Naval

Check out the full article, and watch the video.

It’s a common complaint – venture investors are driven by what other investors think, and therefore lack imagination and spine.

There’s some truth to it – it is human nature, after all, to look for social proof and authority when making decisions. However, that’s not the whole story.

In public markets, Investors make their decisions to invest in parallel, and in theory, most of the relevant information about a company is publicly disclosed, by law. Businesses are also much more mature, and therefore easier to value. Finally, the market is very liquid and very deep, so there isn’t much uncertainty about the supply of money available and availability of money in the future.

In a public market, it’s unlikely that I have access to private data about a company’s prospects, and if I do, I buy or sell the stock and move the price. Your ability to act on my knowledge is zero – by the time you learn about it, it will already be built into the price.

By contrast, in private markets, there is a lot more non-public information scattered across many individuals, and they have the luxury of deciding in series. Businesses are brand new and immature, and very difficult to value. The market is shallow and illiquid, and a “Keynesian Beauty Contest” means that you want to finance a company now just because it is likely to be financed in the future.

Therefore, when you see other investors piling into a company, you can infer: – They probably know something about the company or the market that you don’t, given that a lot of the information (quality of founders, state of competition, true size of market, etc.) is private and scattered across many minds
- This company is more likely to get financed in the future, since it seems able to attract many, high quality investors (the aforementioned Keynesian Beauty Contest)
- And you *still have time to act at the same price* on this new information

That last fact more than any other causes Investors to move in herds.

It is rational for private investors to move in herds. They have the strong incentive – limited and diffuse knowledge. More importantly, they have the means – financings in which the price doesn’t change as the investors decide in series.

A lot of entrepreneurs assume that the initial way to engage with an investor is to *insist* on a meeting. It’s a relatively safe assumption that anyone on the buy side (an investor, an advertiser, an executive at a large company) receives far more requests for meetings than they can follow up on, and are constantly looking for excuses to say “no.”

Synchronous activities, such as phone calls, screencasts, videos, and webex conferences are almost as bad. If you’re trying to get the attention of an investor or exec at a major company, and don’t want to waste either your time or their time, pay very, very close attention to the cost of their time and you’ll fare better. In order of escalation, one should proceed as follows:

- Introduction – have your introducer send them an email *without putting you in the to or cc line.* That way, if the target does not wish to engage, you haven’t put them in the awkward position of having to supply an excuse or a turndown. The introducer protects their ability to be taken seriously this way.

- Once you have a response / interest, send something written for them to look over and offer a phone call, webex, or meeting as next steps. Written always beats a video or screencast, since most intelligent people can read a lot faster than they can listen. A webex demo is a crutch – if your product has to be explained, it probably isn’t ready for the average consumer. And if it’s in beta, you should at least know how to open up a password-protected demo version.

- If the target displays interest in learning more, then you can move to a call or in-person meeting.

People who insist on a webex demo or in-person meeting at the outset are forcing the target to make a high-cost decision, and are subtly signaling that they don’t value their own time, and certainly don’t value the targets’ time. They might think that they are demonstrating persistence, but one wants to see persistence in chasing the product, not in chasing dead-ends.

In short, your high-value targets don’t have time for meetings between un-screened parties, and since you’re busy building a company, you shouldn’t have time for them either.

For those of you going to SXSW, I’ll be on the Seed Combinators Panel on Monday March 15 3:30pm. I’m joining Paul Graham, David Cohen, Marc Nathan, and Joshua Baer to talk about YStars, TechCombinators, SeedBoxes, and the like. Here’s the Plancast if you want me to “count you in.”

I’m also throwing a meetup on SundayMarch 14 5-7pm in the Four Seasons Lobby Lounge at 98 San Jacinto Blvd.

If you’re a Venture Hacker, please come talk to me about your startup and venture hacking at these two events. I’m looking forward to pressing the flesh and kissing some babies.

Please RSVP on Facebook xor Plancast so we can get a headcount. Gracias.

Congratulations to portfolio companies DocVerse (now at Google) and Mixer Labs (now at Twitter). The best part was getting to know and work with people that I genuinely liked and now consider friends.

BusinessWeek includes me on a “Smart Money” list. Thanks guys!

Perhaps not in this incarnation – remember the first iPod? But the concept is very, very important for two reasons:

- It’s the first computing device that’s social in the real world. The iPhone is something that one person uses at a time. The Laptop screen faces you – two people using it at one time is awkward. iPad style devices can be shared in the real world – imagine laying it flat and playing multiplayer games facing each other, or watching a movie together, or even showing someone a web page – far easier than on any other device.

- It runs the iPhone OS. Why do users need to know what a file system is? Or map the interactions of a moving block of plastic onto a screen (mice)? Or worry about memory management? Or multiple levels of trash-delete? Or the concept of multiple, mounted volumes? Or which network you’re connected to?

