is that when it operates directly, it unfolds in an elliptical, unorthodox manner.

The second is that it often works indirectly.

The third is that some problems it may help solve are uncommonly difficult to understand because they have gone through a process of selection.

We must bear in mind that, by the time Chance IV finally occurs, the easy, more accessible problems will already have been solved earlier by conventional actions, conventional logic, or by the operations of the other forms of chance. What remains late in the game, then, is a tough core of complex, resistant problems. Such problems yield to none but an unusual approach...

[Chance IV involves] a kind of discrete behavioral performance focused in a highly specific manner.

Here's the money quote:

Whereas the lucky connections in Chance II might come to anyone with disposable energy as the happy by-product of any aimless, circular stirring of the pot, the links of Chance IV can be drawn together and fused only by one quixotic rider cantering in on his own homemade hobby horse to intercept the problem at an odd angle.

A recap?

Chance I is completely impersonal; you can't influence it.

Chance II favors those who have a persistent curiosity about many things coupled with an energetic willingness to experiment and explore.

Chance III favors those who have a sufficient background of sound knowledge plus special abilities in observing, remembering, recalling, and quickly forming significant new associations.

Chance IV favors those with distinctive, if not eccentric hobbies, personal lifestyles, and motor behaviors.

This of course leads to a number of challenges for how we live our lives as entrepreneurs and creators in any field:

• How energetic are we? How inclined towards motion are we? Those of you who read my first age and the entrepreneur post will recognize that this is a variation on the "optimize for the maximum number of swings of the bat" principle. In a highly uncertain world, a bias to action is key to catalyzing success, and luck, and is often to be preferred to thinking things through more throughly.
• How curious are we? How determined are we to learn about our chosen field, other fields, and the world around us? In my post on hiring great people, I talked about the value I place on curiosity -- and specifically, curiosity over intelligence. This is why. Curious people are more likely to already have in their heads the building blocks for crafting a solution for any particular problem they come across, versus the more quote-unquote intelligent, but less curious, person who is trying to get by on logic and pure intellectual effort.
• How flexible and aggressive are we at synthesizing -- at linking together multiple, disparate, apparently unrelated experiences on the fly? I think this is a hard skill to consciously improve, but I think it is good to start most creative exercises with the idea that the solution may come from any of our past experiences or knowledge, as opposed to out of a textbook or the mouth of an expert. (And, if you are a manager and you have someone who is particularly good at synthesis, promote her as fast as you possibly can.)
• How uniquely are we developing a personal point of view -- a personal approach -- a personal set of "eccentric hobbies, personal lifestyles, and motor behaviors" that will uniquely prepare us to create? This, in a nutshell, is why I believe that most creative people are better off with more life experience and journeys afield into seemingly unrelated areas, as opposed to more formal domain-specific education -- at least if they want to create.

In short, I think there is a roadmap to getting luck on our side, and I think this is it.

Age and the entrepreneur, part 1: Some data

A short time back, several smart bloggers engaged in an enthusiastic debate about age and entrepreneurs -- some taking the position that kids have a leg up on older entrepreneurs at least for certain categories of startups, and others theorizing that age is largely irrelevant (or as Ali G would put it, "geezers is good entrepreneurs as well, man").

I have opinions on this topic, but rather than just mouthing off like I would normally do, I decided to go get some data. This post presents that data -- the next post will have the mouthing off.

I'm not aware of any systematic data on age and high-tech entrepreneurs. As far as I'm aware, all we have are anecdotes. However, a professor of psychology at University of California Davis named Dean Simonton has conducted extensive research on age and creativity across many other fields, including science, literature, music, chess, film, politics, and military combat.

Dr. Simonton's research is unparalleled -- he's spent his career studying this and related topics and his papers make for absolutely fascinating reading.

For this post, I'll be concentrating on his paper Age and Outstanding Achievement: What Do We Know After a Century of Research? from 1988. I haven't been able to find a PDF of the paper online but you can read a largely intact cached HTML version courtesy of Google Scholar.

Let's go to the paper:

For centuries, thinkers have speculated about the association between a person's age and exceptional accomplishment: Is there an optimal age for a person to make a lasting contribution to human culture or society? When during the life span can we expect an individual to be most prolific or influential?

You can see why I think this is relevant.

Here we adopt the product-centered approach, that is, our focus is on real-life achievements rather than performance on abstract... measures. ...

[A]chievement [takes] the form of noteworthy creativity... the goal is to assess how productivity changes over the life span... [I] focus on individual accomplishment in such endeavors as science, philosophy, literature, music, and the visual arts. ...

[Studies like these focus] on three core topics: (a) the age curve that specifies how creative output varies over the course of a career, (b) the connection between productive precocity, longevity, and rate of output, and (c) the relation between quantity and quality of output (i.e., between "productivity" and "creativity").

Dr. Simonton also discusses leadership as distinct from creative production, but I'm ignoring the leadership part for now since it's quite different.

One empirical generalization appears to be fairly secure: If one plots creative output as a function of age, productivity tends to rise fairly rapidly to a definite peak and thereafter decline gradually until output is about half the rate at the peak.

This is the centerpiece of Dr. Simonton's overall theory across many domains. And is probably not unexpected. But here's where it gets really interesting:

[T]he location of the peak, as well as the magnitude of the postpeak decline, tends to vary depending on the domain of creative achievement.

At one extreme, some fields are characterized by relatively early peaks, usually around the early 30s or even late 20s in chronological units, with somewhat steep descents thereafter, so that the output rate becomes less than one-quarter the maximum. This age-wise pattern apparently holds for such endeavors as lyric poetry, pure mathematics, and theoretical physics...

The typical trends in other endeavors may display a leisurely rise to a comparatively late peak, in the late 40s or even 50s chronologically, with a minimal if not largely absent drop-off afterward. This more elongated curve holds for such domains as novel writing, history, philosophy, medicine, and general scholarship.

Well, that's interesting.

It must be stressed that these interdisciplinary contrasts do not appear to be arbitrary but instead have been shown to be invariant across different cultures and distinct historical periods.

