1. “The top investment is worth the total amount of all the other projects and more. You’re looking for the one high water mark, not the average. People don’t come to you looking for singles.” Venture capitalists focus on hitting tape measure home runs because that is what overwhelmingly drives investor return. A portfolio of 30-40 bets on startups per fund, with massive potential upside and small downside, will have its financial return driven by 1-3 huge winners and a distribution of overall financial returns that is a power law. Andy Rachleff has a great post on venture capital economics in which he notes: “the industry rule of thumb has been to look for deals that have the chance to return 10x your money in five years. … If 20% of a fund is invested in deals that return 10x in five years and everything else results in no value then the fund would have an annual return of approximately 15%.”
One negative outcome of all the attention given to the financial success of a few massive start up successes is that there are many businesses one can start which do not require venture capital, which many people believe are not fundable or worth pursuing. These non-venture capital-backed businesses can generate attractive financial returns and can, if selected correctly, have a substantially lower probability of failure. This should not surprise anyone, since you simply can’t have the failure rate of venture capital-backed businesses and have the winners return two to five-times invested capital over a similar period. Too many people believe that all startups should raise venture capital and that is a shame, since it is likely that fewer new businesses are created than is optimal for the economy as a result. Bill Gurley has said on this point: “If you want to get to 50 to 100 employees ‘unless you’ve discovered the next Google AdWords,’ you’re going to need outside funding, but that doesn’t mean VC investment is the path for everyone.” Marc Andreessen has pointed out that there are about 200 “fundable” startups per year by top tier venture firms. A healthy economy must generate far more than 200 new business in a given year to grow and create new employment opportunities.
2. “At a start-up, or early-stage project, the only really massive early-stage projects are where you’re contrarian and right. The projects where everyone agrees often end up having less overall success than the projects where there was some disagreement amongst the board. Where’s the contrarian thinking that, if they turn out to be right, could be really, really big? Consensus indicates it’s probably not a total break-out project. If your thinking isn’t truly contrarian, there’s a dog pile of competitors thinking the same thing, and that will limit your total success.” This series of blog posts has featured a veritable parade of successful investors of all kinds who believe that being contrarian is essential to outperforming a market. It should surprise no one that these successful investors feel this way, since it is mathematically provable that you can’t beat the crowd if you are the crowd.
3. “A great founding strategy is contrarian and right. That ensures that, at least for an important initial time, no one is coming after you. Eventually people will come after you, if you’re onto something good.” “It’s so important for early stage companies to avoid competition because you can’t isolate it to one front. Competition affects you on the customer front, hiring front, and financing and business development fronts—on all of them. When you’re 1 of n, your job becomes much harder, and it’s hard enough already. Difficult competition with no edge makes for a war of attrition. People may get sucked in to ruthlessly competitive situations by the allure of the pot of gold to be had. It’s like rushing the Cornucopia in the Hunger Games instead of running away into the forest.” Having a barrier to entry against competitors (a moat) is essential. What Reid is saying here is that the creation of the moat can be greatly enabled if the startup is able to avoid competition during its formative period. In other words, it is helpful to have a business operating in a portion of the market that is not “dog-eat-dog” competition from the beginning. In this sense, being a contrarian as an investor has a double benefit: it is where greater market-beating returns can be found and it allows the business to grow in a less competitive environment.
4. “People also underestimate how much of an edge you need. It really should be a compounding competitive edge. If your technology is a little better or you execute a little better, you’re screwed. Marginal improvements are rarely decisive.” “The question comes down to…not to think of it just as a question of ‘Oh, I have a better product, and with a better product, my thing will work, as opposed to other things.’ Because unless your product is like 100x better, usually your average consumer…they use what they encounter. If other[s] are much more successful at distribution and they have much better viral spread, they have better index and SEO…it doesn’t matter if your product is 10x better, the folks don’t encounter it.” Going up against an entrenched competitor with loads of cash, experience and sales/marketing/distribution channels is hard enough that you need a significant edge to win. For example, convincing a customer to move to a new product or service is hard if the offering of a new business is only slightly better.
