What happened to innovation?

There’s a lot of debate about whether or not the pace of innovation has slowed, and if so, what that means.  After some particularly brutal pitches that felt like Saturday Night Live parodies of startups, I feel compelled to weigh in.  This question cannot be answered with a yes or a no; innovation has slowed dramatically in some areas and gone faster than most people would have thought possible in others.  It’s interesting to ponder why.

We were once great at innovating in the physical world.  Sometimes I stand in Manhattan and think about how amazing it is that everything around me was dug out of the ground, and made with things that were dug out of the ground.  Making an iPhone starts with digging silicon out of the ground, putting some impurities in it and making it into a chip. Then robots, also made with metal mined from the ground, assemble all the chips plus more stuff dug out from the ground to make a phone.

But recently, software (and mostly Internet software) has been the focus of innovation, and its importance is probably still underestimated—there are compounding effects to how it’s changing the world that we’re only now beginning to see.

It’s amazing how fast it’s happened.

In 1990, the Internet was 21 years old and only 2.8 million people had access to it.  (HTML/HTTP wouldn’t be released for another year.)   There are now over 2.5 billion Internet users—a nearly 100,000% increase in 23 years.  Also in 1990, there were 12.4 million mobile phone subscribers.  These were very basic phones, of course—even in 1999, there was no such thing as smartphone.  In 2012, the number of global smartphone users crossed 1 billion, and the number of mobile phone subscribers is much greater.  There are now approximately as many mobile subscriptions (not unique subscribers) as people in the world!

But innovation in the physical world (besides phones and computers) over the same time period has been less impressive.  We went from the first flight with a piston engine to the first flight with a jet engine in about 30 years; 30 years after that we landed on the moon.  Since 1939, jet engines have certainly improved incrementally, but I’m still waiting to travel by ramjet (which incidentally was patented in 1908).  When we made it to the moon in 1969—guided by computers with 64KB of memory and a clock speed of 0.043MHz, similar to a modern high-end toothbrush—people thought the rest of the solar system and the stars were not far off.  We are still waiting.

In the 1960s, oil was our primary energy source, followed by coal, gas, hydro, nuclear, and a tiny fraction of renewables.  Today, the order is…oil, coal, gas, hydro, nuclear, and a tiny fraction of renewables.

Instead of way better ways to generate energy, we talk about reducing usage.  I’m all for conservation, but there’s still something defeatist about it—weren’t we supposed to be generating huge amounts of cheap, clean energy by now? 

There are countless other examples of apparent lack of breakthrough progress in materials science, biotech, food, healthcare, etc.  I can’t order food from a Replicator.  In some ways we’ve even backtracked—I have not been able to travel faster than the speed of sound since I was a kid.   (To be fair, there may be great innovation happening now that is difficult to see.  Innovation often looks like the creation of idle toys while it’s happening, and only in retrospect can we see how important developments really are.)

There’s another important consideration in addition to software/physical—short-term/long-term (or incremental/radically new).  We’ve seen much more progress on things that can be incrementally improved in a short time frame than things that require open-ended, new development.  This is true for both software and physical things.  For example, there are a huge number of people working on making websites really nice-looking and easy-to-use—and they’re doing a fine job—but not very many people working on artificial intelligence.  There are a decent number of people working on more efficient jet engines, but not very many civilians working on replacing the jet engine with something new.

Incremental progress is good—it compounds, and it’s a way to develop great things eventually.  It works a much higher percentage of the time than step change innovation.  It’s certainly the model I’ve observed help many startups reach great success.  The iPhone, which I think is the most important innovation of 2005-2010, came about at least somewhat via compounding incremental progress.  But there were a few critical discontinuities, and Apple took as much time as they needed to figure those out.  They also had the luxury of one guy saying that they were going to do these crazy things like ship a phone with no keyboard running a real OS and require everyone to buy a data plan. 

Part of the reason Internet businesses have been so successful is that it’s easy to iterate quickly with incremental changes.  This makes them appealing businesses.  But there are some things incremental refinement will never get us.

