I certainly had a choice at that point of retiring and go buy one of the islands in the Bahamas somewhere, sipping mai-tais, and turn it into my personal fiefdom, but that was not of interest to me at all. I mean, I like going to the beach for a short period of time, but not much longer than a few days or something like that. The idea of lying on a beach as my main thing, just sounds like the worst - it sounds horrible to me. I would go bonkers. I would have to be on serious drugs, I'd be super-duper bored. I like high intensity.
When I was in college I was reading about the fastest car in the world, the McLaren F1. It's a interesting work of art, it's really done right. I thought if I ever made enough money, I would buy the McLaren. I was actually living in an apartment in Palo Alto that cost significantly less than the $1 million car. It was either upgrade to a house or buy the car, and I bought the car. I was pretty excited about getting it. There were 62 McLaren F1s in the world, and I owned one of them. It probably wasn't the best idea.
I had it for several years and I put 11.000 miles on it, and I drove it from LA to San Francisco. I had it as my daily driver, which is a crazy car to have as a daily driver, particularly on the 405. In fact it was kind of funny there was this show, if there ever was a show on hubris it would probably be it, called ‘Silicon Valley Gold Rush’ and it was actually filmed in 1999. They filmed me getting the McLaren and a number of other people as well. Just four years earlier showering at the Y and sleeping on the office floor to quite a few creature comforts. Fortunately PayPal worked out otherwise it would've been extremely embarrassing.
The PayPal story is quite complicated, even though it took place in a relatively short time, about roughly three and half years from the creation of the company and it being sold to eBay mid 2002. PayPal was created from the merger of two companies X.com which I founded, and Confinity which was founded by Peter Thiel and Max Levchin.
The goal in doing my second Internet company was creating something that would have a profound effect, because I thought we hadn't really reached the potential that we could have with Zip2. We had really sophisticated software, our software was at least comparable to what Yahoo or Excite or others had. In fact, I thought in some ways it was better, but because it was all filtered through these partners it wasn't getting properly used. I thought, I want to do something that can be a more significant contribution to the Internet, so immediately post the sale, I didn’t really take any time off, I tried to get where the opportunities remained in the internet. The initial thought was financial services because money is digital, it's low bandwidth, at the time most people were on slow modems, because this was late '98, early '99. It seemed to me that the financial sector had not seen a lot of innovation on the Internet. At the time transactions were very slow. If you bought something, people had to mail checks to each other. It would take weeks to conduct the transfer. It could take weeks just to complete a single transaction. When you think about it, money is just an entry in a database, so it's low bandwidth. Essentially prices are just information, the primary information to allow for labor allocation. You don't need some sort of big infrastructure improvement to do things with it. The paper form of money is really only a small percentage of all the money that's out there. It should lend itself to innovation on the internet.
We thought of a couple of different things we could do. One of the things was to combine all of somebody's financial services needs into one website, so you could have banking, brokerage, insurance and all sorts of things in one place.
In the early going our company was called X.com. X started off as a financial services company, to aggregate all of your financial services seamlessly in one place, and make it really easy to use, so you don't have to go to multiple financial institutions to take care of your mortgage, your credit card, your banking relationship, insurance, mutual funds. You could just go to one location.
I sunk the great majority of my net worth into X.com. I had essentially no background in financial services except for an internship at a bank. It was all like a series of poker games, now I’d gone on to a higher stakes poker game. Raising $50 million was a matter of making a series of phone calls and the money was there.
So the thought with X was to create one place and do any financial anything.
Then we had a little feature, which took us about a day, that was the ability to email money from one customer to another. You could type in an email address or, actually, any unique identifier - so, like, an email address or a phone number or something like that - and transfer funds, or conceivably stocks or mutual funds or whatever, from one account holder to another. We had that as a feature and whenever we’d demo and show the system off to someone, they wouldn't get excited about the hard stuff, the conglomeration of financial services, which was quite difficult to put together. We'd say: “This took us a lot of effort to do and look how you can see your bank statement and your mutual funds and insurance and all that. It's all in one page and look how convenient that is.” and people would go, ho hummm, and we would say, and by the way we have this feature where you can enter somebody's email address and transfer his funds, and they go, “Wow! All right, OK.” They would really be wowed by the fact that you could email the money to somebody, so we started focusing more and more on the email payments part of it.
It's important to take feedback from your environment. You want to be as closed-loop as possible. If we hadn't responded to what people said, we probably would not have been successful. It’s important to look for things like that, and focus on when you see them, and correct your prior assumptions.
