vcsqueeze

November 2005In the next few years, venture capital funds will find themselves
squeezed from four directions.  They're already stuck with a seller's
market, because of the huge amounts they raised at the end of the
Bubble and still haven't invested.  This by itself is not the end
of the world.  In fact, it's just a more extreme version of the
norm
in the VC business: too much money chasing too few deals.Unfortunately, those few deals now want less and less money, because
it's getting so cheap to start a startup.  The four causes: open
source, which makes software free; Moore's law, which makes hardware
geometrically closer to free; the Web, which makes promotion free
if you're good; and better languages, which make development a lot
cheaper.When we started our startup in 1995, the first three were our biggest
expenses.  We had to pay $5000 for the Netscape Commerce Server,
the only software that then supported secure http connections.  We
paid $3000 for a server with a 90 MHz processor and 32 meg of
memory.  And we paid a PR firm about $30,000 to promote our launch.Now you could get all three for nothing.  You can get the software
for free; people throw away computers more powerful than our first
server; and if you make something good you can generate ten times
as much traffic by word of mouth online than our first PR firm got
through the print media.And of course another big change for the average startup is that
programming languages have improved-- or rather, the median language has.  At most startups ten years
ago, software development meant ten programmers writing code in
C++.  Now the same work might be done by one or two using Python
or Ruby.During the Bubble, a lot of people predicted that startups would
outsource their development to India.  I think a better model for
the future is David Heinemeier Hansson, who outsourced his development
to a more powerful language instead.  A lot of well-known applications
are now, like BaseCamp, written by just one programmer.  And one
guy is more than 10x cheaper than ten, because (a) he won't waste
any time in meetings, and (b) since he's probably a founder, he can
pay himself nothing.Because starting a startup is so cheap, venture capitalists now
often want to give startups more money than the startups want to
take.  VCs like to invest several million at a time.  But as one
VC told me after a startup he funded would only take about half a
million, "I don't know what we're going to do.  Maybe we'll just
have to give some of it back." Meaning give some of the fund back
to the institutional investors who supplied it, because it wasn't
going to be possible to invest it all.Into this already bad situation comes the third problem: Sarbanes-Oxley.
Sarbanes-Oxley is a law, passed after the Bubble, that drastically
increases the regulatory burden on public companies. And in addition
to the cost of compliance, which is at least two million dollars a
year, the law introduces frightening legal exposure for corporate
officers.  An experienced CFO I know said flatly: "I would not
want to be CFO of a public company now."You might think that responsible corporate governance is an area
where you can't go too far.  But you can go too far in any law, and
this remark convinced me that Sarbanes-Oxley must have.  This CFO
is both the smartest and the most upstanding money guy I know.  If
Sarbanes-Oxley deters people like him from being CFOs of public
companies, that's proof enough that it's broken.Largely because of Sarbanes-Oxley, few startups go public now.  For
all practical purposes, succeeding now equals getting bought.  Which
means VCs are now in the business of finding promising little 2-3
man startups and pumping them up into companies that cost $100
million to acquire.   They didn't mean to be in this business; it's
just what their business has evolved into.Hence the fourth problem: the acquirers have begun to realize they
can buy wholesale.  Why should they wait for VCs to make the startups
they want more expensive?  Most of what the VCs add, acquirers don't
want anyway.  The acquirers already have brand recognition and HR
departments.  What they really want is the software and the developers,
and that's what the startup is in the early phase: concentrated
software and developers.Google, typically, seems to have been the first to figure this out.
"Bring us your startups early," said Google's speaker at the Startup School.  They're quite
explicit about it: they like to acquire startups at just the point
where they would do a Series A round.  (The Series A round is the
first round of real VC funding; it usually happens in the first
year.) It is a brilliant strategy, and one that other big technology
companies will no doubt try to duplicate.  Unless they want to have
still more of their lunch eaten by Google.Of course, Google has an advantage in buying startups: a lot of the
people there are rich, or expect to be when their options vest.
Ordinary employees find it very hard to recommend an acquisition;
it's just too annoying to see a bunch of twenty year olds get rich
when you're still working for salary.  Even if it's the right thing
for your company to do.The Solution(s)Bad as things look now, there is a way for VCs to save themselves.