As a case in point, the gap between the expected peaks for poets and prose authors has been found in every major literary tradition throughout the world and for both living and dead languages.

Indeed, because an earlier productive optimum means that a writer can die younger without loss to his or her ultimate reputation, poets exhibit a life expectancy, across the globe and through history, about a half dozen years less than prose writers do.

You know what that means -- if you're going to argue that younger entrepreneurs have a leg up, then you also have to argue that they will have shorter lifespans. Fun with math!

You may not be surprised to find that in creative fields, the power law rule -- also known as the 80/20 rule -- definitely applies:

A small percentage of the workers in any given domain is responsible for the bulk of the work. Generally, the top 10% of the most prolific elite can be credited with around 50% of all contributions, whereas the bottom 50% of the least productive workers can claim only 15% of the total work, and the most productive contributor is usually about 100 times more prolific than the least.

Here's where it gets really interesting again:

Precocity, longevity, and output rate are each strongly associated with final lifetime output -- that is, those who generate the most contributions at the end of a career also tend to have begun their careers at earlier ages, ended their careers at later ages, and produced at extraordinary rates throughout their careers. ...

These three components are conspicuously linked with each other: Those who are precocious also tend to display longevity, and both precocity and longevity are positively associated with high output rates per age unit.

OK, so on to the main question, which is, when's the peak?

Those creators who make the most contributions tend to start early, end late, and produce at above-average rates, but are the anticipated career peaks unchanged, earlier, or later in comparison to what is seen for their less prolific colleagues? Addressing this question properly requires that we first investigate the relation between quantity and quality, both within and across careers. ...

This is a very complex topic and Dr. Simonton goes into great detail about it throughout his work. I'm going to gloss over it a bit, but if you are interested in this topic, by all means dig into it more via Google Scholar.

First, if one calculates the age curves separately for major and minor works within careers, the resulting functions are basically identical...

Second... minor and major contributions... fluctuate together. Those periods in a creator's life that see the most masterpieces also witness the greatest number of easily forgotten productions, on the average.

Another way of saying the same thing is to note that the "quality ratio," or the proportion of major products to total output per age unit, tends to fluctuate randomly over the course of any career. The quality ratio neither increases nor decreases with age...

These outcomes are valid for both artistic and scientific modes of creative contribution. What these two results signify is that... age becomes irrelevant to determining the success of a particular contribution.

OK, that's interesting. Quality of output does not vary by age... which means, of course, that attempting to improve your batting average of hits versus misses is a waste of time as you progress through a creative career. Instead you should just focus on more at-bats -- more output. Think about that one.

If this sounds insane to you, Dr. Simonton points out that the periods of Beethoven's career that had the most hits also had the most misses -- works that you never hear. As I am always fond of asking in such circumstances, if Beethoven couldn't increase his batting average over time, what makes you think you can?

[C]reativity is a probabilistic consequence of productivity, a relationship that holds both within and across careers.

Within single careers, the count of major works per age period will be a positive function of total works generated each period, yielding a quality ratio that exhibits no systematic developmental trends.

And across careers, those individual creators who are the most productive will also tend, on the average, to be the most creative: Individual variation in quantity is positively associated with variation in quality.

Wow.

OK, next step:

[This] constant-probability-of-success model has an important implication for helping us understand the relation between total lifetime output and the location of the peak age for creative achievement within a single career.

Because total lifetime output is positively related to total creative contributions and hence to ultimate eminence, and given that a creator's most distinguished work will appear in those career periods when productivity is highest, the peak age for creative impact should not vary as a function of either the success of the particular contribution or the final fame of the creator. ...

Thus, even though an impressive lifetime output of works, and subsequent distinction, is tied to precocity, longevity, and production rate, the expected age optimum for quantity and quality of contribution is dependent solely on the particular form of creative expression.

Wow, again.

Anyone who demonstrates... an age decrement in achievement is likely to provoke controversy. After all, aging is a phenomenon easy enough to become defensive about, and such defensiveness is especially probable among those of us who are already past the putative age peak for our particular field of endeavor...

I think Dr. Simonton is ready to start blogging.

His paper then goes on to discuss many possible extrinsic factors such as health that could impair later-life output, but in the end he concludes that the data is pretty conclusive that such extrinsinc factors serve as "random shocks" to any individual's career that do not affect the overall trends.

He then goes on to discuss possible intrinsic factors that could explain a relationship between age and creative accomplishment:

G. M. Beard was not merely the earliest contributor [in 1874] to the empirical literature on age and achievement but its first theorist as well. According to him, creativity is a function of two underlying factors, enthusiasm and experience. Enthusiasm provides the motivational force behind persistent effort, yet enthusiasm in the absence of the second factor yields just original work. Experience gives the achiever the ability to separate wheat from chaff and to express original ideas in a more intelligible and persistent fashion. Yet experience in the absence of enthusiasm produces merely routine contributions. Genuine creativity requires the balanced cooperation of both enthusiasm and experience.

Beard postulates, however, that these two essential components display quite distinctive distributions across the life span. Whereas enthusiasm usually peaks early in life and steadily declines thereafter, experience gradually increases as a positive monotonic function of age. The correct equilibrium between the two factors is attained between the ages of 38 and 40, the most common age optima for creative endeavors. Prior to that expected peak, an individual's output would be excessively original, and in the postpeak phase the output would be overly routine. The career floruit in the late 30s thus represents the uniquely balanced juxtaposition of the rhapsodies of youth and the wisdom of maturity.

Hmmmmmm...

Beard's theory is not without attractive features... Beard's account, for all its simplicity, can boast a respectable amount of explanatory power. Besides handling the broad form of the age curve, this theory leads to an interpretation of why different endeavors may peak at distinct ages.

The contrast between poetic and prose literature, for instance, can be interpreted as the immediate consequence of the assumption that the two domains demand a different mix of the two factors: poetry, more enthusiasm, and prose, more experience. Indeed, in fields in which expertise may be far more crucial than emotional vigor, most notably in scholarship, we would anticipate little if any decline with age, and such is the case.