There was another company called Confinity, which started out from a different angle. They started out as a PalmPilot cryptography company, and developed an application with that cryptography that was able to beam money tokens via the infrared port of the PalmPilot. Yeah, if people remember that one, that was big at one point. If you remember back in the day PalmPilots did not have any connectivity really, but they had infrared ports. You could beam token payments from one Palm Pilot to another via the infrared port. Then they had a website which was called Paypal, sort of parallel to that, because once you'd beamed the infrared tokens you had to still then synchronize your Palm Pilot and do the transfer via the website. What they found was that people weren't that interested in the PalmPilot stuff, but they were interested in the website, so they started leaning their business in that direction. We kind of converged to the same point, and were quite close together so we decided to merge the companies, and in I think January or so of 2000, X.com acquired Confinity, and then about a year later we ended up changing the company name to PayPal. We combined our resources when both companies were only about a-year-old at the time. Yeah, it worked out better than we expected. Initially, Confinity and X.com started out from slightly different directions and converged to the same point, and by pulling our resources we were able to compete effectively against eBay's build in system, and survive the dotcom implosion of late 2000. It was a very turbulent period.
I was once driving on Sandhill Road with Peter Thiel, one of the cofounder of PayPal, and we were actually just going to visit Mike Moritz at Seqouia capital. This is in 2000. I didn't really know how to drive the McLaren, and Peter says: “so what can this do?” I'm probably number one on the list of famous last words, I said: “Watch this.” I floored it and did a lane change. The McLaren doesn't have traction control or anything, it's just massive power to the wheels 640 brake horsepower, and it only weighs a ton, so it has massive power to weight. It can break the wheels free at 80 miles an hour. It broke the rear end free and it started spinning, I was going straight, and I can remember seeing the cars coming towards me while I was going backwards. We hit an embankment, sort of a 45 degree embankment which knocked the car into the air, which continued spinning like a discus, like 3 feet in the air according to witnesses, and then Bam!! Slammed down on the ground going the original direction. It was like in a movie, I drove to the side of the road and I was like “Holy cow.”
Peter hitched a ride to Mike. I waited till the fire truck and ambulance arrived. Once the car was taken care of I hitched a ride to, so we continued the meeting. Lucky to be alive really. I blew out the suspension and didn't actually wreck the car, the core chassis and the engine we're OK, but all the glass and the wheels were shredded. There was massive body damage to the front and rear. That was crazy. After that I took driving lessons on the McLaren, because it's a difficult car to drive.
As far as PayPal, we focused on e-mail payments and really tried to make that work. That's what really got things to take off. It was very easy to implement in the beginning, it gets harder as you try to minimize the fraud in the system, but the initial implementation of email payment is really trivial. Although it's easy in principle, what gets really hard is adding security while still keeping it easy to use. It's like the Willy Loman quote, why do you rob banks? because that's where the money is. Why do people rob PayPal? same reason. You can dial up the security to a really high level, but then you're going to make it very hard to use. That was one of the toughest things we wrestled with, and that was actually quite a difficult problem to solve, but we solved most of the issues associated with that.
There were a lot of back-office relationships that we needed to establish, and to attach to various heterogeneous data sources. We needed to attach to the credit card system for processing credit cards, we needed to attach to the Federal Reserve System for doing electronic funds transfers, we needed to attach to various fraud databases to run fraud checks. There was a lot that we had to interface with. That took a while. It all came together I think roughly simultaneously. I mean developing the software and having it ready for the general public reasonably coincided with us being able to conclude those deals, and interface with the outside vendors, and all that took about a year.
We figured out how to make it really fast and easy to transfer funds from one person to another. The key was figuring out how to make the friction of signing up for an account very very low, and make it easy for one person to refer another. We did a bunch of things to decrease the friction. If you tried to transfer money to somebody who didn't have an account in the system, it would then forward an email to them saying, hey, why don't you sign up and open an account? We started off first by offering people $20 if they opened an account, and $20 if they referred anyone. Then we dropped it to $10, and then we dropped it to $5.That cost a fair amount. I think it was probably $60 or $70 million. As the network got bigger and bigger, the value of the network itself exceeded any sort of carrot that we could offer.