Basically, the iPad is (a) usable by the other 5.5 Billion humans, and (b) it can enhance real, physical human interactions. These two facts alone make it a worthy successor to the iPod and iPhone. Steve isn’t ready to start filling niche markets just yet. He’s still looking to rule the world.

Y Combinator* is the new Graduate School.

In some ways, it’s better:

- You pay to go to graduate school. YC pays you.
- After school, you get a job. After YC, you create jobs.
- You repeat the works of the greats in school. YC expects you to do original work.
- In school, you are graded on an arbitrary scale by arbitrary people. After YC, you are graded by the real world.

Some day, most schools in most disciplines will be like this.

* – Of course, “Y Combinator” is a generic term for Techstars, I/O Ventures, SeedCamp, Capital Factory, Founders Institute, and all of the other similar pre-angel incubators.

For years I didn’t believe this. I thought that you could take advantage of the benefits of Boston, Seattle, NY, Austin – cheaper talent, no echo chamber, local Universities, etc.. But I give up. I found myself telling an entrepreneur why he had to be in Silicon Valley if he wanted to succeed. Most of my points are about Consumer Internet businesses…

I won’t belabor the obvious reasons – the Investors are here, the best engineers and entrepreneurs self-select and come here, Stanford and Berkeley, yadda yadda.

Instead, here are some points that you may not have considered:

- Especially on the Consumer Internet, modern businesses are becoming winner-take-all (thanks to leverage and network effects). Therefore, if you’re 10% better than the competition, you win, likely the whole market. You need every possible edge…

- All of the companies that you need to partner with are out here. Business development doesn’t happen in formal meetings. It happens in informal coffees, parties, and relationships.

- If you are here, your network will be using all of the latest tools – Twitter, Foursquare, Quora, Nexus One, etc., before other networks in other cities will. These networks hit critical mass here earlier and are thus more valuable to the early adopters here. You’ll have a 3-month+ head start on people outside to see what’s coming next. Imagine trying to design next year’s clothing without firsthand immersion in this year’s fashion, in Milan or Paris.

Sure, it’s possible to build a great Consumer Internet business starting out somewhere else, but given that these are winner-take-all businesses, do you want to start out that far behind the curve?

More of a warning so you know where not to go, I suppose…

I’ll be on a panel at the “Future of Funding” event in San Mateo on February 18th.

More information here:

The Growth of Small Firms
February 18, 2010
11:00-12:00pm

Description: There are an increasing number of venture capital firms with smaller and smaller fund sizes. These firms are starting to see some interesting returns, while remaining popular with entrepreneurs. What is working? What is not? This panel will explore how some of the small firms are investing and looking for big wins.

Fellow Panelists:
- Moderator: Matt Marshall, CEO and Editor, VentureBeat
- Mike Maples Jr., Managing Partner, Maples Investments
- Rob Hayes, Partner, First Round Capital
- Reid Hoffman, Partner, Greylock Partners

If you’d like to attend and if we know each other, please contact me and I might be able to obtain a discounted pass for you.

I have a new post on picking a co-founder, up here:

http://venturehacks.com/articles/pick-cofounder

I was at dinner the other night with a group of entrepreneurs. One told the story of a 27-year-old whiz kid whose company will likely exit for $500M – $1B – the business now being less than two years old. You can imagine the effect that this had on the brilliant, hardworking 35+ entrepreneurs in the group, who have had their share of hits, but not at that magnitude and not that quickly.

These stories are getting more commonplace. It seems that the entrepreneurs who “hit” these days are doing it more quickly, making more money, and doing it at a younger age. Back in the 70s, it took a decade plus to build a company and $10M, even in today’s dollars, was a big victory for an individual. Up until the late 90s dot-com boom, even though these stories existed, they were less common and took longer.

The storyteller explained that this 27-year-old is more brilliant and more hard-working than the previous entrepreneurs he’s seen.

That can’t be it. There are only so many hours in the day, and the entrepreneurs of yesteryear worked just as hard as the entrepreneurs of today. And the ones who came before were just as brilliant. Human intelligence has not evolved that dramatically in 10-20 years.

Rather, I posit that the amount of leverage available to a modern Internet entrepreneur is far, far greater than was available to entrepreneurs of previous generations. The number of entrants has dramatically increased as well. The overall hit rate might be lower, but the ones who win, win bigger and faster thanks to the leverage.

Gone are server farms, telesales and support, marcom material, tradeshow booths, direct sales forces, licensed software, mountains of code, reseller agreements, plane tickets, hotel rooms, printing CDs, voicemail systems, and so on and so forth.