5. “You want to start building a company 1-4 years, maybe 5 years, in advance. So that when the technology converges with the change in the world you see coming, you’re positioned to capitalize. You have to be right about a set of things, including what your competitors are going to do.” The great hockey player Wayne Gretzky is famous for saying “I skate to where the puck is going to be, not where it has been.” This sort of thinking is all about (1) optionality and (2) arbitrage of people’s lack of understanding of exponential phenomenon. Key to finding significant opportunities is realizing that exponential phenomenon are not common. Bill Gates put it this way once: “When things are improving so rapidly, how do you create a model in your head? Computers are doubling in power, relative to the price, about every 18 months. Most humans don’t have a situation where something doubles in its power every two years.”
6. “Silicon Valley….should now be called Software Valley.” This is a version of Marc Andreessen’s “software is eating the world” thesis. Software delivered over networks is driving financial returns in the venture capital business because hardware is relatively ubiquitous, can be purchased on demand and in many cases is already in place – most notably in the form of smartphones. Advances in silicon drive the exponential phenomenon, but the companies that surf this wave are largely software driven. Yes, there are important and successful hardware startups, and yes, 3-D printers and GoPro and such, but in most cases if you look deeply at a company that has achieved at least the 10X financial return hurdle that a venture capitalist like Reid Hoffman desires, it is inevitably the software or software enabled cloud-based services that are driving the innovation and new customer value. There are also inevitably a lot of very important software engineers at what some people would call a hardware business.
7. “Having a great product is important but having great product distribution is more important. I meet a lot of entrepreneurs who think the best product is the most important thing and that the best product should always win. What a lot of people fail to realize is that without great distribution, the product dies. How will you get your product in the hands of millions or hundreds of millions of people?” I’ve written on the importance of sales, marketing and distribution previously. Great product distribution is not optional. Customers do not magically appear at a company’s doorway holding stacks of hundred dollar bills ready to buy what a business sells.
8. “In tech, if you’re not continually thinking about catching the next curve, one of the next curves will get you. Yahoo owned the front end of the Internet in 2000. It had the perfect strategy. But it did not adapt; it failed at social and other trends; that didn’t go so perfectly. Just over a decade later, having missed some very key tech curves, it’s in a very different position.” This is Reid Hoffman’s version of Andy Grove’s “only the paranoid survive” thesis. Because important phenomenon emerge with essentially no warning from complex adaptive systems, you can find yourself in deep trouble for a mistake you made several years before. Looking back at the cause of what is killing a business now may seem obvious, but that is the nature of complex adaptive systems. What is understandable retroactively is not predictable prospectively. “Missing a curve” can send a business flying over a precipice.
9. “If you are not embarrassed by the first version of your product, you’ve launched too late.” “Product and market fit requires you to figure out the earliest tells. How do you bring in as much networked intelligence into that process as possible? In Silicon Valley, you bring in early advisors, employees, customers. What you’re trying to figure out is, is the path I’m trying to build the company around accurate? Most people begin with the financing process as a series of hoops to get a certain amount of money in the bank. But the most interesting thing of the financing process is getting network intelligence on the critical question of, “Is this a good plan?” What is the piece of common intelligence about my project? What are the risks in their investment?” “When you have an idea for a startup consult your network. Ask people what they think. Don’t look for flattery. If most people get it right away and call you a genius, you’re probably screwed; it likely means your idea is obvious and won’t work. What you’re looking for is a genuinely thoughtful response.” An idea that is not exposed to feedback from a strong and diverse network of very smart people is not going to get better and attract the sort of people needed to translate that idea into success. Your competitors will be doing this if you don’t. The winners in today’s economy are the businesses that adapt best to change and you can’t adapt without great sources of feedback.