They need to do two things, one of which won't surprise them, and
another that will seem an anathema.Let's start with the obvious one: lobby to get Sarbanes-Oxley
loosened.  This law was created to prevent future Enrons, not to
destroy the IPO market.  Since the IPO market was practically dead
when it passed, few saw what bad effects it would have.  But now
that technology has recovered from the last bust, we can see clearly
what a bottleneck Sarbanes-Oxley has become.Startups are fragile plants—seedlings, in fact.  These seedlings
are worth protecting, because they grow into the trees of the
economy.  Much of the economy's growth is their growth.  I think
most politicians realize that.  But they don't realize just how
fragile startups are, and how easily they can become collateral
damage of laws meant to fix some other problem.Still more dangerously, when you destroy startups, they make very
little noise.  If you step on the toes of the coal industry, you'll
hear about it.  But if you inadvertantly squash the startup industry,
all that happens is that the founders of the next Google stay in
grad school instead of starting a company.My second suggestion will seem shocking to VCs: let founders cash
out partially in the Series A round.  At the moment, when VCs invest
in a startup, all the stock they get is newly issued and all the
money goes to the company.  They could buy some stock directly from
the founders as well.Most VCs have an almost religious rule against doing this.  They
don't want founders to get a penny till the company is sold or goes
public.  VCs are obsessed with control, and they worry that they'll
have less leverage over the founders if the founders have any money.This is a dumb plan.  In fact, letting the founders sell a little stock
early would generally be better for the company, because it would
cause the founders' attitudes toward risk to be aligned with the
VCs'.  As things currently work, their attitudes toward risk tend
to be diametrically opposed: the founders, who have nothing, would
prefer a 100% chance of $1 million to a 20% chance of $10 million,
while the VCs can afford to be "rational" and prefer the latter.Whatever they say, the reason founders are selling their companies
early instead of doing Series A rounds is that they get paid up
front.  That first million is just worth so much more than the
subsequent ones.  If founders could sell a little stock early,
they'd be happy to take VC money and bet the rest on a bigger
outcome.So why not let the founders have that first million, or at least
half million?  The VCs would get same number of shares for the
money.  So what if some of the money would go to the
founders instead of the company?Some VCs will say this is
unthinkable—that they want all their money to be put to work
growing the company.  But the fact is, the huge size of current VC
investments is dictated by the structure
of VC funds, not the needs of startups.  Often as not these large
investments go to work destroying the company rather than growing
it.The angel investors who funded our startup let the founders sell
some stock directly to them, and it was a good deal for everyone.
The angels made a huge return on that investment, so they're happy.
And for us founders it blunted the terrifying all-or-nothingness
of a startup, which in its raw form is more a distraction than a
motivator.If VCs are frightened at the idea of letting founders partially
cash out, let me tell them something still more frightening: you
are now competing directly with Google.
Thanks to Trevor Blackwell, Sarah Harlin, Jessica
Livingston, and Robert Morris for reading drafts of this.


wisdom

February 2007A few days ago I finally figured out something I've wondered about
for 25 years: the relationship between wisdom and intelligence.
Anyone can see they're not the same by the number of people who are
smart, but not very wise.  And yet intelligence and wisdom do seem
related.  How?What is wisdom?  I'd say it's knowing what to do in a lot of
situations.  I'm not trying to make a deep point here about the
true nature of wisdom, just to figure out how we use the word.  A
wise person is someone who usually knows the right thing to do.And yet isn't being smart also knowing what to do in certain
situations?  For example, knowing what to do when the teacher tells
your elementary school class to add all the numbers from 1 to 100?
[1]Some say wisdom and intelligence apply to different types of
problems—wisdom to human problems and intelligence to abstract
ones.  But that isn't true.  Some wisdom has nothing to do with
people: for example, the wisdom of the engineer who knows certain
structures are less prone to failure than others.  And certainly
smart people can find clever solutions to human problems as well
as abstract ones.