Modern Internet entrepreneurship starts with a few engineers working for nothing and carrying latops and cellphones. They coordinate with Skype and GTalk and wikis and bug tracking sytems. The company itself is snapped together with outsourced HR, cookie-cutter incorporation, and outsourced finance / payroll. Marketing is done virally, or through SEO, or SEM. Customer service is handled via the community and forums. PR and outreach through tweets and blogging. Payments come via Paypal. Ads are served up by third-party ad networks. Storage goes on Amazon. Computation scales via Amazon, Softlayer or Rackspace. Code is built upon stacks of open source, SaaS, and $10/month services.

What used to cost $1M-$2M to set up, now costs $10K. What used to cost $5M to build, now costs $250K. What used to cost $20M to go to market now costs $1M.

But the upside hasn’t gone down. It has gone *up.* The 3 billionth person will be online shortly. They can all use the product. Network effects are stronger than ever, and some businesses become natural monopolies very quickly. Most web products have no marginal cost of replication, so adding a new customer is pure profit.

Less labor required. Less capital required. Less cost to scale. Larger markets. Cheaper marketing. No cost to ship more product.

No, people aren’t getting any smarter or harder-working. But the amount of leverage is obscene. The hits – Yahoo!, EBay, Google, Skype, MySpace, YouTube, Facebook, Twitter, Zynga, are each arriving faster than the previous one did. And the leverage is increasing, not decreasing.

The returns to scale for being smart, young, skilled, and high-energy have gone up tremendously, and that has profound implications for society. The smart are getting richer.

Update: An insightful comment on Hacker News: Basically, the Internet is a wide and deep place. The depth creates a few huge winners and the breadth creates a large number of small winners (who would have been losers in the old system, but due to the above-mentioned low costs, can still win). What’s missing is the traditionally fat middle. We’ve gone from a normally distributed set of outcomes, to a power-law distribution. The median is a small fraction of the mean. This is bad news for anyone who has built their business predicated on their achieving mean outcomes. That includes mid-stage VC funds, moderately-capitalized companies (traditionally speaking), and societies that care about “equal” outcomes.

Remember when mainframes did all of the computing? And workstations were dumb terminals docked to the mainframes? The terminals had less power, but were more “mobile.”

Then everyone got a desktop. And the desktop is where you did most of your computing. And you carried around your underpowered laptop, which had to be synced with your desktop, or docked to a big screen, keyboard and mouse to be usable. The laptop had less power, but it was more mobile than the desktop.

Now most early adopters have a laptop as their main computer. And are carrying around their underpowered smartphone, which has to be synced with their laptop on a regular basis. The smartphone has less power, but well, it’s more mobile.

We’ll dock our smartphones to our laptops for a while. But, if we can extrapolate from the history of computing, the laptop is headed for the dustbin.

Which means that Apple will be ok. Google will be ok. But if Windows Mobile is any indicator, Microsoft is in deep, deep trouble.

“The foundation of cooperation is not really trust, but the durability of the relationship.” – Robert Axelrod

“The whole aim of practical politics is to keep the populace alarmed (and hence clamorous to be led to safety) by menacing it with an endless series of hobgoblins, all of them imaginary. ” –H. L. Mencken

Please update your RSS readers to my new Feed address:

http://feeds.startupboy.com/startupboy

Duh.

But how?

I only know of four viable methods:

• A simple core built-in feature, where by using the product, users invite / share it with others. This used to be mostly about email address import, although these days Digging, Tweeting, and of course, spreading on Facebook are very popular
• Users embed the product onto their own blogs / pages / sites
• Users create original content that gets picked up by GoogleBot, gets SEO’ed, and then brings in other users via Google search.
• Users actually pay for your content, whether through subscriptions, or much more likely, virtual goods. This, in turn, allows you to buy traffic

If you don’t have one of these four methods in operation, and you’re building a web-based company, you’re going to find yourself begging for traffic a lot. 

We get these questions a lot from the enterprising young. It’s a very intelligent question: You look at some old guy who’s rich and you ask,

“How can I become like you, except faster?”;

Spend each day trying to be a little wiser than you were when you woke up. Discharge your duties faithfully and well. Step by step you get ahead, but not necessarily in fast spurts. But you build discipline by preparing for fast spurts… Slug it out one inch at a time, day by day, at the end of the day – if you live long enough – most people get what they deserve.

- Charlie Munger

Out of school I offered to work for [Benjamin] Graham for free and he said I was overpriced.

– Warren Buffett

If you love wealth more than liberty, the tranquility of servitude better than the animating contest of freedom, depart from us in peace. We ask not your counsel nor your arms. Crouch down and lick the hand that feeds you. May your chains rest lightly upon you and may posterity forget that you were our countrymen.

- Samuel Adams

There is no subtler, surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and it does it in a manner which not one man in a million is able to diagnose.

– John Maynard Keynes

When’s the last time that you had an accurate, timely, thorough, and polite response to an email to a free service?

