Questions 19 to 22 are based on the passage you've just heard。
Sprinters apparently reach their highest speed right out of the blocks,
and spend the rest of the race slowing down. The winners slow down the
least. It’s that way with most startups too. The earliest phase is
usually the most productive. That’s when they have the really big ideas.
Imagine what Apple was like when 100 percent of its employees were
either Steve Jobs or Steve Wozniak.
The striking thing about this phase is that it’s completely different from most people’s idea of what business is like. If you looked in people’s heads (or stock photo collections) for images representing “business,” you’d get images of people dressed up in suits, groups sitting around conference tables looking serious, PowerPoint presentations, and people producing thick reports for one another to read. Early-stage startups are the exact opposite of this. And yet they’re probably the most productive part of the whole economy.
Why the disconnect? I think there’s a general principle at work here: the less energy people expend on performance, the more they expend on appearances to compensate. More often than not, the energy they expend on seeming impressive makes their actual performance worse. A few years ago, I read an article in which a car magazine modified the sports model of some production car to get the fastest possible standing quarter mile. You know how they did it? They cut off all the crap the manufacturer had bolted onto the car to make it look fast.
Business is broken the same way that car was. The effort that goes into looking productive is not merely wasted, but actually makes organizations less productive. Suits, for example, do not help people to think better. I bet most executives at big companies do their best thinking when they wake up on Sunday morning and go downstairs in their bathrobe to make a cup of coffee. That’s when you have ideas. Just imagine what a company would be like if people could think that well at work. People do in startups, at least some of the time. (Half the time they’re in a panic because their servers are on fire, but the other half they’re thinking as deeply as most people only get to sitting alone on a Sunday morning.)
Ditto for most of the other differences between startups and what passes for productivity in big companies. And yet conventional ideas of “professionalism” have such an iron grip on our minds that even startup founders are affected by them. In our startup, when outsiders came to visit, we tried hard to seem “professional.” We’d clean up our offices, wear better clothes, and try to arrange a lot of people to be there during conventional office hours. In fact, programming didn’t get done by well-dressed people at clean desks during office hours. It got done by badly dressed people (I was notorious for programming wearing just a towel) in offices strewn with junk at 2:00 in the morning. But no visitor would understand that. Not even investors, who are supposed to be able to recognize real productivity when they see it. Even we were affected by the conventional wisdom. We thought of ourselves as impostors, succeeding despite being totally unprofessional. It was as if we’d created a Formula 1 car but felt sheepish because it didn’t look like a car was supposed to look.
19. What does Huang Yi do in his company?
In addition to having perseverance, founders need to be adaptable. Not only because it takes a certain level of mental flexibility to understand what users want, but because the plan will probably change. People think startups grow out of some brilliant initial idea like a plant from a seed. But almost all the founders I interviewed changed their ideas as they developed them. PayPal started out writing encryption software, Excite started as a database search company, and Flickr grew out of an online game.
21. What did Huang Yi do in addition to lecturing?
Levchin: No, because I think we didn’t know what we were doing. I think the hallmark of a really good entrepreneur is that you’re not really going to build one specific company. The goal—at least the way I think about entrepreneurship—is you realize one day that you can’t really work for anyone else. You have to start your own thing. It almost doesn’t matter what that thing is. We had six different business plan changes, and then the last one was PayPal.
20. What did Huang Yi think of his work?
Huang Yi works for a company that sells financial software to small and medium size businesses. His job is to show customers how to use the new software. He spends two weeks with each client, demonstrating the features and functions of the software. The first few months in the job were difficult. He often left the client feeling that even after two weeks he hadn't been able to show the employees everything they needed to know. It's not that they weren't interested; they obviously appreciated his instruction and showed a desire to learn. Huang couldn't figure it out the software was difficult for them to understand, or if he was not doing a good job of teaching. During the next few months, Huang started to see some patterns. He would get to a new client site and spend the first week going over the software with the employees. He usually did this in ships, with different groups of employees listening to him lecture. Then he would spend the next week in installing the program and helping individuals trouble-shoot. Huang realized that during the week of trouble shooting and answering questions, he ended up addressing the same issues over and over. He was annoyed because most of the individuals with whom he worked seem to have retained very little information from the first week. They asked very basic questions and often needed prompting from beginning to end. At first, he wondered if these people were just a little slow, but then he began to get the distinct feeling that part of the problem might be his style presenting information。
The Internet was just unfolding, so I started spending more and more time on it, and it was interesting. It was exciting to see these little companies get started. Two of my colleagues from Stanford had gone on to start Yahoo, and I thought, “Wow. This is just a list, a directory which tells you what is where. And somebody put $1 million in them.” I mean, that was huge. So I thought, “This Internet thing is here to stay,” and I started playing around with it and came up with the idea to do a simple-to-install database at the back end. Then you’d use the browser as the front end. It could store any piece of information at the back, but the browser would be used to display it. So people could just look for it and be able to create a personal database of anything: contact information, phone numbers, special files, or whatever it is that you would do on a local PC.