On the software side, it’s relatively easy right now to raise money for a new website or mobile app that brings an existing, offline industry online.  In most cases, this is a real, but small, step forward.  It’s harder to raise money for software companies working on uncertain, long-term, high-reward projects (like AI).  When it comes to hardware, it’s medium hard to raise money for a consumer hardware company, even with a well-understood plan and a short timeframe to ship [0].  It’s very difficult to raise money for a new car company, a new rocket company, a new energy company, etc.

Right now in Silicon Valley, most investors are more interested in your growth graph than your long-term plan—i.e., more interested in the past than the future.  Some possible explanations for this are risk aversion and intellectual laziness.  (Actually, it’s a little better than that—compounding growth is an extremely powerful force, and if investors believe growth will keep going at the same rate, then they can be making a very wise decision.)  This focus makes it hard for companies to raise money if they’re doing things that won’t have a growth graph of any sort for years.

Looking at the past and projecting it forward is good for public market investors, who probably should judge a company on past performance.  But venture investors are supposed to be taking risks on unproven technology and ideas.  Perversely, in the current world, public market investors love to speculate about the future when pricing a stock (sometimes getting themselves badly burned, e.g. the Internet bubble) while most venture investors—the occasional $40+MM A round aside—seem to be leaning in Benjamin Graham’s direction [1].

A two-by-two matrix of progress in innovation (and ease of attracting investment) with software/physical on one axis and short-term/long-term on the other axis looks like this:

 Green is good, yellow is ok, and red is bad.

I don’t think it’s totally correct to say that innovation has slowed—what’s happened is that innovative energy has mostly been directed to short-timeframe opportunities in software.  This is at least mostly rational—honestly, over the last few decades there have just been way more successes in the computer industry than in biotech, cleantech, etc.   The virtual world is far, far less regulated than the physical world, which makes it a less risky place to start a new business.  (Although a very interesting side note is that many of the most successful Internet businesses have been ones that connect the virtual to the physical world in some way.)   And many founders, if you catch them after a few drinks, will often say that they want to get rich in a small handful of years, and timeframes on the Internet are much faster.  Many investors are even worse on this point.

And most importantly, computers are awesome.  Again, it’s not clear to me that we’re worse off focusing our collective energy here, although I do think we should do more on the long-term opportunities.  If the Internet is the most important development of the last 30 years, it makes sense to have most of our best people working on it [2]. 

And now we get to the fundamental issue with innovation today.  People—founders, employees, and investors—are looking for low-cost (and virtual is lower cost than physical), short-term opportunities.  But what causes the low-cost, short-timeframe preference?

For one, there is some deeply human appeal to getting rich quickly, which has probably been around forever.  Investing in software businesses has worked (sometimes), and will probably continue to do so for some time.  Software has been a great place—that did not exist during the physical innovation boom—to direct investment capital.

We haven’t had a really capital-intensive war in a long time, and while that’s obviously great, I am always astonished when I read about how much real innovation has involved the military or national security—it’s hard to get effectively unlimited budgets and focus any other way.  The Internet itself came from the military.

Regulatory uncertainty for non-Internet businesses is another issue, which can at least be improved—although it will be challenging to ever match the freedom of the Internet. 

Perhaps most importantly of all, we can use software to drive innovation in the non-software world by doing as much as possible in software.  We should focus on the intersection of software and everything else—for example, programs that let us do design in software can bring down cost and cycle time.  I believe that short sub-project times are almost always a win, and many companies in the physical realm seem to have long timelines without a lot of intermediate milestones. 

Another thing we can do is to better reward truly long-term investing.  Right now, there’s a focus on the extreme short-term—many investors care mostly about what earnings are going to be next quarter, and the rise in volume of weekly options has been impressive.  Unfortunately, what Wall Street thinks trickles down the pyramid to venture capitalists and even angel investors, so we see a shortening of time horizons everywhere.  This is probably difficult to stop entirely, but I’m sure that a very favorable tax policy on multi-year holdings (and an even less favorable one for short-term holdings) would help. 

Venture funds commonly have a ten year life; lengthening that to fifteen or twenty might help.  I’d also like to see companies move to five- or six-year vesting for founders and employees. 