The growth from the company was pretty crazy. I didn't expect PayPal's growth rate to be what it was. It actually grew super fast, it grew virally. At the end of the first 4 or 5 weeks of the website being active, we had 100,000 customers. Yeah, it was nutty. PayPal is really a perfect case example of viral marketing like Hotmail was. Where one customer would essential act as a sales person for you by bringing in other customers. They would send money to a friend and, essentially, recruit that friend into the network, so you had this exponential growth. The more customers you had the faster it grew. It was like bacteria in a Petri dish, it just goes like this S-curve. What you want to do is try to have one customer generate like two customers, or something like that, maybe three customers, ideally, and then you want that to happen really fast. You could probably model it just like bacteria growth in a Petri dish, and then it'll just expand very quickly until it hits the sides of the Petri dish and then it slows down.
That actually created major problems. It wasn't all good because we had some bugs in the software and, you know, even if the bug only occurs 1 in 1000 times, it's still 100 very angry customers like “where’s my money?” that would be a reasonable concern that people would have. We had customer service on University Avenue in Palo Alto where we started PayPal. There were five people, so when something went wrong, customer service phones would basically explode.
About a year after we opened the website we had about 1 million customers and we really didn't expect 1 million customers. It was something like expecting The Spanish Inquisition, it's not something you expect. It gives you a sense of how fast things grow in that scenario. We didn't have a sales force, we, actually, didn't have a VP of Sales, we didn't have a VP of Marketing, and we didn't spend any money on advertising.
PayPal was not the first to do email payments. There was a company that was acquired by Amazon, it was also an email payments company, I forget what it’s called. eBay had initially acquired Billpoint, and then there was eBay Payments. It was a really pretty tough long running battle of PayPal versus eBay's payment system. It was certainly very challenging. I think there were times when it felt like we were trying to win a land war in Asia and they kind of set the ground rules, or trying to beat Microsoft in their own operating system. It's really pretty hard. That took a lot of our effort to actually beat eBay on their own system.
NASDAQ kind of peaked in March 2000, and that was when we did the evaluation of PayPal for $500 million. We had many challenges and then the various financial regulatory agencies were trying to shut us down. Visa and Mastercard were trying to shut us down, eBay was trying to shut us down, FTC was trying to shut us down. There were a lot of battles there. It was a close call. We definitely came very close to dying there in 2000 and 2001. The challenge was really to keep the company alive till we sold the company 2 years later to eBay.
I ran PayPal for about the first two years of its existence. I think it's not a good idea to leave the office when there's a lot of major things under way which are causing people a great deal of stress. It was a combination of needing to raise money, and I had gotten married earlier that year and had not had a vacation or honeymoon or anything. I had this kind of financing trip/honeymoon, I went away for two weeks and there was a just lot of worry, and that caused the management team to decide I wasn't the right guy to run the company. I could have fought it really hard at the time, but I said rather than fight it at this critical time it’s best to sort of concede. I didn't agree with their conclusion, but I understood why they did what they did.
Since PayPal was not the first to do email payments, you have to say why did it succeed where others did not. How is it that PayPal was able to beat all of them, in particular how is it possible to beat Billpoint, when Billpoint was eBay's in-house service? very few people understand why. There's a couple of things, first of all if you look at the underlying economics of the system, we figured out a way to authenticate bank accounts. It's really hard from the standpoint of pulling money from somebody's bank account, because you can give us a bank account number, but how do we know it's you? The Federal Reserve has no authentication system that works for pulling money from people's accounts. We came up with an idea for authenticating it by making two small deposits in somebody’s bank account which effectively made it a four digit pin. Only the person that had the bank account could tell what the four digit pin was because of those two tiny deposits. We figured out how to authenticate a bank account without even seeing you. That was one of the fundamental breakthroughs, there were many, but that's a very big one.
Another big reason is when you send money from one person to another using a credit card, you have a very high fee associated with that, but if you send it using an electronic check it only costs a few cents. Plus the electronic check is very unlikely to be fraudulent, whereas with the credit card there is a huge amount of fraud associated with credit cards. With the credit card system your effective costs including fraud is probably about 3.5% of the transaction, and the effective cost of the electronic check is maybe a quarter of a percent.
We initially took PayPal public in February 2002. Which was quite a dark time for Internet companies. I think we were the only internet company to go public in the first part of that year. It went off reasonably well, although I think we had more SEC rewrites than any company I can imagine. I think we set a record on SEC rewrites. This was right around the Enron time, when there was all sorts of corporate scandals, so they put us through the wringer.
Shortly thereafter, about June, July, we struck a deal with eBay, to sell the company to eBay for about 1,5 billion dollars. One of the long-term risks certainly for the company was that eBay would one day prevail, and one way to retire that risk obviously was to sell to eBay.