22. What did Huang Yi realize in the end?
Livingston: Take me back to how the idea got started and evolved into
Hotmail. How did you know Jack?
Bhatia: I met Jack Smith when I joined Apple Computer. We were working on the same project building PowerBook portables. Our manager left the company to join a startup in the Valley called FirePower Systems. Jack and I knew Apple would have given us steady, stable employment, but it wasn’t with grand stock options. So we decided to leave Apple and join this startup.
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Livingston: Was there ever a time when you thought you were in
Bhatia: The only time was when we had to go in for the second round of financing. We didn’t have any money and Tim was at the Olympics in Atlanta and he refused to fund us because we wanted a slightly higher valuation. This was what all the other VCs were telling us, but he wanted to invest at a lower valuation. We had only a couple of weeks worth of money left and I would not have been able to meet the next payroll. So as soon as he came back, we literally had to accept his terms and move on.
Livingston: When did you first notice fraudulent behavior?
Levchin: From day one. It was pretty funny because we met with all these people in the banking and credit card processing industry, and they said, “Fraud is going to eat you for lunch.” We said, “What fraud?” They said, “You’ll see, you’ll see.”
I actually had an advisor or two from the financial industry, and they said, “Get ready for chargebacks. You need to have some processing in place.” We said, “Uh huh.” They said, “You don’t know what a chargeback is, do you?”
Livingston: So you didn’t foresee this fraud?
Levchin: I had no idea what was going to happen.
Livingston: But you weren’t too surprised?
Levchin: We tried to attack the system for ourselves, like a good security person would. How can you cheat and steal money and do whatever? We made some provisions from day one to prevent fraud. We prevented all the obvious fraud, and then, I think 6 months into it, we saw the first chargeback and were like, “Ah, one per week. OK.” Then it was like an avalanche of losses; 2000 was basically the year of fraud, where we were just losing more and more and more money every month. At one point we were losing over $10 million per month in fraud. It was crazy.
That was when I decided that that was going to be my next challenge. I started researching it, figuring out what could be done and attacking the problem.
Livingston: You finally pitched Draper Fisher Jurvetson (DFJ) and they
passed the test. Tell me about getting funding.
Bhatia: They liked the idea right off the bat. They said, “We’re going to get one of our partners to come in and take a look at this because it could be big.” So Tim Draper came in the following week and he liked the idea. After another meeting he said, “OK, we’re ready to fund you. We like this very much. How much do you want?”
I did some calculations on the back of an envelope and asked for $3 million, which was our plan based on hiring a few engineers.
They said, “No, that’s too much. How much money do you need just to prove to us that you can do this—that it’s even possible to make email available on the web?” So I asked for half a million and he said, “I’ll give you $300,000.” I said, “Alright, I’ll take it.”
They wanted 30 percent of the company, which would value us at $1 million. It was an intense negotiation; I threatened to go to the other VCs if they didn’t pony up the money. We finally settled on a 15 percent split with them and they valued the company at $2 million post money. But they’d put in a right of first refusal. Since I was a young entrepreneur at the time, I didn’t understand that this basically meant that you couldn’t go to any other VC. So even though they didn’t get their chunk in the first piece, in any subsequent round they would have the ability to take up the entire round.
Livingston: Your lawyer didn’t point out that clause?
Bhatia: We didn’t have a very good lawyer back then. Of course it was touted to us as “We love you so much that we want to have the right to buy the next round. You can go to other people too.”
But that’s the one that got us. It impeded our ability to go to another VC. What ended up happening was that we could not get a higher valuation because DFJ wanted to put more money in the company themselves. So any time we would talk to another VC, they would talk him out of it: “This is not a good company, don’t worry about it.” So we were really stuck with DFJ for the next round.
Livingston: They put you down to other VCs?
Bhatia: They did. Of course, that was very early on and now everything is all fine and dandy, but at that point in time . . . we had a term sheet for a much higher valuation. But when we would talk to any other VC, the other VC would call the guys at DFJ and they’d say, “No, don’t invest in them.”
Livingston: Were they helpful at all?
Bhatia: Yes. Steve Jurvetson was very helpful; he introduced us to a lot of people and, on the whole, they’re a good VC firm in the sense that they try to put deals together. But sometimes they don’t play by the rules.
When did you start Y Combinator?
Livingston: We started Y Combinator in March 2005. Around that same time, I had gotten a book deal for Founders at Work, so I had planned to quit my job doing marketing at an investment bank and work full-time for a little while on the book. But we started Y Combinator simultaneously, so I didn’t really get to spend much time on the book.
What was the process when Y Combinator got started?
Livingston: That would assume that we had a process. There was no process. Remember, Y Combinator started off as an experiment. Paul had wanted to do angel investing. He wanted to help people start companies. But he didn’t really want all the requirements that come with being an angel investor, so he thought he should start an organization that could handle all of this for him. I said, “That sounds interesting. I’d love to work with entrepreneurs.” So we sort of hatched this idea for Y Combinator, and I was the one in charge of doing a lot of the business stuff.
