JESSICA LIVINGSTON COFOUNDED THE world’s largest and most successful startup accelerator, Y Combinator in March 2005. She is a partner of this startup accelerator and a driving force in its operation. Her cofounder and husband Paul Graham has said, “Everything we did as an organization went through her first—who to fund, what to say to the public, how to deal with other companies, who to hire, everything.” Livingston has written a book entitled Founders at Work, based on interviews with startup founders. Jessica has said, “Writing that book inspired me to help early-stage startups — and ultimately to want to start Y Combinator. Prior to cofounding Y Combinator, Livingston was vice-president of marketing at Adams Harkness Financial Group.
1. “I definitely think of Y Combinator as a startup in many ways. There are origin stories very similar to the way a startup would get started. We were kind of thinking about a problem, and thinking we could do some cool things to solve it.”
We started talking about the brokenness of the funding world in 2004 … and it was.
There are many ways that the venture capital business has evolved and innovated, and it will continue to do so. Livingston is saying that Y Combinator’s evolution is an example of what a startup must go through to be successful. At the core of sustainable success for a business is always a real solution to a real customer problem. Livingston and her other Y Combinator cofounders found (1) core product value; (2) a way to successfully deliver it to customers; and (3) a significant barrier to entry against competitors from network effects and cumulative advantage. Firms like Andreessen Horowitz, Baseline Ventures, Benchmark, and Sequoia have similarities in terms of how they operate in the venture capital business, but they also vary in significant ways.
2. “Originally we were targeting programmers and wanted to teach them the business side of running a startup.”
What Livingston describes is a noble calling. Huge value is locked up and lost to society when engineers with great ideas cannot bring them successfully to market. I have spent most of my professional life working with engineers who are sometimes challenged when it comes to business. I have seen the full spectrum: from engineers who know next to nothing and have no desire to learn to those who are business savants.
The best business mind I have ever seen up close is that of Bill Gates, who incidentally furnishes a good example of Livingston’s goal of cultivating engineers for business. Gates ran the business side of the house at Microsoft from the time the business was first established in Albuquerque. He was the CFO and the CEO for many years. Contracts with customers were his responsibility. Gates was able to make intelligent decisions because he grew up with a lawyer as a dad and a mom who served on many business and nonprofit boards and had excellent business sense. That someone with programming skills like Bill Gates also knew a lot about the law, business, and contracts was incredibly fortunate. He learned these things at the dinner table with his family; because of the many conversations that occurred there and elsewhere, Bill Gates understood the difference between a license and an outright sale in the early IBM negotiations that changed business history. Gates also sufficiently understood business, economics, and science such that he was able to recognize the value of positive feedback and the likely rise of a new industry based on software, resulting in a young man with the right mix of skills and knowledge taking IBM to the cleaners when it was in its prime. The mix of business, legal, and technical acumen characteristic of Gates is what engineers learn at a place like Y Combinator.
3. “What we wanted to do was create a standardized branded form of funding. Y Combinator wanted to be the ‘first gear’ for startups.”
We’re not expecting the money we invest to be the last a startup ever raises. It’s just to get them going. And we want to get as many startups going as we can.
Livingston is describing decisions that illustrate the power of focus in creating a valuable business. The founders of Y Combinator decided to focus on the unique problems that early-stage startups face. Because of this focus and specialization, other later-stage venture capital firms view Y Combinator as a partner, which creates a self-reinforcing positive feedback loop.
4. “Our motto is to make something that people want. If you create something and no one uses it, you’re dead. Nothing else you do is going to matter if people don’t like your product.”
What guided the founders through this process was their empathy for the users. They never lost sight of making things that people would want.
The point Livingston is making here is obvious and yet so often forgotten. If the customer is not having an “aha” moment in relation to the positive core value of a product, the business will not be successful. Creating such value in new ways with a barrier to entry is a rare thing. This idea also applies to Y Combinator itself.
5. “At the time we were realizing, ‘Hey, it’s a lot cheaper to start a software company. I mean, all you need is a computer and to pay some of your server costs.’ So we thought, ‘Why don’t VCs write smaller checks?’ And finally we said, ‘Let’s do something. Let’s create an investment company that does standardized branded funding. We’ll have an application process, and this will be a new thing.’ But we always had thought that we’d do asynchronous investing just like every other investor. But then we said, ‘Neither of us knows anything about angel investing. Let’s learn quickly by funding a bunch of startups at once.’ ”
Creating a system that runs startups through a synchronous process to create a valuable business is efficient and logical. This reminds me of the many years I spent in school, especially in college and graduate school. There is no question that I learned more from my classmates than I did from my professors. In my involvement with accelerators, I see just this same thing going on, with founders teaching each other in addition to learning from the program itself. Micro VCs are proliferating to a point where there are now more than 350 in the United States alone. This means that more people are getting funded and that these people are more diverse in every sense. Founders today are able to maintain greater ownership stakes in their businesses. Founders who must sell 60 percent of their business at seed stage do not have the same incentive to persevere in tough times.
6. “Even Y Combinator got rejected at first. Nowadays there are a lot of groups that do the kind of investing we do, but when we started, no one was. Even our own lawyers tried to talk us out of it.”
It’s really important for people to remember how often startup founders, who are hugely successful now, get rejected early on. They will hear, “This is a dumb idea. You shouldn’t be working on that. No investor will invest in them.” I mean, there are countless examples of people trying to raise funding, and they just got turned down by investors because they thought it was a bad idea or didn’t think the person was formidable enough. That’s important because it’s hard to start a startup. If you’re a first-time founder, you’re going to get rejected a lot in a lot of different ways, and it’s really hard.