10. “So many entrepreneurs are worried about protecting their precious ideas, but the truly valuable thing is that you’re in motion, you have momentum, you’re gathering all the necessary resources to actually make it happen.” “We’re moving from an information age to a network age. Part of that is, how do you increase the possibility of positive outcome from serendipity? There’s still luck, but you can increase the probability of the right decisions made. When you have a problem connecting challenges and solutions, that generally involves connections in a human network.” An idea without execution is not going to get anyone very far in business. Everyone has ideas for businesses and may think “I thought of that first” when they see a success. Winning in the market requires doing things, not just generating new ideas.
11. “Entrepreneurs are often given two pieces of contradictory advice: persistence and flexibility. Have a vision and pursue it through years of people telling you you’re out of your mind. Or, be flexible: look at data, iterate, and change based on the signals you’re getting. There isn’t an actual algorithm. You have an investment thesis about why this project is likely to work and have some outside result, and usually that’s expressed in a set of statements and hypotheses, that if you’re right about, adds up like a logical proof and gives you the output you’re looking for. And you can have varying level of confidence in how these pieces are adding up and supporting your theses.” “The challenge is to follow them both, but know which advice is most appropriate for which situation. You must know how to maintain flexible persistence.” There is no substitute for good judgment on questions that involve issues like what Reid calls flexible persistence. And the source of most good judgment is having made bad judgments. Some people learn better from mistakes than others and make mostly new mistakes rather than repeating old ones. If you learn from those people and from your own mistakes and you will have a better life. Being a learning machine pays big dividends.
12. “It’s not that everyone should start a company, it’s the fact that a career ladder is no longer a strong model for how you do your work and pursue your career. The Good grades -> Good university -> Good career path model has been broken for years, by globalization and technology’s disruption of industry. The model for how to think about your life, career, and work is different. How entrepreneurs think about product market fit, product differentiation, creative risks, all apply to how you, as an individual, live your life.” “The network of people around you is what extends your ability to be effective in terms of expertise and reaching your goals. …really put yourself out there and get the feedback. … don’t be afraid to take a risk.”
“The notion of a career has changed. Whereas we used to have a career ladder, now we have a career jungle gym. Success in a career is no longer a simple ascension on a path of steps. You need to climb sideways and sometimes down; sometimes you need to swing and jump from one set of bars to the next. And, to extend the metaphor, sometimes you need to spring from the jungle gym and establish your own turf somewhere else on the playground. And, if we really want the playground metaphor to accurately describe the modern world, neither the playground or the jungle gym are fixed. They are constantly changing—new structures emerge, old structures are in constant change and sometimes collapse, and the playground constantly moves the structure around.”
“Another huge thing to emphasize is the importance of your network. Get to know smart people. Talk to them. Stay current on what’s happening. People see things that other people don’t. If you try to analyze it all yourself, you miss things. Talk with people about what’s going on. Theoretically, startups should be distributed evenly throughout all countries and all states. They’re not. Silicon Valley is the heart of it all. Why? The network. People are talking to teach other.” As stated above for companies and people, networks of all kinds are of increasing importance. The types of networks which are valuable are very different that the networks people had in mind when they repeated the old adage “it’s not what you know, but who you know that matters.” These old school networks were about webs of what one might call “influence.” By contrast, the intent with networks today should instead be to generate the information and feedback needed to be agile and better informed. As an example: Why do a tiny number of VCs generate 95% the financial return in the venture capital industry? Simply put, they have the best networks defined in the broadest possible sense and the quality of their networks is feeding back on itself to generate even more quality. This is the Matthew Effect at work: better networks get even better as success feeds back on itself.
Notes on Reid Hoffman:
Blake Masters – Peter Thiel’s Startup Class
WSJ – Venture Capitalist Reid Hoffman
Wired – Reid Hoffman, Network Philosopher
Kissmetrics – Hoffman’s Advice for Entrepreneurs
Financial Times – Reid Hoffman, Mr. LinkedIn
AllThingsD – LinkedIn’s Reid Hoffman’s Five Tips for Startups
BigThink – Interview with Hoffman
FastCompany – How LinkedIn’s Reid Hoffman jumped off a cliff and built an airplane
Babson – Reid Hoffman Commencement Speech
Forbes – Reid Hoffman and Peter Thiel in conversation; the biggest misses