[2]Another popular explanation is that wisdom comes from experience
while intelligence is innate.  But people are not simply wise in
proportion to how much experience they have.  Other things must
contribute to wisdom besides experience, and some may be innate: a
reflective disposition, for example.Neither of the conventional explanations of the difference between
wisdom and intelligence stands up to scrutiny.  So what is the
difference?  If we look at how people use the words "wise" and
"smart," what they seem to mean is different shapes of performance.Curve"Wise" and "smart" are both ways of saying someone knows what to
do.  The difference is that "wise" means one has a high average
outcome across all situations, and "smart" means one does spectacularly
well in a few.  That is, if you had a graph in which the x axis
represented situations and the y axis the outcome, the graph of the
wise person would be high overall, and the graph of the smart person
would have high peaks.The distinction is similar to the rule that one should judge talent
at its best and character at its worst.  Except you judge intelligence
at its best, and wisdom by its average.  That's how the two are
related: they're the two different senses in which the same curve
can be high.So a wise person knows what to do in most situations, while a smart
person knows what to do in situations where few others could.  We
need to add one more qualification: we should ignore cases where
someone knows what to do because they have inside information.
[3]
But aside from that, I don't think we can get much more specific
without starting to be mistaken.Nor do we need to.  Simple as it is, this explanation predicts, or
at least accords with, both of the conventional stories about the
distinction between wisdom and intelligence.  Human problems are
the most common type, so being good at solving those is key in
achieving a high average outcome.   And it seems natural that a
high average outcome depends mostly on experience, but that dramatic
peaks can only be achieved by people with certain rare, innate
qualities; nearly anyone can learn to be a good swimmer, but to be
an Olympic swimmer you need a certain body type.This explanation also suggests why wisdom is such an elusive concept:
there's no such thing.  "Wise" means something—that one is
on average good at making the right choice.  But giving the name
"wisdom" to the supposed quality that enables one to do that doesn't
mean such a thing exists.  To the extent "wisdom" means anything,
it refers to a grab-bag of qualities as various as self-discipline,
experience, and empathy.
[4]Likewise, though "intelligent" means something, we're asking for
trouble if we insist on looking for a single thing called "intelligence."
And whatever its components, they're not all innate.  We use the
word "intelligent" as an indication of ability: a smart person can
grasp things few others could.  It does seem likely there's some
inborn predisposition to intelligence (and wisdom too), but this
predisposition is not itself intelligence.One reason we tend to think of intelligence as inborn is that people
trying to measure it have concentrated on the aspects of it that
are most measurable.  A quality that's inborn will obviously be
more convenient to work with than one that's influenced by experience,
and thus might vary in the course of a study.  The problem comes
when we drag the word "intelligence" over onto what they're measuring.
If they're measuring something inborn, they can't be measuring
intelligence.  Three year olds aren't smart.   When we describe one
as smart, it's shorthand for "smarter than other three year olds."SplitPerhaps it's a technicality to point out that a predisposition to
intelligence is not the same as intelligence.  But it's an important
technicality, because it reminds us that we can become smarter,
just as we can become wiser.The alarming thing is that we may have to choose between the two.If wisdom and intelligence are the average and peaks of the same
curve, then they converge as the number of points on the curve
decreases.  If there's just one point, they're identical: the average
and maximum are the same.  But as the number of points increases,
wisdom and intelligence diverge.  And historically the number of
points on the curve seems to have been increasing: our ability is
tested in an ever wider range of situations.In the time of Confucius and Socrates, people seem to have regarded
wisdom, learning, and intelligence as more closely related than we
do.  Distinguishing between "wise" and "smart" is a modern habit.
[5]
And the reason we do is that they've been diverging.  As knowledge
gets more specialized, there are more points on the curve, and the
distinction between the spikes and the average becomes sharper,
like a digital image rendered with more pixels.One consequence is that some old recipes may have become obsolete.