Livingston is arguing that the nonconsensus, contrarian view is powerful and significant. Howard Marks has also argued that to earn more than the market return, you must adopt a nonconsensus view and that view must be correct in a significant way. This is all provable with mathematics. If your idea is not a little crazier than other people’s, there are very likely to be competitors already working on the idea.
7. “Perseverance is important because in a startup nothing goes according to plan. Founders live day to day with a sense of uncertainty, isolation, and sometimes lack of progress. Plus startups, by their nature, are doing new things, and when you do new things, people often reject you.”
In general, your best weapon is determination. Even though we usually use one word for it, it’s actually two: resilience and drive. One reason you need resilience is that you’ll get rejected a lot. Everyone you encounter will have doubts about what you’re doing.
Missionaries are far more likely to successfully survive the process of creating a business than mercenaries. Steve Jobs said in 1995, “I’m convinced that about half of what separates successful entrepreneurs from the unsuccessful ones is pure perseverance.” Bill Gates has similarly said, “Perseverance has been characteristic of our great success.” There is an inherent tension between the need to sing for the fences and the reality that so few startups will be a grand slam. This tension means that being a founder is not a fully rational act. The sort of people who step up and swing early for the fence tend to be maniacally driven people who are on a mission. They are less tentative and less likely to sell the business early in the process. Missionaries are builders rather than sellers.
8. “The media often glamorizes successful founders and makes their paths seem easier than they actually were.”
Just be determined, and have a little luck.
There is way more luck involved in life than people imagine. You will sometimes hear people say that they worked hard to get lucky. The reality is that there is no way to increase your luck because anything you do to improve the probability of a positive outcome is skill.
9. “Starting a startup is a process of trial and error. A lot of the startups in my book Founders at Work, and I see this again in Y Combinator startups, they start out saying, ‘We’re going to do this.’ They try to do it, and it doesn’t really stick, and so they think, ‘Oh, gosh. The users are actually more interested in this aspect of our site,’ and they work on that. So there’s a lot of trial and error, and it gets glamorized, I think, in the press with these successful startups. They say, ‘Oh, he had this brilliant idea. We knew this was going to be big, and it was great.’ That’s not the way it usually is. It’s usually a lot of testing one thing out, it not working, and then happening upon the right thing.”
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 idea as they developed it.
Mistakes are essential in venture capital since they are how information is acquired, and they enable benefits to be captured. Capitalism without mistakes and failure does not work since it is an evolutionary system. Similarly, creating a successful startup or running any business is impossible without mistakes since both startups and established businesses are evolutionary systems interacting with other evolutionary systems. As in nature, the startups that survive are the ones that are best able to find a successful place for themselves in the ecosystem and adapt as conditions change. The best way to discover that place is by testing value and growth hypotheses using the scientific method. Part of what Y Combinator has done so successfully is systematize this discovery process in a way that scales well. By running these experiments simultaneously for a class of startups and making coaching and other resources available, the success rate of the startups increases, particularly for founders who have never been through the process before.
10. “Innovations seem inevitable in retrospect, but at the time it’s an uphill battle.”
Michael Mauboussin points out, “Increasingly, professionals are forced to confront decisions related to complex systems, which are by their very nature nonlinear. Complex adaptive systems effectively obscure cause and effect. You can’t make predictions in any but the broadest and vaguest terms.” After the fact, people tend to think they knew what was going to happen all along, but that is often an illusion. Wikipedia describes hindsight bias well: “Sometimes called the ‘I-knew-it-all-along’ effect, hindsight bias is the tendency to see past events as being predictable at the time those events happened.” Most people say to themselves at one time or another as they go through life encountering new products, “Hey, I thought of that idea a long time ago.” Okay, but what did you do actually about it then?
11. “People like the idea of innovation in the abstract, but when you present them with any specific innovation, they tend to reject it because it doesn’t fit with what they already know.”
Livingston is describing how powerful the “person-with-a-hammer-syndrome” can be (to the person with a hammer everything looks like a nail). The most interesting example of this I have ever seen comes from how AT&T saw mobile in the early days of mobile phones. The mobile phone was definitely an innovation, but no one at AT&T really knew how big it would be. So the company hired consultants to find an answer. McKinsey in its famously botched study vastly underestimated demand for mobile-phone service by assuming that no one would use mobile phones when they had access to a land line. Mobile phones did not fit with what McKinsey and AT&T already knew. Even when AT&T bought McCaw Cellular in 1995, it thought it was doing so to save the long-distance business. I remember Craig McCaw laughing out loud at this and lamenting that he had to sell AT&T the entire business since you cannot partner with a firm that does not understand core product value or even its own industry. AT&T had the cash from its legacy business to pay off the debt used to build the industry, so it was decided that the deal needed to be done. AT&T bought McCaw Cellular for the wrong reasons, but it was the right decision anyway. It is sometimes better to be lucky than good.
12. “Investors, most of them, have a herd mentality. They want to invest only if other people are investing. It’s like a catch-22, like not being able to get a job because you don’t have enough experience.”
The best and most experienced founders and the best venture capitalists know how to profit from this aspect of human nature by being contrarians. They know that most people like to do what other people are doing since, when facing uncertainty, it is efficient from an informational standpoint. The opportunity for a venture capitalist is to find assets or opportunities that are mispriced owing to the herding instinct. In his book Extraordinary Popular Delusions and the Madness of Crowds, Charles Mackay wrote, “People think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.”