We decided to do a batch of investments at once, so that we could learn how to be investors. We decided, “OK, we’ll invest in a group of startups, and we’ll do it over the summer since a lot of people are free over the summertime.”
I’m especially hoping this book inspires people who want to start startups. The fame that comes with success makes startup founders seem like they’re a breed apart. Perhaps if people can see how these companies actually started, it will be less daunting for them to envision starting something of their own. I hope a lot of the people who read these stories will think, “Hey, these guys were once just like me. Maybe I could do it too.”
Livingston: Tell me about the negotiation process.
Bhatia: They called us to meet with Bill on October 13, 1997, and we were shown the Microsoft campus, headquarters, the whole works. We were taken to Bill’s office, met with him, and then we were taken to a room with a gigantic table, and there were about 15 Microsoft negotiators sitting on the other side: business development people, lawyers, accountants, all of them.
They gave a presentation about how much they liked the company and this and that, and they said they wanted to buy us and placed an offer of $160 million. I knew that that was the opening shot and I said, “Thank you very much for making an offer. We really, really like your company and like the fact that you like us so much. We’ll go back to our board and discuss this and get back to you.”
And the CFO said, “C’mon, is that in the right ballpark?” He wanted me to open my mouth, but I was told beforehand that if I opened my mouth, there was no way I could negotiate with so many people. It was just the three of us: Jack Smith, myself, and our VP of marketing.
Livingston: The VCs gave you the liberty to negotiate, right? That surprises me.
Bhatia: Luckily it was very early on; had we been burning through a lot of cash, had we been around for a while, they probably would have put pressure on us. But we were under no pressure at that point in time.
Livingston: What drove you to keep on negotiating until you got the $400 million?
Bhatia: Once you’ve got a lead in terms of a subscriber base, that is unassailable. It can’t be replicated easily. So I knew even if they started developing the product—I have no doubt in my mind that they could have developed it, so many engineers and smart people in Microsoft. At that time they had something like 16,000 engineers, and I had a total of 60 people in the company, only 14 engineers, so it would have been easy to pick 15 guys from 16,000 and build this product. But I knew we had that momentum behind us and that is very hard to replicate.
Livingston: You arrived in this country with only $250 in your pocket. Wasn’t it tempting for you to agree to sell for, say, $300 million?
Bhatia: Once you have tasted this kind of success, once you’ve tasted that it works, that you’ve got subscribers who are telling you it’s good, you know you are going to get there. In fact, that’s exactly what’s happened. That 6-month lead that we had already over any of our competitors today has translated into about a 50 to 100 million–user lead.
Seeing how they did a lousy job of providing email to their 2.5 million subscribers, I also knew that they didn’t have the technology in house. Because if they did, they wouldn’t have been asking to license this from us. If we had gone the licensing route, I think we would have been as big as Google. Because that’s what Google did, right? Initially, they said, “We’ve got search. Why don’t we license search to everyone else?” That was their original business model. They licensed it to Yahoo, Microsoft, and AOL and grew big based on their subscribers.
Livingston: Tell me a little about how PayPal got started.
Levchin: The company was really not founded to do payments at all. My focus in college was security. I wanted to do crypto and stuff like that. I had already founded three different companies during college and the year after, which I spent in Champaign-Urbana, where I went to school. Then, in favor of not doing graduate school, I decided to move out to Silicon Valley and try to start another company.
So I was hanging around Silicon Valley in the summer of ’98 and was not really sure what I was going to do with my life. I was living in Palo Alto, squatting on the floor of a friend. I went to see this random lecture at Stanford—given by a guy named Peter, who I had heard about, but never met before.
The lecture turned out to have only six people in it. It was in the heat of the summer, so nobody showed up. This guy was like, “There are only six of you, OK.” Afterwards I walked up to talk to him. He was this really intense guy, and he said, “We should get breakfast sometime.” So we met up the next week.
I had two different ideas that I was considering starting companies around, and I pitched him on both evenly. Peter was running a hedge fund at the time. For a few weeks we kept talking, and eventually he said, “Take this idea, because this one is better, and you go start a company around it, and then I can have my hedge fund invest a little bit of money in it”—like a couple hundred thousand dollars. That was a good thing, since I was starting to run out of money.
I had just moved from Champaign; most of my contacts and friends were in Chicago. One of them I was trying to convince to be the CEO. He wasn’t really available, so I wound up being without a CEO. I called Peter and said, “This investment is a great thing, but I have no one to run the company. I’m just going to write the code and recruit the coders.” And he said, “Maybe I could be your CEO.” So I said, “That’s a really good idea.” The next 2 weeks we were sort of playing with the idea, and by 1/1/99 we agreed that he would be the CEO and I would be the CTO.