Or maybe we need a new funding model for radical innovation.  Investment capital will look for the best risk-adjusted return; right now, lots of investors believe Internet companies are it.  As mentioned above, many of the things we consider to be breakthrough innovations with physical things happened before computers, when there was not such a readily available and attractive investment platform.  Investors are often making rational decisions by choosing a shorter-timeframe opportunity that requires less capital.  So maybe the government needs to spend more money on discovery (although right now, it’s decreasing funding for things like the National Labs and the NIH), and maybe there’s a philanthropic model that makes sense.

And there are probably a lot of other things we should be doing too. 

I am a proud child of the computer age.  I can’t imagine life without them, and I’m happy lots of people are working to make them better.  Although it makes sense that most innovation is happening incrementally on the Internet, it would be a shame for us as a species to lose the drive for the sort of discontinuous innovations that got us the Internet in the first place.  I can’t go live in a computer yet, so I’d also like the real world to continue to get better.

Thanks to Jack Altman, Patrick Collison, Kevin Lawler, Eric Migicovsky, Geoff Ralston, and Nick Sivo for reading drafts of this.

 [0] ]It used to be really hard, but preorders have made it easier.  For example, Pebble was unable to raise money from investors until they no longer needed it—they collected more than $10MM in effective preorders on Kickstarter.  But until then, investors dismissed them, saying “we don’t like hardware.”

[1] No disrespect to Color’s investors—they believed strongly in something radical, without a growth graph, and took a big capital risk.  I’d be happy to see more of that, but maybe for different sorts of companies.

[2] Talk about STEM—the study of science, technology, engineering, and mathematics—is mostly BS.  Learning to hack Rails in ten weeks is regrettably a good career move as of June 20th, 2013.  Learning physics over ten years has a much worse economic payoff.  In today’s world, we have programming, and we have everything else.  At least in terms of a plan to become qualified for better jobs, STEM should be renamed CS.

As a side note to the side note, I don’t blame finance for stealing our good engineers.  The failure is that non-CS engineering career paths don’t look very attractive right now.

Premature optimization

Startups talk a lot about optimization—A/B testing, product enhancements, conversion funnels, email campaigns, etc.  These sorts of things can often produce 10% gains, and much more if you can compound several together. 

This is great, but only if the business is already working.  If no users love your product, you’re wasting your time working on anything but that.  It’s always painful to sit in a board meeting and listen to a company miss the forest for the trees—i.e., even if they make all these incremental improvements that the entire company is focused on, they’re going to end up at 2X, and they need to get to 100X. 

It’s dangerous to spend all your mental energy on incremental improvements when what you really need is a step change.

It’s a useful exercise to think about whether or not all the optimization work (or ad buying, for that matter) you’re doing is worth it, even if it all works.  It is usually not until you’re already quite successful.  Until then, you should focus relentlessly on making a product your users love (and making sure you're going after a large enough market).

Startups often ask me how to grow faster.  I usually say “build a great product, and you will be able to make it grow”.  The most sustainable (and cheapest) kind of growth is word-of-mouth growth.


Party rounds

There is a recent trend in Silicon Valley towards party rounds—in early financing rounds, instead of raising large amounts of money from a few large investors, companies are instead raising small amounts of money from many small investors.  The number of investors in such a round is commonly between 10 and 20, but I’ve seen rounds with over 50 investors.

I think the rising popularity of party rounds is bad for companies.

Ask some startups how useful their investors are, and you’ll get a variety of responses, but some commonalities emerge. It turns out that investors are generally about as involved as they are invested. Having at least one investor very focused on your company is valuable, even if the investor is not very good.  The cadence and rhythm of meeting with someone every month to review progress and goals turns out to be an important focusing function [1].

In a typical party round, no single investor cares enough to think about the company multiple times a day.  Each investor assumes that at least 1 of the N other investors will be closely involved, but in fact no one is, and the companies sometimes wander off into a very unfocused wilderness.

While it’s true that many investors are bad, I have found wonderful exceptions.  Good investors stay out of the way when you don’t need them and help you a lot when you do.  This is really valuable—it turns out that most of the great companies end up having great investors.

Additionally, a closely involved investor will help coordinate your next round, and can bridge the company if necessary (things often take longer than founders plan).  I’ve noticed that companies that raise party rounds seem to have a harder time raising their next round compared to companies that raised their first big round from a VC.

Perhaps another reason that party round companies have a harder time raising capital is that worse companies get funded this way—everyone seems less disciplined in deciding to invest.  Social proof plays a large role, and because the amounts are smaller people don’t think as hard about the quality of the business.