Dr. Simonton, however, then goes on to explain that this theory does not really match the data -- for example, the data shows that quality of output in practically all fields does not decline systematically with age, which is what you'd expect from Beard's theory.

The paper then digs into possible correlations between intelligence as measured by such metrics as IQ, and creative output:

[E]ven if a minimal level of intelligence is requisite for achievement, beyond a threshold of around IQ 120 (the actual amount varying across fields), intellectual prowess becomes largely irrelevant in predicting individual differences in... creativity.

So what have we learned in a nutshell?

• Generally, productivity -- output -- rises rapidly from the start of a career to a peak and then declines gradually until retirement.
• This peak in productivity varies by field, from the late 20s to the early 50s, for reasons that are field-specific.
• Precocity, longevity, and output rate are linked. "Those who are precocious also tend to display longevity, and both precocity and longevity are positively associated with high output rates per age unit." High producers produce highly, systematically, over time.
• The odds of a hit versus a miss do not increase over time. The periods of one's career with the most hits will also have the most misses. So maximizing quantity -- taking more swings at the bat -- is much higher payoff than trying to improve one's batting average.
• Intelligence, at least as measured by metrics such as IQ, is largely irrelevant.

So here's my first challenge: to anyone who has an opinion on the role of age and entrepreneurship -- see if you can fit your opinion into this model!

And here's my second challenge: is entrepreneurship more like poetry, pure mathematics, and theoretical physics -- which exhibit a peak age in one's late 20s or early 30s -- or novel writing, history, philosophy, medicine, and general scholarship -- which exhibit a peak age in one's late 40s or early 50s? And how, and why?

[Update: Naval Ravikant has written a particularly interesting response to this post here.]

Quote of the week: Glenn Kelman of Redfin on startups

Glenn Kelman writes:

In the early days, start-ups focus on how great it’s going to be when they succeed; but the moment they do, they start talking about how great it was before they did.

Whenever I get this way, I remember the Venerable Bede’s complaint that his eighth century contemporaries had lost the fervor of seventh century monks. Even in the darkest of the Dark Ages, people were nostalgic for...the Dark Ages.

Start-ups are like medieval monasteries: always convinced that paradise is just ahead or that things only recently got worse. If you can begin to enjoy the process of building a start-up rather than the outcome, you'll be a better leader.

The Pmarca Guide to Startups, part 7: Why a startup's initial business plan doesn't matter that much

A startup's initial business plan doesn't matter that much, because it is very hard to determine up front exactly what combination of product and market will result in success.

By definition you will be doing something new, in a world that is a very uncertain place.  You are simply probably not going to know whether your initial idea will work as a product and a business, or not.  And you will probably have to rapidly evolve your plan -- possibly every aspect of it -- as you go.

(The military has a saying that expresses the same concept -- "No battle plan ever survives contact with the enemy."  In this case, your enemy is the world at large.)

It is therefore much more important for a startup to aggressively seek out a big market, and product/market fit within that market, once the startup is up and running, than it is to try to plan out what you are going to do in great detail ahead of time.

The history of successful startups is quite clear on this topic. 

Normally I would simply point to Microsoft, which started as a programming tools company before IBM all but forced Bill Gates to go into the operating system business, or Oracle, which was a consultancy for the CIA before Larry Ellison decided to productize the relational database, or Intel, which was a much smaller company focused on the memory chip market until the Japanese onslaught of the mid-80's forced Andy Grove to switch focus to CPUs.

However, I've recently been reading Randall Stross's marvelous book about Thomas Edison, The Wizard of Menlo Park.

Edison's first commercially viable breakthrough invention was the phonograph -- the forerunner to what you kids know as the record player, the turntable, the Walkman, the CD player, and the IPod.  Edison went on, of course, to become one of the greatest inventors and innovators of all time.

As our story begins, Edison, an unknown inventor running his own startup, is focused on developing better hardware for telegraph operators.  He is particularly focused on equipment for telegraph operators to be able to send voice messages over telegraph lines.

Cue the book:

The day after Edison had noted the idea for recording voice messages received by a telegraphy office, he came up with a variation.  That evening, on 18 July 1877, when [his lab's] midnight dinner had been consumed... [Edison] turned around to face [his assistant Charles Batchelor] and casually remarked, "Batch, if we had a point on this, we could make a record of some material which we could afterwards pull under the point, and it would give us the speech back."

As soon as Edison had pointed it out, it seemed so obvious that they did not pause to appreciate... the suggestion.  Everyone jumped up to rig a test... within an hour, they had the gizmo set up on the table... Edison sat down, leaned into the mouthpiece... [and] delivered the stock phrase the lab used to test telephone diaphragms: "Mary had a little lamb."

...Batchelor reinserted the beginning of the [strip on which the phrase had been recorded]... out came "ary ad ell am."  "It was not fine talking," Batchelor recalled, "but the shape of it was there."  The men celebrated with a whoop, shook hands with one another, and worked on.  By breakfast the following morning, they had succeeded in getting clear articulation from waxed paper, the first recording medium -- in the first midnight recording session.

...The discovery was treated suprisingly casually in the lab's notebooks...

It was a singular moment in the modern history of invention, but, in the years that would follow, Edison would never tell the story the way it actually unfolded that summer, always moving the events from July 1877 to December.  We may guess the reason why: in July, he and his assistants failed to appreciate what they had discovered.  At the time, they were working feverishly to develop a set of working telephones to show their best prospect... Western Union... There was no time to pause and reflect on the incidental invention of what was the first working model of the phonograph...

The invention continued to be labeled in the notebooks with the broader rubric "speaking telegraph", reflecting the assumption that it would be put to use in the telegraph office, recording messages.  An unidentified staff member draw up a list of possible names for the machine, which included: tel-autograph, tel-autophone, "chronophone = time-announcer = speaking clock", "didaskophone = teaching speaker = portable teacher", "glottophone = language sounder or speaker", "climatophone = weather announcer", "klangophone = bird cry sounder", "hulagmophone = barking sounder"...