We had several offers actually from a number of different entities for PayPal, and in fact the closer we got to IPO, the more offers we got. We always felt that those undervalued the company, and subsequently when we went public, I think the public markets kind of indicated the value of the company. That's one of the good things about public markets, it’s that they're an objective valuer of companies. When you're a private company it's very hard to say how much you're worth, because you have to basically think of some metric. Are you going to go for multiple of future earnings? Are you going to go off something of revenue? What are your comparables going to be? There are all sorts of questions. It's really up for debate what sort of value your company is. When you're public, it's what the market says you're worth, that's what you're worth. eBay made a number of offers prior to going public that were substantially below the value. Once we went post public that kind of cleared up the disagreement and then we sold to them. I actually was against the sale. I wasn't in favor of the sale. I was the largest owner of PayPal at the time, but I only had like 12%. Everybody else really wanted to sell so we went forward with that, but I think we probably should not have.
As far as common themes between Zip2 and PayPal. I guess, both of them involved software and internet related stuff as the heart of the technology. Certainly that's a huge commonality. They were both in Palo Alto, where I lived. I think we took a similar approach to building both companies, which was to have a small group of very talented people and keep it small. I think PayPal had, at it's height, probably 30 engineers for a system that, I would say, is more sophisticated than the Federal Reserve clearing system. I'm pretty sure it is actually, because the Federal Reserve clearing system sucks. What else is there? Generally, I think the way both Zip2 and PayPal operated was, it was really your canonical Silicon Valley start up. You know, pretty flat hierarchy, everybody had a roughly similar cube, and anyone could talk to anyone. We had a philosophy of ‘best idea wins’ as opposed to a person proposing the idea winning because they are who they are. Even though there are times when I thought that should have been the way. Obviously, everyone was an equity stake holder. If there were two paths that, let's say, we had to choose one thing or the other, and one wasn't obviously better than the other. Then rather then spend a lot of time trying to figure out which one was slightly better, we would just pick one and do it. Sometimes we'd be wrong, and we'd pick ourselves up from our path. Often it's better to pick a path and do it than to just vacillate endlessly on a choice. We didn't worry too much about intellectual property, paperwork or legal stuff. We were really very focused on building the best product that we possibly could. Both Zip2 and PayPal were very product-focused companies. We were incredibly obsessive about how do we build something that is really going to be the best possible customer experience. That was a far more effective selling tool than having a giant sales force or thinking of marketing gimmicks or twelve-step processes or whatever.
PayPal definitely hasn't moved much from since it was bought by eBay. The long-term vision that I had for PayPal in finance was to, it sounds a bit strange, convert the financial system from a series of heterogeneous insecure databases into one secure database. Well maybe not one database maybe there would be a few more. Money is just a number in a database, that's what it is. It’s primarily an information mechanism for labor allocation, and the current databases are not very efficient. There are these old legacy mainframes that don't talk to each other very well, have poor security, and only do their batch processing once a day. I think I would convert more into a full service financial institution, so you just want to do all the things. You want to have all the financial services that somebody needs in one place, seamlessly integrated together and easy to use, and I think really care about the consumer, I think a lot of banks don't seem to care that much about the customer. I think there is an opportunity to be like a really good bank, but much more than what people think of as a bank. I think payment systems are pretty easy, particularly if you don't have to integrate with a lot of legacy stuff, then payment systems are super easy. That's just like World of Warcraft, you know, credits, how many credits do you have in your database? You don't have exchange rates and have to, like, interface with bills and coins, and have credit cards, and have a Federal Reserve and all these things, they complicate things.What PayPal really did was de-complicate things, but PayPal would be, like, super-trivial in a new environment.
I think Bitcoin is probably a good thing. I think it's primarily going to be a means of doing illegal transactions. That is not necessarily entirely bad. You know somethings maybe shouldn't be illegal. It will be used for legal and illegal transactions otherwise it would have no value as a use for illegal transactions. Because you have to have a legal/illegal bridge. I don't own any Bitcoin by the way.
I think we had a really talented group of people at PayPal and a lot of those people have actually gone on to start many other companies - YouTube, Linked-In, Yelp, Yammer, it's quite a long list actually.
Anyway that's just an approximate evolution of the company. That's summarizing a crazy amount of stuff that happened over that period.
I did take a bit of time off after PayPal. I did reasonably well from PayPal. I was the largest shareholder in the company, and we were acquired for about a billion and a half in stock and then the stock doubled. Ultimately after taxes I had about $180 million, and I ended up investing all of that. I could've bought probably a chain of islands, but again that was obviously not of interest to me.