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April 2008  
  
Umair Haque wrote recently that the reason there aren't more Googles is that
most startups get bought before they can change the world.

> Google, despite serious interest from Microsoft and Yahoo—what must have
> seemed like lucrative interest at the time—didn't sell out. Google might
> simply have been nothing but Yahoo's or MSN's search box.  
>  
> Why isn't it? Because Google had a deeply felt sense of purpose: a
> conviction to change the world for the better.

This has a nice sound to it, but it isn't true. Google's founders were willing
to sell early on. They just wanted more than acquirers were willing to pay.  
  
It was the same with Facebook. They would have sold, but Yahoo blew it by
offering too little.  
  
Tip for acquirers: when a startup turns you down, consider raising your offer,
because there's a good chance the outrageous price they want will later seem a
bargain.   
  
From the evidence I've seen so far, startups that turn down acquisition offers
usually end up doing better. Not always, but usually there's a bigger offer
coming, or perhaps even an IPO.  
  
Of course, the reason startups do better when they turn down acquisition
offers is not necessarily that all such offers undervalue startups. More
likely the reason is that the kind of founders who have the balls to turn down
a big offer also tend to be very successful. That spirit is exactly what you
want in a startup.  
  
While I'm sure Larry and Sergey do want to change the world, at least now, the
reason Google survived to become a big, independent company is the same reason
Facebook has so far remained independent: acquirers underestimated them.  
  
Corporate M&A is a strange business in that respect. They consistently lose
the best deals, because turning down reasonable offers is the most reliable
test you could invent for whether a startup will make it big.  
  
**VCs**  
  
So what's the real reason there aren't more Googles? Curiously enough, it's
the same reason Google and Facebook have remained independent: money guys
undervalue the most innovative startups.  
  
The reason there aren't more Googles is not that investors encourage
innovative startups to sell out, but that they won't even fund them. I've
learned a lot about VCs during the 3 years we've been doing Y Combinator,
because we often have to work quite closely with them. The most surprising
thing I've learned is how conservative they are. VC firms present an image of
boldly encouraging innovation. Only a handful actually do, and even they are
more conservative in reality than you'd guess from reading their sites.  
  
I used to think of VCs as piratical: bold but unscrupulous. On closer
acquaintance they turn out to be more like bureaucrats. They're more
upstanding than I used to think (the good ones, at least), but less bold.
Maybe the VC industry has changed. Maybe they used to be bolder. But I suspect
it's the startup world that has changed, not them. The low cost of starting a
startup means the average good bet is a riskier one, but most existing VC
firms still operate as if they were investing in hardware startups in 1985.  
  
Howard Aiken said "Don't worry about people stealing your ideas. If your ideas
are any good, you'll have to ram them down people's throats." I have a similar
feeling when I'm trying to convince VCs to invest in startups Y Combinator has
funded. They're terrified of really novel ideas, unless the founders are good
enough salesmen to compensate.  
  
But it's the bold ideas that generate the biggest returns. Any really good new
idea will seem bad to most people; otherwise someone would already be doing
it. And yet most VCs are driven by consensus, not just within their firms, but
within the VC community. The biggest factor determining how a VC will feel
about your startup is how other VCs feel about it. I doubt they realize it,
but this algorithm guarantees they'll miss all the very best ideas. The more
people who have to like a new idea, the more outliers you lose.  
  
Whoever the next Google is, they're probably being told right now by VCs to
come back when they have more "traction."  
  
Why are VCs so conservative? It's probably a combination of factors. The large
size of their investments makes them conservative. Plus they're investing
other people's money, which makes them worry they'll get in trouble if they do
something risky and it fails. Plus most of them are money guys rather than
technical guys, so they don't understand what the startups they're investing
in do.  
  
**What's Next**  
  
The exciting thing about market economies is that stupidity equals
opportunity. And so it is in this case. There is a huge, unexploited
opportunity in startup investing. Y Combinator funds startups at the very
beginning. VCs will fund them once they're already starting to succeed. But
between the two there is a substantial gap.  
  
There are companies that will give $20k to a startup that has nothing more
than the founders, and there are companies that will give $2 million to a
startup that's already taking off, but there aren't enough investors who will
give $200k to a startup that seems very promising but still has some things to
figure out. This territory is occupied mostly by individual angel
investors—people like Andy Bechtolsheim, who gave Google $100k when they
seemed promising but still had some things to figure out. I like angels, but
there just aren't enough of them, and investing is for most of them a part
time job.  
  
And yet as it gets cheaper to start startups, this sparsely occupied territory
is becoming more and more valuable. Nowadays a lot of startups don't want to
raise multi-million dollar series A rounds. They don't need that much money,
and they don't want the hassles that come with it. The median startup coming
out of Y Combinator wants to raise $250-500k. When they go to VC firms they
have to ask for more because they know VCs aren't interested in such small
deals.  
  
VCs are money managers. They're looking for ways to put large sums to work.
But the startup world is evolving away from their current model.  
  
Startups have gotten cheaper. That means they want less money, but also that
there are more of them. So you can still get large returns on large amounts of
money; you just have to spread it more broadly.  
  
I've tried to explain this to VC firms. Instead of making one $2 million
investment, make five $400k investments. Would that mean sitting on too many
boards? Don't sit on their boards. Would that mean too much due diligence? Do
less. If you're investing at a tenth the valuation, you only have to be a
tenth as sure.  
  
It seems obvious. But I've proposed to several VC firms that they set aside
some money and designate one partner to make more, smaller bets, and they
react as if I'd proposed the partners all get nose rings. It's remarkable how
wedded they are to their standard m.o.  
  
But there is a big opportunity here, and one way or the other it's going to
get filled. Either VCs will evolve down into this gap or, more likely, new
investors will appear to fill it. That will be a good thing when it happens,
because these new investors will be compelled by the structure of the
investments they make to be ten times bolder than present day VCs. And that
will get us a lot more Googles. At least, as long as acquirers remain stupid.  
  
  
  
  
  
**