...In October 1877, [Edison] wrote his father that he was "at present very hard up for cash," but if his "speaking telegraph" was successful, he would receive an advance on royalties.  The commercial potential of his still-unnamed recording apparatus remained out of sight...

[A description of the phonograph in Scientific American in early November] set off a frenzy in America and Europe.  The New York Sun was fascinated by the metaphysical implications of an invention that could play "echoes from dead voices".  The New York Times predicted [in an eerie foreshadowing of their bizarre coverage of the Internet in the mid-1990's] that a large business would develop in "bottled sermons", and wealthy connoisseurs would take pride in keeping "a well-stocked oratorical cellar."

...Such was the authority of Scientific American's imprimatur that all of this extraordinary attention was lavished not on the first working phonograph made for public inspection, but merely a description supplied by Edison's assistant.

...By late November, Edison and his staff had caught onto the phonograph's commercial potential as a gadget for entertainment... a list of possible uses for the phonograph was noted [by Edison and his staff], assembled apparently by free association: speaking toys (dogs, reptiles, humans), whistling toy train engines, music boxes, clocks and watches that announced the time.  There was even an inkling of the future importance of personal music collections, here described as the machine for the whole family to enjoy, equipped with a thousand [music recordings], "giving endless amusement."

...The first actual model, however, remained to be built... On 4 December 1877, Batchelor's diary laconically noted, "[staff member John Kruesi] made phonograph today"; it received no more notice than the other entry, "working on speaking tel", the invention [for telegraph operators] that continued to be at the top of the laboratory's research agenda...

...On 7 December 1877, [Edison] walked into the New York office of Scientific American, placed a small machine on the editor's desk, and with about a dozen people gathered around, turned the crank.  "How do you do?" asked the machine, introducing itself crisply.  "How do you like the phonograph?"  It itself was feeling quite well, it assured its listeners, and then cordially bid everyone a good night...

...Having long worked within the world of telegraphic equipment, [Edison] had been perfectly placed to receive the technical inspiration for the phonograph.  But that same world, oriented to a handful of giant industrial customers, had nothing in common with the consumer marketplace...

The story goes on and on -- and you should read the book; it's all like this.

The point is this:

If Thomas Edison didn't know what he had when he invented the phonograph while he thought he was trying to create better industrial equipment for telegraph operators...

...what are the odds that you -- or any entrepreneur -- is going to have it all figured out up front?

Why you and I don't have it very hard

From "4 Things I Learned in the War Zone" by Adam Benayoun at Foundread:

Continuing from where I left off in my previous post, Founding in a War Zone: I and my cofounder Eran Galperin had both just been sent to the Israel-Lebanon border with our Army Reserve units. It was July 2006 and our units were unexpectedly deployed as part of an Israeli military action during the 2006 War with Hezbollah. The timing couldn’t have been worse for us. Our startup Octabox was in its earliest stages. We had “alpha” customers, and we had code, but we weren’t even incorporated. Uncertain if we’d even make it back to our homes in Tel Aviv...

The Pmarca Guide to Startups, part 6: How much funding is too little? Too much?

In this post, I answer these questions:

How much funding for a startup is too little?

How much funding for a startup is too much?

And how can you know, and what can you do about it?

The first question to ask is, what is the correct, or appropriate, amount of funding for a startup?

The answer to that question, in my view, is based my theory that a startup's life can be divided into two parts -- Before Product/Market Fit, and After Product/Market Fit.

Before Product/Market Fit, a startup should ideally raise at least enough money to get to Product/Market Fit.

After Product/Market Fit, a startup should ideally raise at least enough money to fully exploit the opportunity in front of it, and then to get to profitability while still fully exploiting that opportunity.

I will further argue that the definition of "at least enough money" in each case should include a substantial amount of extra money beyond your default plan, so that you can withstand bad surprises. In other words, insurance. This is particularly true for startups that have not yet achieved Product/Market Fit, since you have no real idea how long that will take.

These answers all sound obvious, but in my experience, a surprising number of startups go out to raise funding and do not have an underlying theory of how much money they are raising and for precisely what purpose they are raising it.

What if you can't raise that much money at once?

Obviously, many startups find that they cannot raise enough money at one time to accomplish these objectives -- but I believe this is still the correct underlying theory for how much money a startup should raise and around which you should orient your thinking.

If you are Before Product/Market Fit and you can't raise enough money in one shot to get to Product/Market Fit, then you will need get as far as you can on each round and demonstrate progress towards Product/Market Fit when you raise each new round.

If you are After Product/Market Fit and you can't raise enough money in one shot to fully exploit your opportunity, you have a high-class problem and will probably -- but not definitely -- find that it gets continually easier to raise new money as you need it.

What if you don't want to raise that much money at once?

You can argue you should raise a smaller amount of money at a time, because if you are making progress -- either BPMF or APMF -- you can raise the rest of the money you need later, at a higher valuation, and give away less of the company.

This is the reason some entrepreneurs who can raise a lot of money choose to hold back.

Here's why you shouldn't do that:

What are the consequences of not raising enough money?

Not raising enough money risks the survival of your company, for the following reasons:

First, you may have -- and probably will have -- unanticipated setbacks within your business.

Maybe a new product release slips, or you have unexpected quality issues, or one of your major customers goes bankrupt, or a challenging new competitor emerges, or you get sued by a big company for patent infringement, or you lose a key engineer.

Second, the funding window may not be open when you need more money.

Sometimes investors are highly enthusiastic about funding new businesses, and sometimes they're just not.

When they're not -- when the "window is shut", as the saying goes -- it is very hard to convince them otherwise, even though those are many of the best times to invest in startups because of the prevailing atmosphere of fear and dread that is holding everyone else back.

Those of us who were in startups that lived through 2001-2003 know exactly what this can be like.

Third, something completely unanticipated, and bad, might happen.

Another major terrorist attack is the one that I frankly worry about the most. A superbug. All-out war in the Middle East. North Korea demonstrating the ability to launch a true nuclear-tipped ICBM. Giant flaming meteorites. Such worst-case scenarios will not only close the funding window, they might keep it closed for a long time.