I’m all for seeing founders have more power and more ownership, and I’m all for VCs being forced to evolve, but I don’t think that having party rounds replace what used to be an A round is the answer.


[1] There is a version of this that makes Y Combinator work—the deadline of Demo Day is extremely good at focusing companies on the right things.


Man has a large capacity for effort. In fact it is so much greater than we think it is that few ever reach this capacity. We should value the faculty of knowing what we ought to do and having the will to do it. Knowing is easy; it is the doing that is difficult. The critical issue is not what we know but what we do with what we know. The great end of life is not knowledge, but action. I believe that it is the duty of each of us to act as if the fate of the world depended on him ... we must live for the future, not for our own comfort or success.

--Admiral Rickover

A founder-friendly term sheet

When I invest (outside of YC) I make offers with the following term sheet.  I’ve tried to make the terms reflect what I wanted when I was a founder.  A few people have asked me if I’d share it, so here it is.  I think it’s pretty founder-friendly.

If you believe the upside risk theory, then it makes sense to offer compelling terms and forgo some downside protection to get the best companies to want to work with you.

What’s most important is what’s not in it:

*No option pool.  Taking the option pool out of the pre-money valuation (ie, diluting only founders and not investors for future hires) is just a way to artificially manipulate valuation.  New hires benefit everyone and should dilute everyone.

*The company doesn’t have to pay any of my legal fees.  Requiring the company to pay investors’ legal fees always struck me as particularly egregious—the company can probably make better use of the money than investors can, so I’ll pay my own legal fees for the round (in a simple deal with no back and forth they always end up super low anyway).

*No expiration.  I got burned once by an exploding offer and haven’t forgotten it; the founders can take as much time as they want to think about it.  In practice, people usually decide pretty quickly.

*No confidentiality.  Founder/investor relationships are long and important.  The founders should talk to whomever they want, and if they want to tell people what I offered them, I don’t really care.  Investors certainly tell each other what they offer companies. (Once we shake hands on a deal, of course, I expect the founders to honor it.)

*No participating preferred, non-standard liquidation preference, etc.  There is a 1x liquidation preference, but I’m willing to forgo even that and buy common shares (and sometimes do, although it has implications on the strike price for employee options so most founders don’t want it).  In early-stage investing, you should not focus on downside protection.

I have an allergic reaction to complex deal structures, as they invariably end up with all sorts of unintended consequences.  Also, getting this right in early rounds is important—future rounds tend to do whatever the previous rounds did.

(What I do care about is ownership percentage and pro rata rights to maintain that ownership percentage in future rounds.  Most of the rest I don’t care about, but it’s never contentious anyway.)

Startup Advice

In honor of the new YC batch starting tomorrow, here is some of the best startup advice I’ve heard or given (mostly heard):

1.     Make something people want.

2.     A great team and a great market are both critically important—you have to have both.  The debate about which is more important is silly.

3.     Write code, talk to users, and build the company (hire the best people you can find, get the culture right, fundraise, close sales, etc.)  Most other things that founders do are a waste of time.

4.     Set a clear, easy-to-understand vision for your company, and make it be a mission people believe in.

5.     Stay focused and don’t try to do too many things at once.  Care about execution quality.

6.     You have to have an almost crazy level of dedication to your company to succeed.

7.     In general, don’t start a startup you’re not willing to work on for ten years.

8.     Be relentlessly resourceful.

9.     In the current pivot-happy world, good ideas are underweight.  It’s worth the time to think through a good one.

10.  Growth solves (nearly) all problems.

11.  While growth is critical and you should focus on it, occasionally consider where you’re going—you need both growth and to be growing towards something valuable.

12.  Obsess about the quality of the product.

13.  Overcommunicate with your team.  For some reason most founders are really bad at this one.  Transparency is your friend.

14.  Move fast.  Speed is one of your main advantages over large companies.

15.  Hire slow; fire fast.  Hiring is the most important thing you do; spend at least a third of your time on it.

16.  Occasionally think about why the 20th person will join your company.

17.  Hire smart and effective people that are committed to what you’re doing.  The last five words there are important.

18.  Hire friends and friends of friends.  Go after these people like crazy to get them to join.  Some other candidate sources are ok, but I always got bad results from technical recruiters.