At the very least we have to go back and figure out if they were
really recipes for wisdom or intelligence.  But the really striking
change, as intelligence and wisdom drift apart, is that we may have
to decide which we prefer.  We may not be able to optimize for both
simultaneously.Society seems to have voted for intelligence.  We no longer admire
the sage—not the way people did two thousand years ago.  Now
we admire the genius.  Because in fact the distinction we began
with has a rather brutal converse: just as you can be smart without
being very wise, you can be wise without being very smart.  That
doesn't sound especially admirable.  That gets you James Bond, who
knows what to do in a lot of situations, but has to rely on Q for
the ones involving math.Intelligence and wisdom are obviously not mutually exclusive.  In
fact, a high average may help support high peaks.  But there are
reasons to believe that at some point you have to choose between
them.  One is the example of very smart people, who are so often
unwise that in popular culture this now seems to be regarded as the
rule rather than the exception.  Perhaps the absent-minded professor
is wise in his way, or wiser than he seems, but he's not wise in
the way Confucius or Socrates wanted people to be.
[6]NewFor both Confucius and Socrates, wisdom, virtue, and happiness were
necessarily related.  The wise man was someone who knew what the
right choice was and always made it; to be the right choice, it had
to be morally right; he was therefore always happy, knowing he'd
done the best he could.  I can't think of many ancient philosophers
who would have disagreed with that, so far as it goes."The superior man is always happy; the small man sad," said Confucius.
[7]Whereas a few years ago I read an interview with a mathematician
who said that most nights he went to bed discontented, feeling he
hadn't made enough progress.
[8]
The Chinese and Greek words we
translate as "happy" didn't mean exactly what we do by it, but
there's enough overlap that this remark contradicts them.Is the mathematician a small man because he's discontented?  No;
he's just doing a kind of work that wasn't very common in Confucius's
day.Human knowledge seems to grow fractally.  Time after time, something
that seemed a small and uninteresting area—experimental error,
even—turns out, when examined up close, to have as much in
it as all knowledge up to that point.  Several of the fractal buds
that have exploded since ancient times involve inventing and
discovering new things.  Math, for example, used to be something a
handful of people did part-time.  Now it's the career of thousands.
And in work that involves making new things, some old rules don't
apply.Recently I've spent some time advising people, and there I find the
ancient rule still works: try to understand the situation as well
as you can, give the best advice you can based on your experience,
and then don't worry about it, knowing you did all you could.  But
I don't have anything like this serenity when I'm writing an essay.
Then I'm worried.  What if I run out of ideas?  And when I'm writing,
four nights out of five I go to bed discontented, feeling I didn't
get enough done.Advising people and writing are fundamentally different types of
work.  When people come to you with a problem and you have to figure
out the right thing to do, you don't (usually) have to invent
anything.  You just weigh the alternatives and try to judge which
is the prudent choice.  But prudence can't tell me what sentence
to write next.  The search space is too big.Someone like a judge or a military officer can in much of his work
be guided by duty, but duty is no guide in making things.  Makers
depend on something more precarious: inspiration.  And like most
people who lead a precarious existence, they tend to be worried,
not contented.  In that respect they're more like the small man of
Confucius's day, always one bad harvest (or ruler) away from
starvation. Except instead of being at the mercy of weather and
officials, they're at the mercy of their own imagination.LimitsTo me it was a relief just to realize it might be ok to be discontented.
The idea that a successful person should be happy has thousands of
years of momentum behind it.  If I was any good, why didn't I have
the easy confidence winners are supposed to have?  But that, I now
believe, is like a runner asking "If I'm such a good athlete, why
do I feel so tired?" Good runners still get tired; they just get
tired at higher speeds.People whose work is to invent or discover things are in the same
position as the runner.  There's no way for them to do the best
they can, because there's no limit to what they could do.  The
closest you can come is to compare yourself to other people.  But
the better you do, the less this matters.  An undergrad who gets
something published feels like a star.  But for someone at the top
of the field, what's the test of doing well?  Runners can at least
compare themselves to others doing exactly the same thing; if you
win an Olympic gold medal, you can be fairly content, even if you
think you could have run a bit faster.  But what is a novelist to
do?Whereas if you're doing the kind of work in which problems are
presented to you and you have to choose between several alternatives,
there's an upper bound on your performance: choosing the best every
time.  In ancient societies, nearly all work seems to have been of
this type.  The peasant had to decide whether a garment was worth
mending, and the king whether or not to invade his neighbor, but
neither was expected to invent anything.  In principle they could
have; the king could have invented firearms, then invaded his
neighbor.  But in practice innovations were so rare that they weren't
expected of you, any more than goalkeepers are expected to score
goals.