Funny story: it turns out that a lot of Internet business models from the late 90's that looked silly at the time actually work really well -- either in their original form or with some tweaking.

And there are quite a few startups from the late 90's that are doing just great today -- examples being OpenTable (which is about to go public) and TellMe (which recently sold itself to Microsoft for $800 million), and my own company Opsware -- which would be bankrupt today if we hadn't raised a ton of money when we could, and instead just did its first $100 million revenue year and has a roughly $1 billion public market value.

I'll go so far as to say that the big difference between the startups from that era that are doing well today versus the ones that no longer exist, is that the former group raised a ton of money when they could, and the latter did not.

So how much money should I raise?

In general, as much as you can.

Without giving away control of your company, and without being insane.

Entrepreneurs who try to play it too aggressive and hold back on raising money when they can because they think they can raise it later occasionally do very well, but are gambling their whole company on that strategy in addition to all the normal startup risks.

Suppose you raise a lot of money and you do really well. You'll be really happy and make a lot of money, even if you don't make quite as much money as if you had rolled the dice and raised less money up front.

Suppose you don't raise a lot of money when you can and it backfires. You lose your company, and you'll be really, really sad.

Is it really worth that risk?

There is one additional consequence to raising a lot of money that you should bear in mind, although it is more important for some companies than others.

That is liquidation preference. In the scenario where your company ultimately gets acquired: the more money you raise from outside investors, the higher the acquisition price has to be for the founders and employees to make money on top of the initial payout to the investors.

In other words, raising a lot of money can make it much harder to effectively sell your company for less than a very high price, which you may not be able to get when the time comes.

If you are convinced that your company is going to get bought, and you don't think the purchase price will be that high, then raising less money is a good idea purely in terms of optimizing for your own financial outcome. However, that strategy has lots of other risks and will be addressed in another entertaining post, to be entitled "Why building to flip is a bad idea".

Taking these factors into account, though, in a normal scenario, raising more money rather than less usually makes sense, since you are buying yourself insurance against both internal and external potential bad events -- and that is more important than worrying too much about dilution or liquidation preference.

How much money is too much?

There are downside consequences to raising too much money.

I already discussed two of them -- possibly incremental dilution (which I dismissed as a real concern in most situations), and possibly excessively high liquidation preference (which should be monitored but not obsessed over).

The big downside consequence to too much money, though, is cultural corrosion.

You don't have to be in this industry very long before you run into the startup that has raised a ton of money and has become infected with a culture of complacency, laziness, and arrogance.

Raising a ton of money feels really good -- you feel like you've done something, that you've accomplished something, that you're successful when a lot of other people weren't.

And of course, none of those things are true.

Raising money is never an accomplishment in and of itself -- it just raises the stakes for all the hard work you would have had to do anyway: actually building your business.

Some signs of cultural corrosion caused by raising too much money:

• Hiring too many people -- slows everything down and makes it much harder for you to react and change. You are almost certainly setting yourself up for layoffs in the future, even if you are successful, because you probably won't accurately allocate the hiring among functions for what you will really need as your business grows.
• Lazy management culture -- it is easy for a management culture to get set where the manager's job is simply to hire people, and then every other aspect of management suffers, with potentially disastrous long-term consequences to morale and effectiveness.
• Engineering team bloat -- another side effect of hiring too many people; it's very easy for engineering teams to get too large, and it happens very fast. And then the "Mythical Man Month" effect kicks in and everything slows to a crawl, your best people get frustrated and quit, and you're in huge trouble.
• Lack of focus on product and customers -- it's a lot easier to not be completely obsessed with your product and your customers when you have a lot of money in the bank and don't have to worry about your doors closing imminently.
• Too many salespeople too soon -- out selling a product that isn't quite ready yet, hasn't yet achieved Product/Market Fit -- alienating early adopters and making it much harder to go back when the product does get right.
• Product schedule slippage -- what's the urgency? We have all this cash! Creating a golden opportunity for a smaller, scrappier startup to come along and kick your rear.

So what should you do if you do raise a lot of money?

As my old boss Jim Barksdale used to say, the main thing is to keep the main thing the main thing -- be just as focused on product and customers when you raise a lot of money as you would be if you hadn't raised a lot of money.

Easy to say, hard to do, but worth it.

Continue to run as lean as you can, bank as much of the money as possible, and save it for a rainy day -- or a nuclear winter.

Tell everyone inside the company, over and over and over, until they can't stand it anymore, and then tell them some more, that raising money does not count as an accomplishment and that you haven't actually done anything yet other than raise the stakes and increase the pressure.

Illustrate that point by staying as scrappy as possible on material items -- office space, furniture, etc. The two areas to splurge, in my opinion, are big-screen monitors and ergonomic office chairs. Other than that, it should be Ikea all the way.

The easiest way to lose control of your spending when you raise too much money is to hire too many people. The second easiest way is to pay people too much. Worry more about the first one than the second one; more people multiply spending a lot faster than a few raises.

Generally speaking, act like you haven't raised nearly as much money as you actually have -- in how you talk, act, and spend.

In particular, pay close attention to deadlines. The easiest thing to go wrong when you raise a lot of money is that suddenly things don't seem so urgent anymore. Oh, they are. Competitors still lurk behind every bush and every tree, metaphorically speaking. Keeping moving fast if you want to survive.

There are certain startups that raised an excessive amount of money, proceeded to spend it like drunken sailors, and went on to become hugely successful. Odds are, you're not them. Don't bet your company on it.

There are a lot more startups that raised an excessive amount of money, burned through it, and went under.

Remember Geocast? General Magic? Microunity? HAL? Trilogy Systems?

Exactly.

Now playing: Silicon Valley short attention span theater

Oh, this is so exciting!

Five weeks after the launch of Facebook's new platform, certain Internet commentators (whom you can find in my "Guilty Pleasures" blogroll, directly to your right -- and no, I'm not talking about Rosie) have declared Facebook's new initiative to be passe, so over, no longer groovy, kicked out of the in club, and a "pricked bubble".

That was fast.