19.  Generally, value aptitude over experience.

20.  Hire people that you could describe as animals.

21.  Eliminate distractions.

22.  Don’t die.

23.  Be frugal.

24.  You’ll often hear conflicting advice about everything but “build a great product”.  This means you can go either way on much of the rest of it and it doesn’t really matter.  Just make a decision and get back to work.  Product/market fit is what matters.  You can—and will—make a lot of mistakes.

25.  You make what you measure.

26.  Startups are very hard no matter what you do; you may as well go after a big opportunity.

27.  Momentum is critical.  Don’t lose it.

28.  Keep salaries low and equity high.

29.  Keep the organization as flat as you can.

30.  When working on a deal—raising money, trying to get a partnership, etc.—it’s important to create a competitive situation.

31.  Schleps are good.

32.  Don’t forget to make money.

33.  Journalists like hearing directly from founders.  If you hire PR people, resist their desire to control all the contact.

34.  It’s standard for founders to keep board control in the first round.

35.  Listen to everyone.  Then make your own decision.

36.  Remember that you are more likely to die because you execute badly than get crushed by a competitor.

37.  Get lucky.

38.  Have a direct relationship with your customers.

39.  Be formidable—do not be easy to push around.

40.  Don’t let your company be run by a sales guy.  But do learn how to sell your product.

41.  Have a culture that rewards output.

42.  Don’t hire professional managers too early.

43.  Simple is good.  Be suspicious of complexity.

44.  Get on planes in marginal situations.  In-person is still better than tele-anything.

45.  Most things are not as risky as they seem.

46.  Be suspect of anyone who says the word process too often.

47.  Raise a bit more money than you think you need.

48.  Ignore the fact that “the press loves [you]”.

49.  Have great customer service.

50.  You can create value with breakthrough innovation, incremental refinement, or complex coordination.  Great companies often do two of these.  The very best companies do all three.

51.  The role of the board is advice and consent.  If the CEO does not lay out a clear strategy and tries to get the board to set one, it will usually end in disaster.

52.  Board observers are usually a headache.

53.  If you pivot, do it fully and with conviction.  The worst thing is to try to do a bit of the old and the new—it’s hard to kill your babies.

54.  It’s better to make a decision and be wrong than to equivocate.

55.  Set goals for the company and motivate people to get there.

56.  Always praise good work.

57.  Celebrate your wins as a company.  Get t-shirts for big milestones.

58.  Have a good operational cadence where projects are short and you’re releasing something new on a regular basis.

59.  You can win with the best product, the best price, or the best experience.

60.  Meetups and conferences are generally a waste of time.

61.  If the founders of your company seem to care more about being founders than they care about your specific company, go join another company.

62.  It’s easier to sell painkillers than vitamins.

63.  Be suspicious of any work that is not building product or getting customers.  It’s easy to get sucked into an infrastructure rewrite death spiral.

64.  It’s better to have a few users love your product than for a lot of users to sort of like it.

65.  Learn how to stay extermally optimistic when your world is melting down.

66.  Startups should require as few miracles as possible, but at least one.

67.  You have to have great execution—far more people have good ideas than are willing to roll up their sleeves and get shit done.

68.  Don’t have a diverse culture in the early days.

69.  Keep a to-do list every day.  At the top of it, put the one or two big things you want to work on.

70.  Being the CEO is miserable more often than it’s good.  But when it’s good, it’s really good.

71.  On the really bad days, remember that tomorrow will be better—it’s hard to see it being much worse!

72.  Sleep and exercise.

73.  Success in a startup is usually pass/fail.  Worry more about making sure you pass than an extra point of dilution.

74.  Good investors are worth a reasonable premium.

75.  Give your investors something to do.

76.  Go for a few highly involved investors over a lot of lightly engaged ones.

77.  Raise money on promise.  Raise money on clean terms.

78.  Do reference checks on your potential investors.  Ask other founders how they are when everything goes wrong.

79.  Investors love companies other investors love.

80.  A lot of the best ideas seem silly or bad initially—you want an idea at the intersection of “seems like bad idea” and “is good idea”. (It’s important to note you need to be contrarian and right, not simply contrarian.)

