Between failure and Facebook

Recently, a friend was trying to recruit a programmer to join his early-stage startup. The programmer had just graduated from college and his impression of startups was shaped mostly by popular media. His main concern, he said, was: “What if we end up being the next MySpace instead of the next Facebook?”.

Of course, for those of us immersed in startup world, creating the next MySpace would be considered a huge success. MySpace was once the most visited website in the US and was acquired for $580M. It flamed out later under its corporate owner, but that happens to a lot of great startups.

Mainstream culture seems to depict startups as either being complete failures where everyone loses their shirts or else huge hits like Facebook. But the reality, as usual, lies in the middle: in 2010, according to Dow Jones, there were 522 venture-backed exits with a combined exit value of $53 billion – implying an average exit price of around $100M.

The best thing about startups is you get to work with great people on interesting projects, and can be successful by conventional metrics, even if no one outside of tech has ever heard of you or what you’ve built. There’s great stuff between failure and Facebook.

Who should learn to program?

Recently, there’s been a lot of talk in the tech world and beyond about getting more people to learn computer programming. I think this is a worthy goal*, but the question should be considered from various angles.

1. Jobs & the economy. Businesses all over the world need more programmers. Every company I know is hiring engineers (e.g. see this list of NY tech startups). Top programmers can make $100K+ right out of college. Yet there were only about 14,000 computer science (CS) majors last year. Meanwhile about 40,000 people got law degrees even though demand for lawyers has been shrinking. America is suffering from what economists call structural unemployment:  jobs are available but our labor force isn’t trained for those jobs.

2. Programming is a great foundation for a tech/startup career. CS is a great foundation to do other things in tech industry like starting a tech company (although I’d argue that design is an increasingly valuable foundation for web startups). I suspect one of the reasons for the low number of CS majors is people don’t realize all the non-programming opportunities that are opened up by a background in programming.

3. Programming is an important part of being “culturally literate.” Algorithmic thinking is as fundamental a type of thinking as mathematical thinking. For example, Daniel Dennett convincingly argues that the best way to understand Darwin’s theory of evolution is by thinking of it as an algorithm. (I haven’t read it yet but I’m told the premise of Stephen Wolfram’s A New Kind of Science is that algorithmic methods should be applied much more broadly across the sciences). Teaching algorithmic thinking – which is what CS does – should be a core part of a liberal arts education.

4. Programming is a great activity.  Most people who program describe themselves as entering a mental flow state where they are intensely immersed and time seems to fly by. It feels similar to reading a great book. You also feel great afterwards – it is the mental equivalent of going to the gym.

5. Should non-technical people at tech startups learn to code? This is where I disagree with some of the conventional wisdom. Certainly it is worthwhile learning programming, at least for reasons 3 & 4 above. You should realize, however, that to become a good programmer takes thousands of hours of practice. I’d also argue that if you are a non-technical person working at a web company the the first thing you should learn is internet architecture (DNS, http, html, web servers, database, TCP/UDP, IP, etc). Learning some programming is good too, to help relate to technical colleagues. But if your goal is to build a large-scale web service, your time as a non-technical person is better spent recruiting people who have been coding for years.

* Disclosure: I’m an investor via Founder Collective in two companies related to teaching programming:  Codecademy and Hacker School.

“Otherwise do something else”

I remember back when I started my first company, a friend said to me “get ready to have a knot in your stomach and feel nauseous for years.”  I laughed it off then, but it was probably the most accurate advice I’ve ever gotten.

I haven’t slept well for years. Even now with my last startup sold, I stay up at night thinking about how to change the website, make payroll, raise more money, etc.

In 1995, I was a graduate student studying philosophy at Columbia.  I was also doing computer programming on the side.  The programming was going well and I was getting some good job offers. I happened to get to have dinner with the philosopher Daniel Dennett, and I asked him what he thought I should do with my career.  He said: “If there is absolutely no way you can imagine being happy except studying philosophy, study philosophy. Otherwise do something else.”

I’d say the same thing about starting companies.

Do you want to sell sugar water or do you want to change the world?

“Do you want to sell sugar water for the rest of your life or come with me and change the world?” – Steve Jobs

I sometimes wish that instead of working on internet and software projects, I worked on cleantech or biotech projects. That way, when I came home at night, I’d know that I had literally spent my day trying to cure cancer or prevent global warming.  But information technology is what I know, and it’s probably too late for me to learn a new field from scratch.