Five f______ weeks!

If the backlash against Facebook's platform has begun, then let me now start the backlash against the backlash.

Silicon Valley -- and the tech industry generally -- suffers from a particularly acute form of "short attention span theater".

This has always been the case -- there has always been an "inside baseball" effect within our industry where new trends are adopted and dissected at a hyperactive pace by those of us who care a lot about new technology.

The topics of focus used to be new chip architectures, new disk drives, new database architectures, new operating systems, new networking protocols -- and have now moved on to new consumer Internet services, new forms of messaging, new ways to deploy video, new ways to do scripting and embedding, new approaches to ecommerce.

More recently, aided and abetted by new communications technologies such as blogging and instant messaging, the inside baseball effect has become particularly acute and short-sighted among the group Josh Kopelman famously dubbed the Techcrunch 50,000 -- the core group of Internet industry aficionados and early adopters, including myself and many of my friends, who live, sleep, and breathe this stuff.

It works like this: A new technology hits the market in its earliest form -- social networking, or peer-to-peer video streaming, or voice over IP, or widget-style embedding, or now the Facebook platform. Said technology is rapidly adopted by the Techcrunch 50,000, who jump all over it, enthuse about it, dissect it, analyze it, write about it, use it some more, find some limitations in it, tire of it, cynically dismiss it, and then move on to the next thing, almost overnight.

Sometimes the new thing then proceeds to fall over and die, starved of attention and press coverage, and forever confined to life in a tiny niche of die-hards. And the Techcrunch 50,000 say, yep, called it.

But sometimes, the new thing goes on its merry way, ignored and dismissed by the in crowd, and grows, and grows, and grows, and grows, and grows, and grows -- and is ultimately discovered by millions, tens of millions, hundreds of millions, or even billions of people all around the world who incorporate it into their daily lives and don't have the foggiest idea that there was ever a group of insiders who dismissed it a few weeks into its pre-adolescence.

Let's take a look at the points made by our friends in my Guilty Pleasures blogroll:

• "Unimpressive apps" -- "for users, the novelty has worn off" the first set of Facebook apps. My response: five f______ weeks! We haven't even begun to see the interesting apps on Facebook yet.
• "Illusory popularity" -- "it's not clear" that "users" will "stick" with apps. My response: five f______ weeks! We don't have the slightest idea yet how Facebook users six months from now, a year from now, two years from now are going to react to, adopt, stick with, and/or abandon apps. How can we -- we don't even know what those apps will be yet!
• "Disappointing numbers" -- "most of the attention is hogged by the most popular apps, and those tend to be the ones present at launch". My response: five f______ weeks! Any new app on Facebook that wasn't present at launch by definition can have only been in market for a max of about five weeks -- that isn't enough time to draw any conclusions about numbers.

  An anonymous commentator made the observation that, of the last 500 apps to be approved by Facebook, only five have more than 100,000 members. The last 500 apps, logically, have to all have been approved within the last three or four f______ weeks!

  Further, how many new apps on any platform in the whole history of computing are you aware of that acquired more than 100,000 members in their first three or four weeks, before this? Approximately none.

• "Change in the rules" -- Facebook is tweaking the invitation algorithms, reducing the rate at which users can invite their quote-unquote friends to new apps -- which, I would imagine, is the first of many such changes that Facebook will do to both their virality features and limitations, as Facebook does the sensible thing and attempts to balance the goals of preserving a clean user experience with enabling proliferation of lots of applications.

  Again, my response: five f______ weeks! You have to expect this will continue to change, and that some of the changes will accelerate app adoption while some will reduce it, as Facebook, its developers, and its users learn how this new world is going to work at scale.

• "Natural saturation point" where "people stop inviting their friends" and "trying out every new triviality". First up, if you're developing a triviality, don't expect anyone to use it. That's no surprise.

  However, that said, if you're developing a real app, you can conclude absolutely nothing from some theory that we've already hit a "natural saturation point" five f______ weeks in, and the rest of this post will talk about why.

General theory time:

In any given year, a ton of new technologies will hit the market. Most of them will fail to achieve product/market fit, and will fade from view and never be heard from again. That is how it has always been and will always be. This stuff is not easy.

However, every once in a while, you get a new technology that will march, more or less predictably, through the following stages: alpha; beta; pre-adolescent general release where it is adopted, picked apart by, and then dismissed by the inside baseball crowd; silence while it's tweaked and tuned and enhanced to have broader appeal; adoption by a new wave of pragmatic early adopters who have a real use for it in their daily lives; adoption by those early adopters' friends and relatives and colleagues based on enthusiastic word of mouth; and then a gradual spiralling of uptake into the mass market, ultimately resulting in whatever level of millions, tens of millions, hundreds of millions, or billions of users for whom the technology is truly appropriate.

This, also predictably, takes years. Even when it happens really fast.

This is how things go mainstream.

This is what happened with:

• The PC -- 1+ billion users and growing
• The web browser -- 1+ billion users and growing
• SMS -- 2+ billion users and growing
• Ecommerce -- hundreds of millions of users and growing
• Instant messaging -- hundreds of millions of users and growing
• VOIP -- 100+ million users and growing
• The MP3 player -- at least tens of millions of users and growing
• Internet video -- niche/marginal at best until sudden takeoff a couple years ago with Youtube and now exploding in about a hundred different forms for tens of millions of users and growing fast.
• Social networking! The in crowd first wrote off social networking post-Friendster, then again post-Orkut. Then social networking started to get traction in the mainstream market -- four years later! -- in 2005-2006 with MySpace and now Facebook.

Yes, these are the exceptions. But here's what they all have in common: they all got to a point where they had 10 or 20 million users and were still growing fast, and then they just kept on growing. You almost never see a new technology that reaches 10 or 20 million users and is still growing fast, that then falls over and dies.

Call it escape velocity or whatever you want, but social networking now has it, Facebook now has it, and the best prediction you can make is that you are seeing the beginning of widespread mainstream adoption at a scale that the original early adopters can barely imagine.