[9]
In practice, it seemed as if there was a correct decision
in every situation, and if you made it you'd done your job perfectly,
just as a goalkeeper who prevents the other team from scoring is
considered to have played a perfect game.In this world, wisdom seemed paramount.
[10]
Even now, most people
do work in which problems are put before them and they have to
choose the best alternative.  But as knowledge has grown more
specialized, there are more and more types of work in which people
have to make up new things, and in which performance is therefore
unbounded.  Intelligence has become increasingly important relative
to wisdom because there is more room for spikes.RecipesAnother sign we may have to choose between intelligence and wisdom
is how different their recipes are.  Wisdom seems to come largely
from curing childish qualities, and intelligence largely from
cultivating them.Recipes for wisdom, particularly ancient ones, tend to have a
remedial character.  To achieve wisdom one must cut away all the
debris that fills one's head on emergence from childhood, leaving
only the important stuff.  Both self-control and experience have
this effect: to eliminate the random biases that come from your own
nature and from the circumstances of your upbringing respectively.
That's not all wisdom is, but it's a large part of it.  Much of
what's in the sage's head is also in the head of every twelve year
old.  The difference is that in the head of the twelve year old
it's mixed together with a lot of random junk.The path to intelligence seems to be through working on hard problems.
You develop intelligence as you might develop muscles, through
exercise.  But there can't be too much compulsion here.  No amount
of discipline can replace genuine curiosity.  So cultivating
intelligence seems to be a matter of identifying some bias in one's
character—some tendency to be interested in certain types of
things—and nurturing it.  Instead of obliterating your
idiosyncrasies in an effort to make yourself a neutral vessel for
the truth, you select one and try to grow it from a seedling into
a tree.The wise are all much alike in their wisdom, but very smart people
tend to be smart in distinctive ways.Most of our educational traditions aim at wisdom. So perhaps one
reason schools work badly is that they're trying to make intelligence
using recipes for wisdom.  Most recipes for wisdom have an element
of subjection.  At the very least, you're supposed to do what the
teacher says.  The more extreme recipes aim to break down your
individuality the way basic training does.  But that's not the route
to intelligence.  Whereas wisdom comes through humility, it may
actually help, in cultivating intelligence, to have a mistakenly
high opinion of your abilities, because that encourages you to keep
working.  Ideally till you realize how mistaken you were.(The reason it's hard to learn new skills late in life is not just
that one's brain is less malleable.  Another probably even worse
obstacle is that one has higher standards.)I realize we're on dangerous ground here.  I'm not proposing the
primary goal of education should be to increase students' "self-esteem."
That just breeds laziness.  And in any case, it doesn't really fool
the kids, not the smart ones.  They can tell at a young age that a
contest where everyone wins is a fraud.A teacher has to walk a narrow path: you want to encourage kids to
come up with things on their own, but you can't simply applaud
everything they produce.  You have to be a good audience: appreciative,
but not too easily impressed.  And that's a lot of work.  You have
to have a good enough grasp of kids' capacities at different ages
to know when to be surprised.That's the opposite of traditional recipes for education.  Traditionally
the student is the audience, not the teacher; the student's job is
not to invent, but to absorb some prescribed body of material.  (The
use of the term "recitation" for sections in some colleges is a
fossil of this.) The problem with these old traditions is that
they're too much influenced by recipes for wisdom.DifferentI deliberately gave this essay a provocative title; of course it's
worth being wise.  But I think it's important to understand the
relationship between intelligence and wisdom, and particularly what
seems to be the growing gap between them.  That way we can avoid
applying rules and standards to intelligence that are really meant
for wisdom.  These two senses of "knowing what to do" are more
different than most people realize.  The path to wisdom is through
discipline, and the path to intelligence through carefully selected
self-indulgence.  Wisdom is universal, and intelligence idiosyncratic.