That doesn’t mean information technology can’t improve people’s lives. Google’s search engine helps people find information, which, for example, makes cancer and cleantech researchers more productive. Skype allows companies to collaborate remotely, and connects people with friends and family around the world. In the area of information technology, we create infrastructure and hope that people use it for more good than bad.

That said, the best entrepreneurs seem to follow a path of increasing gravitas. Scott Heiferman started out selling online ads and is now creating new communities. Jack Dorsey created Twitter and is now democratizing payments so sole proprietors can compete on a level playing field with large companies. Elon Musk started with online payments and is now developing electric cars and space programs.

Founders of large companies sometimes also follow the path of increasing gravitas. Google is developing new energy technologies, self-driving cars and other world-changing technologies. Bill Gates devotes almost all of his time and money to charity.

The tech press is preoccupied with investments, trends, exits, and other “inside baseball” topics. But these are all means to an end. Investments provide fuel for entrepreneurs to convert ideas into products. Trends shape the terrain that entrepreneurs navigate. Exits provide financial incentives for investors and entrepreneurs.

Tim O’Reilly says that entrepreneurs should try to create more value than they capture. You can make money selling people obfuscated financial products, entertaining them with mind-numbing TV shows, or selling them sugar water decorated in elegant designs.

Alternatively, you can make something that matters and — if you are lucky and smart — change the world.

Options

The financial term “derivative“ refers to a security whose value is a function of another security such as a stock or bond.  The most common types of derivatives are futures – the obligation to buy a security at a future date at pre-agreed upon price – and options – the right to buy something at a future date at pre-agreed upon price.

In theory, the primary societal purpose of derivates is for businesses to hedge against “exogenous” risks.  For example. Southwest Airlines is famously prudent about buying futures on oil to mitigate the effect of fluctuating oil prices on their core business.

In practice, most derivatives are bought and sold by speculators. One of the first speculators was a philosopher names Thales, who Aristotle described in his book Politics (Book 1, Part XI):

There is the anecdote of Thales the Milesian and his financial device, which involves a principle of universal application, but is attributed to him on account of his reputation for wisdom. He was reproached for his poverty, which was supposed to show that philosophy was of no use. According to the story, he knew by his skill in the stars while it was yet winter that there would be a great harvest of olives in the coming year; so, having a little money, he gave deposits for the use of all the olive-presses in Chios and Miletus, which he hired at a low price because no one bid against him. When the harvest-time came, and many were wanted all at once and of a sudden, he let them out at any rate which he pleased, and made a quantity of money. Thus he showed the world that philosophers can easily be rich if they like, but that their ambition is of another sort.

Valuing options was a mystery until 1973 when the Black-Scholes model was invented. The main practical outcome of this model was the idea that the value of an option was determined mostly by the volatility of the underlying security.

One way to understand the important of volatility is to think of options as the opposite of insurance policies. Suppose you are selling insurance on houses in one region that is prone to catastropic events and another that isn’t. Rational insurers would price insurance policies higher in the catastrophe-prone areas.

Startups are inherently very volatile – their price can increase or decrease dramatically in short periods of time. Having an option on a startup is the economic opposite of selling insurance in a catastrophe-prone area.

The US tax system has some rules related to startup options.  The first rule is that there is a special class of options called ISO options that can be granted to employees. ISO options are tax exempt until the options are exercised, which allows employees to receive them and not be liable for taxes until they actually realize cash gains. This rule only applies if the options are assigned a strike price equal to or greater than the “fair market value” of the company’s common shares. The fair market value is normally assessed by an outside valuation firm (a so-called 409A valuation) and usually ends up being significantly lower than the last round VC valuation (a rule of thumb for early-stage companies is the strike price will be approximately 20% of the last VC valuation).

When you are granted options in a startup there are a couple of important things to keep in mind:

1) You should know your percentage ownership of the company’s “fully diluted” outstanding shares (number of shares of the company including the option pool).

2) You should understand that if you leave the company, you normally have 90 days to “exercise” the options (purchase the shares you have the right to buy) before you forfeit your options. Normally the company has no obligation to inform you of this possible forfeiture, and in fact the standard practice is to hope the employee forgets and loses the options.

3) You should know the “preferences” on the company.  The preferences normally equals the amount of money raised. If the company sells for near or less than that number the common shareholders, and hence the employees (who own options on common shares), will receive little or no money.

The strike price of the options is somewhat important but, if you study options theory, not nearly as important as the volatility of the underlying stock. Financially, what matters most is having a reasonable percentage of options in a company with lots of volatility (and hopefully a stock price that has an upward slope).