Remember, people love this stuff. People love the Internet, they love technology, they love new things, and in particular they love new ways to connect, new ways to share, new ways to communicate -- new ways to be part of the network, part of the world. That's why you get more than a billion normal, regular people to adopt the Internet in about 12 years from a nearly standing start, and that's a powerful predictor for what the next decade is going to be like.

Digging into social networking a little bit more: Facebook has something like 20 or 30 million users. MySpace has perhaps 40 or 50 million; it's hard to say exactly. These are big numbers, but the latest estimates from credible sources are that there are more than a billion Internet users already, and that number is growing fast too. The obvious conclusion is that most Internet users have not yet even heard of social networking, much less adopted it, much less decided that it has hit some kind of "natural saturation point".

One billion plus Internet users -- all interconnected, all one click away from the next mainstream service -- is a huge market.

Betting against a market that big, and betting against things that have reached escape velocity at 20+ million users and are growing fast into that market, is a sucker's game.

This stuff is just getting started.

Those of you who were around in the mid 90's, when the Internet was first emerging into its own as a consumer medium, may remember that a certain New York-based newspaper of record had a well-regarded technology reporter who decided to enhance his reputation by writing a series of front-page articles about how the Internet was a fad, about how all the estimated Internet user numbers were inflated, about how the whole thing was overblown, and about how the Internet would most likely never develop into a true consumer medium.

I sure wish I could remember his name.

I'll close with a prediction on Facebook and Facebook apps:

We're now in the summer slump, when all the kids are outside playing and going to the movies (well, at least watching movies of questionable provenance on their laptops), and necking in the bushes.

We'll see three months of experimentation and development of new apps on Facebook, including many false starts and many duds, but also a whole series of innovative new apps that we haven't even thought of yet.

Come September, with the resumption of the school year and a whole crop of new freshpeople, Facebook traffic will once again go vertical, as will adoption of the best of the new apps.

You heard it here first.

The Pmarca Guide to Startups, part 5: The Moby Dick theory of big companies

"There she blows," was sung out from the mast-head.

"Where away?" demanded the captain.

"Three points off the lee bow, sir."

"Raise up your wheel. Steady!" "Steady, sir."

"Mast-head ahoy! Do you see that whale now?"

"Ay ay, sir! A shoal of Sperm Whales! There she blows! There she breaches!"

"Sing out! sing out every time!"

"Ay Ay, sir! There she blows! there -- there -- THAR she blows -- bowes -- bo-o-os!"

"How far off?"

"Two miles and a half."

"Thunder and lightning! so near! Call all hands."

-- J. Ross Browne's Etchings of a Whaling Cruize, 1846

There are times in the life of a startup when you have to deal with big companies.

Maybe you're looking for a partnership or distribution deal. Perhaps you want an investment. Sometimes you want a marketing or sales alliance. From time to time you need a big company's permission to do something. Or maybe a big company has approached you and says it wants to buy your startup.

The most important thing you need to know going into any discussion or interaction with a big company is that you're Captain Ahab, and the big company is Moby Dick.

"Scarcely had we proceeded two days on the sea, when about sunrise a great many Whales and other monsters of the sea, appeared. Among the former, one was of a most monstrous size. ... This came towards us, open-mouthed, raising the waves on all sides, and beating the sea before him into a foam."

-- Tooke's Lucian, "The True History"

When Captain Ahab went in search of the great white whale Moby Dick, he had absolutely no idea whether he would find Moby Dick, whether Moby Dick would allow himself to be found, whether Moby Dick would try to immediately capsize the ship or instead play cat and mouse, or whether Moby Dick was off mating with his giant whale girlfriend.

What happened was entirely up to Moby Dick.

And Captain Ahab would never be able explain to himself or anyone else why Moby Dick would do whatever it was he'd do.

You're Captain Ahab, and the big company is Moby Dick.

"Clap eye on Captain Ahab, young man, and thou wilt find that he has only one leg."

"What do you mean, sir? Was the other one lost by a whale?"

"Lost by a whale! Young man, come nearer to me: it was devoured, chewed up, crunched by the monstrousest parmacetty that ever chipped a boat! -- ah, ah!"

-- Moby Dick

Here's why:

The behavior of any big company is largely inexplicable when viewed from the outside.

I always laugh when someone says, "Microsoft is going to do X", or "Google is going to do Y", or "Yahoo is going to do Z".

Odds are, nobody inside Microsoft, Google, or Yahoo knows what Microsoft, Google, or Yahoo is going to do in any given circumstance on any given issue.

Sure, maybe the CEO knows, if the issue is really big, but you're probably not dealing at the CEO level, and so that doesn't matter.

The inside of any big company is a very, very complex system consisting of many thousands of people, of whom at least hundreds and probably thousands are executives who think they have some level of decision-making authority.

On any given issue, many people inside the company are going to get some kind of vote on what happens -- maybe 8 people, maybe 10, 15, 20, sometimes many more.

When I was at IBM in the early 90's, they had a formal decision making process called "concurrence" -- on any given issue, a written list of the 50 or so executives from all over the company who would be affected by the decision in any way, no matter how minor, would be assembled, and any one of those executives could "nonconcur" and veto the decision. That's an extreme case, but even a non-extreme version of this process -- and all big companies have one; they have to -- is mind-bendingly complex to try to understand, even from the inside, let alone the outside.

"... and the breath of the whale is frequently attended with such an insupportable smell, as to bring on a disorder of the brain."

-- Ulloa's South America

You can count on there being a whole host of impinging forces that will affect the dynamic of decision-making on any issue at a big company.

The consensus building process, trade-offs, quids pro quo, politics, rivalries, arguments, mentorships, revenge for past wrongs, turf-building, engineering groups, product managers, product marketers, sales, corporate marketing, finance, HR, legal, channels, business development, the strategy team, the international divisions, investors, Wall Street analysts, industry analysts, good press, bad press, press articles being written that you don't know about, customers, prospects, lost sales, prospects on the fence, partners, this quarter's sales numbers, this quarter's margins, the bond rating, the planning meeting that happened last week, the planning meeting that got cancelled this week, bonus programs, people joining the company, people leaving the company, people getting fired by the company, people getting promoted, people getting sidelined, people getting demoted, who's sleeping with whom, which dinner party the CEO went to last night, the guy who prepares the Powerpoint presentation for the staff meeting accidentally putting your startup's name in too small a font to be read from the back of the conference room...