And while wisdom yields calmness, intelligence much of the time
leads to discontentment.That's particularly worth remembering.  A physicist friend recently
told me half his department was on Prozac.  Perhaps if we acknowledge
that some amount of frustration is inevitable in certain kinds
of work, we can mitigate its effects.  Perhaps we can box it up and
put it away some of the time, instead of letting it flow together
with everyday sadness to produce what seems an alarmingly large
pool.  At the very least, we can avoid being discontented about
being discontented.If you feel exhausted, it's not necessarily because there's something
wrong with you.  Maybe you're just running fast.Notes[1]
Gauss was supposedly asked this when he was 10.  Instead of
laboriously adding together the numbers like the other students,
he saw that they consisted of 50 pairs that each summed to 101 (100
+ 1, 99 + 2, etc), and that he could just multiply 101 by 50 to get
the answer, 5050.[2]
A variant is that intelligence is the ability to solve problems,
and wisdom the judgement to know how to use those solutions.   But
while this is certainly an important relationship between wisdom
and intelligence, it's not the distinction between them.  Wisdom
is useful in solving problems too, and intelligence can help in
deciding what to do with the solutions.[3]
In judging both intelligence and wisdom we have to factor out
some knowledge. People who know the combination of a safe will be
better at opening it than people who don't, but no one would say
that was a test of intelligence or wisdom.But knowledge overlaps with wisdom and probably also intelligence.
A knowledge of human nature is certainly part of wisdom.  So where
do we draw the line?Perhaps the solution is to discount knowledge that at some point
has a sharp drop in utility.  For example, understanding French
will help you in a large number of situations, but its value drops
sharply as soon as no one else involved knows French.  Whereas the
value of understanding vanity would decline more gradually.The knowledge whose utility drops sharply is the kind that has
little relation to other knowledge.  This includes mere conventions,
like languages and safe combinations, and also what we'd call
"random" facts, like movie stars' birthdays, or how to distinguish
1956 from 1957 Studebakers.[4]
People seeking some single thing called "wisdom" have been
fooled by grammar.  Wisdom is just knowing the right thing to do,
and there are a hundred and one different qualities that help in
that.  Some, like selflessness, might come from meditating in an
empty room, and others, like a knowledge of human nature, might
come from going to drunken parties.Perhaps realizing this will help dispel the cloud of semi-sacred
mystery that surrounds wisdom in so many people's eyes.  The mystery
comes mostly from looking for something that doesn't exist.  And
the reason there have historically been so many different schools
of thought about how to achieve wisdom is that they've focused on
different components of it.When I use the word "wisdom" in this essay, I mean no more than
whatever collection of qualities helps people make the right choice
in a wide variety of situations.[5]
Even in English, our sense of the word "intelligence" is
surprisingly recent.  Predecessors like "understanding" seem to
have had a broader meaning.[6]
There is of course some uncertainty about how closely the remarks
attributed to Confucius and Socrates resemble their actual opinions.
I'm using these names as we use the name "Homer," to mean the
hypothetical people who said the things attributed to them.[7]
Analects VII:36, Fung trans.Some translators use "calm" instead of "happy."  One source of
difficulty here is that present-day English speakers have a different
idea of happiness from many older societies.  Every language probably
has a word meaning "how one feels when things are going well," but
different cultures react differently when things go well.  We react
like children, with smiles and laughter.  But in a more reserved
society, or in one where life was tougher, the reaction might be a
quiet contentment.[8]
It may have been Andrew Wiles, but I'm not sure.  If anyone
remembers such an interview, I'd appreciate hearing from you.[9]
Confucius claimed proudly that he had never invented
anything—that he had simply passed on an accurate account of
ancient traditions.  [Analects VII:1] It's hard for us now to
appreciate how important a duty it must have been in preliterate
societies to remember and pass on the group's accumulated knowledge.
Even in Confucius's time it still seems to have been the first duty
of the scholar.[10]
The bias toward wisdom in ancient philosophy may be exaggerated
by the fact that, in both Greece and China, many of the first
philosophers (including Confucius and Plato) saw themselves as
teachers of administrators, and so thought disproportionately about
such matters.  The few people who did invent things, like storytellers,
must have seemed an outlying data point that could be ignored.Thanks to Trevor Blackwell, Sarah Harlin, Jessica Livingston,
and Robert Morris for reading drafts of this.