81.  Surf someone else’s wave.

82.  Sometimes you can succeed through sheer force of will.

83.  All startups are fucked in at least one major way.  Keep going.

84.  Keep an eye on cash in the bank and don’t run out of it.

85.  Pay a lot of attention to the relationship between cofounders, especially if both/all of you want to be CEO.

86.  Stay small and nimble.

87.  Have a staff meeting at least once a week.

88.  Find a mentor that will teach you how to manage.

89.  Keep burn low until you’re sure everything is working.

90.  Be suspect about buying users.

91.  Lead by example.

92.  Have the right kind of office.  The proper office for a very small company is an apartment or house.

93.  Share results (financial and key metrics) with the company every month.

94.  Have a table in your offer letters that shows how much the stock you’re granting a new hire could be worth in various scenarios.

95.  The best startups are defined by exceptions; all of these rules are probably breakable, but probably not all at the same time.

By endurance we conquer

I'm reading The Endurance and "by endurance we conquer" (Ernest Shackleton's family motto) struck me as a great piece of startup wisdom.

Everyone knows that you need a great team, great execution, and a great idea.  Less obvious is that you have to have great endurance.  It's very tough to keep going when everyone tells you your idea sucks and it will never work (especially when things are plainly not working).  It's tough to keep going when everything goes wrong, which it almost certainly will. And it's tough to keep working when you're really tired, but very often that extra 5% at a critical point is how you beat out a competitor for a critical deal and then they disappear in the rearview mirror.

Most startups don't die at the hands of a competitor.  It's more often something like an internal implosion, the founders giving up, or not building something people want (and failing to remedy that situation). You can win by endurance.

Upside risk

Everyone claims that they understand the power law in angel investing, but very few people practice it.  I think this is because it’s hard to conceptualize the difference between a 3x and a 300x (or 3000x) return. 

It’s common to make more money from your single best angel investment than all the rest put together.  The consequence of this is that the real risk is missing out on that outstanding investment, and not failing to get your money back (or, as some people ask for, a guaranteed 2x) on all of your other companies.

And yet angel investors continue to ask for onerous terms to mitigate their “downside risk”.  All this does is piss founders off, misalign incentives, and harm the investors’ chance of getting to invest in the best deals, because those are usually hotly pursued and good founders check references.  An angel investor is much better off focusing on investing at a reasonable price [1] and not trying to “win” on any other terms.

Instead of downside risk [2], more investors should think about upside risk—not getting to invest in the company that will provide the return everyone is looking for. 

[1] Speaking of price, the mistake that founders make (corresponding to investors focusing too much on downside terms) is focusing too much on getting a high price.  I have seen many founders price out good investors and put the company in a bad situation facing a down round a year later, all because they were obsessed with getting a high sticker price for their company.  I think it’s because it gives founders something quantitative to compete on. 

[2] As a side note, I think most people have terrible intuition about investment risk/reward tradeoffs in general—this is not limited to private companies.  It feels like every time I turn on CNBC (which is thankfully very infrequently) they’re talking about an impending total collapse.  The end of the world only happens once; it’s very unlikely to be Monday morning.  But we seem hardwired to focus on downside risk.  The CNBC watchers would be better off keeping a cushion in cash and not selling their stocks after every panic. 

Software to avoid the software people

A few years ago, many of the Y Combinator B2B startups wrote tools for the developers in other companies--metrics software, deployment software, monitoring software, build software, development frameworks, etc.  The startups would want to meet with the technology people at companies to sell their service.

There's been a significant shift--lots of the YC B2B startups are now building software to help non-technical people in companies (usually large ones with a primary business that is not writing software) avoid their internal IT department when they need software to help them get something done.  It's faster and easier.  So now the startups are trying to avoid the developers at the other company (so they don't get blocked) and sell to the person who is waiting in the internal development queue. 

It will be interesting to see how far this trend goes, and something to keep in mind if you’re starting a new company.

More interesting dinner conversations

When seated at a table with people you don't know, ask "what are you interested in?" or "what have you been thinking about lately?" instead of "what do you do?".

(Surprisingly often you get a look of utter confusion, followed by fifteen seconds of hemming and hawing, and then a version of "man, i really need to take some time off".)