You can't possibly even identify all the factors that will come to bear on a big company's decision, much less try to understand them, much less try to influence them very much at all.

"The larger whales, whalers seldom venture to attack. They stand in so great dread of some of them, that when out at sea they are afraid to mention even their names, and carry dung, lime-stone, juniper-wood, and some other articles of the same nature in their boats, in order to terrify and prevent their too near approach."

-- Uno Von Troil's Letters on Banks's and Solander's Voyage to Iceland In 1772

Back to Moby Dick.

Moby Dick might stalk you for three months, then jump out of the water and raise a huge ruckus, then vanish for six months, then come back and beach your whole boat, or alternately give you the clear shot you need to harpoon his giant butt.

And you're never going to know why.

A big company might study you for three months, then approach you and tell you they want to invest in you or partner with you or buy you, then vanish for six months, then come out with a directly competitive product that kills you, or alternately acquire you and make you and your whole team rich.

And you're never going to know why.

The upside of dealing with a big company is that there's potentially a ton of whale meat in it for you.

Sorry, mixing my metaphors. The right deal with the right big company can have a huge impact on a startup's success.

"And what thing soever besides cometh within the chaos of this monster's mouth, be it beast, boat, or stone, down it goes all incontinently that foul great swallow of his, and perisheth in the bottomless gulf of his paunch."

-- Holland's Plutarch's Morals

The downside of dealing with a big company is that he can capsize you -- maybe by stepping on you in one way or another and killing you, but more likely by wrapping you up in a bad partnership that ends up holding you back, or just making you waste a huge amount of time in meetings and get distracted from your core mission.

So what to do?

First, don't do startups that require deals with big companies to make them successful.

The risk of never getting those deals is way too high, no matter how hard you are willing to work at it.

And even if you get the deals, they probably won't work out the way you hoped.

"'Stern all!' exclaimed the mate, as upon turning his head, he saw the distended jaws of a large Sperm Whale close to the head of the boat, threatening it with instant destruction; -- 'Stern all, for your lives!'"

-- Wharton the Whale Killer

Second, never assume that a deal with a big company is closed until the ink hits the paper and/or the cash hits the company bank account.

There is always something that can cause a deal that looks like it's closed, to suddenly get blown to smithereens -- or vanish without a trace.

At day-break, the three mast-heads were punctually manned afresh.

"D'ye see him?" cried Ahab after allowing a little space for the light to spread.

"See nothing, sir."

-- Moby Dick

Third, be extremely patient.

Big companies play "hurry up and wait" all the time. In the last few years I've dealt with one big East Coast technology company in particular that has played "hurry up and wait" with me at least four separate times -- including a mandatory immediate cross-country flight just to have dinner with the #2 executive -- and has never followed through on anything.

If you want a deal with a big company, it is probably going to take a lot longer to put together than you think.

"My God! Mr. Chace, what is the matter?" I answered, "we have been stove by a whale."

-- "Narrative of the Shipwreck of the Whale Ship Essex of Nantucket, Which Was Attacked and Finally Destroyed by a Large Sperm Whale in the Pacific Ocean" by Owen Chace of Nantucket, First Mate of Said Vessel, New York, 1821

Fourth, beware bad deals.

I am thinking of one high-profile Internet startup in San Francisco right now that is extremely promising, has great technology and a unique offering, that did two big deals early with high-profile big company partners, and has become completely hamstrung in its ability to execute on its core business as a result.

Fifth, never, ever assume a big company will do the obvious thing.

What is obvious to you -- or any outsider -- is probably not obvious on the inside, once all the other factors that are involved are taken into account.

Sixth, be aware that big companies care a lot more about what other big companies are doing than what any startup is doing.

Hell, big companies often care a lot more about what other big companies are doing than they care about what their customers are doing.

Moby Dick cared a lot more about what the other giant white whales were doing than those annoying little people in that flimsy boat.

"The Whale is harpooned to be sure; but bethink you, how you would manage a powerful unbroken colt, with the mere appliance of a rope tied to the root of his tail."

-- A Chapter on Whaling in Ribs and Trucks

Seventh, if doing deals with big companies is going to be a key part of your strategy, be sure to hire a real pro who has done it before.

Only the best and most experienced whalers had a chance at taking down Moby Dick.

This is why senior sales and business development people get paid a lot of money. They're worth it.

"Oh! Ahab," cried Starbuck, "not too late is it, even now, the third day, to desist. See! Moby Dick seeks thee not. It is thou, thou, that madly seekest him!"

-- Moby Dick

Eighth, don't get obsessed.

Don't turn into Captain Ahab.

By all means, talk to big companies about all kinds of things, but always be ready to have the conversation just drop and to return to your core business.

Rare is the startup where a deal with a big company leads to success, or lack thereof leads to huge failure.

(However, see also Microsoft and Digital Research circa 1981. Talk about a huge whale.)

Closing thought:

Diving beneath the settling ship, the whale ran quivering along its keel; but turning under water, swiftly shot to the surface again, far off the other bow, but within a few yards of Ahab's boat, where, for a time, the whale lay quiescent.

"...Towards thee I roll, thou all-destroying but unconquering whale; to the last I grapple with thee; from hell's heart I stab at thee; for hate's sake I spit my last breath at thee. Sink all coffins and all hearses to one common pool! and since neither can be mine, let me then tow to pieces, while still chasing thee, though tied to thee, thou damned whale! THUS, I give up the spear!"

The harpoon was darted; the stricken whale flew forward; with igniting velocity the line ran through the grooves; -- ran foul. Ahab stooped to clear it; he did clear it; but the flying turn caught him round the neck, and voicelessly as Turkish mutes bowstring their victim, he was shot out of the boat, ere the crew knew he was gone.

-- Moby Dick