——-Original Message——-
Date: Sat, 16 Feb 2008 14:05:25 -0800
To: support@tumblr.com
Subject: Migrating from squarespace

>I’m abandoning my squarespace blog and moving to Tumblr. I have my own
>custom domain. My old RSS feed is at:
>
>http://www.startupboy.com/journal/rss.xml
>
>How do I set my tumblr RSS feed to be at the same address! I don’t
>want to lose all of my subscribers in the move… Can I map the domain
>to tumblr and then set the feed URL from somewhere inside Tumblr? Can
>I use a third-party service like Feedburner to do it?
>
>Thanks,
>
>Naval
>

 Hi, Naval. Tumblr doesn’t allow the creation of a custom RSS feed address. You might try burning your Tumblr feed in FeedBurner, using FeedBurner’s MyBrand feature to associate the burned feed with your custom domain, and then editing the Custom HTML of your Tumblr theme to point browsers/RSS readers to the RSS feed from FeedBurner MyBrand rather than to Tumblr’s default RSS feed.

I know MyBrand will let you keep http://www.startupboy.com in your feed address. I’m not sure if it will let you keep /journal/rss.xml. You’d have to experiment or ask the FeedBurner folks.

Info from FeedBurner:

http://www.feedburner.com/fb/a/publishers/mybrand

Sorry that I can’t be of more help on this issue. Please let me know if there’s anything else I can help you with. Thanks for using Tumblr!

Marc  :-)

—
Tumblr Support
support@tumblr.com

Turns out that Yahoo! search can’t find the Pirate Bay. Between moves like this and forcing page inclusion instead of crawling, I as a user, have moved on from Yahoo!. The other day I needed to go back to Yahoo! search to use their backlink checker, and instinctively did this… (see image)

I wasn’t posting enough on my old blog since:

• SquareSpace is annoying

• I was writing long, infrequent posts

I’ll post more frequently on my new WordPress blog – shorter, mor wide-ranging topics, and more as notes to self than anything else.

The economic stimulus is a farce, as should be obvious to anyone who cracked open their Econ 101 textbook or ever ran a lemonade stand.

Where is the $150B going to come from? Reduced spending elsewhere (wash), increased taxes (same as reducing spending from the private sector – worse than a wash), borrowing from abroad (raises the price of capital for private businesses, or causes inflation, resulting in a wash), or printing more money (inflation / reduced purchasing power, which depending on what it does to inflation expectations, can be worse than a wash).

The fact that hundreds of millions of people believe this and that journalists and politicians constantly spout something so egregiously false at face value is a disappointing indictment of the masses.

In their honor, let us create the Perpetual Stimulation Machine! The government should inject more and more money into the economy. As it injects more, the economy will be stimulated, GDP will increase, government tax receipts will rise, and more stimuli can be injected!

In fact, I think just such economies are underway in North Korea and Cuba.

Note: Those who argue that money will be moved in a stimulus package from savers to spenders skipped Econ 102. Savings get loaned out and spent as well. Savings = Investment

Note 2: The stimulus is probably the oldest fallacy in Economics – the Broken Window Fallacy, which is also the same as the “Wars spur Growth” fallacy.

After looking at a lot of Facebook apps, I’ve sortof concluded that users:

1. want sex. If they can’t have sex, they
2. want food. If they can’t have food, they
3. want fun. If they can’t have fun, they
4. leave

When going through hell, keep going

– Winston Churchill

These are notes to myself. Your frame of reference, and therefore your calculations, may vary. These are not definitions – these are algorithms for success. Contributions welcome.

Happiness = Health + Wealth + Good Relationships

Health = Exercise + Diet + Sleep 

Exercise = High Intensity Resistance Training + Sports + Rest

Diet = Natural Foods + Intermittent Fasting + Plants

Sleep = No alarms +  8-9 hours + Circadian Rhythms

Wealth = Income + Wealth * (Return on Investment) 

Income = Accountability + Leverage + Specific Knowledge

Accountability = Personal Branding + Personal Platform + Taking Risk?

Leverage = Capital + People + Intellectual Property

Specific Knowledge = Knowing how to do something that society cannot yet easily train other people to do  

RoI = Buy-and-Hold + Valuation + Margin of Safety

Can older people be great entrepreneurs?

Marc Andreesen has a great post on this age-old question. In part I, he’s digging through the data. Some of his observations are powerful and worth summarizing:

"Generally, productivity — output — rises rapidly from the start of a career to a peak and then declines gradually until retirement.

This peak in productivity varies by field, from the late 20s to the early 50s, for reasons that are field-specific.

Precocity, longevity, and output rate are linked. "Those who are precocious also tend to display longevity, and both precocity and longevity are positively associated with high output rates per age unit." High producers produce highly, systematically, over time.

The odds of a hit versus a miss do not increase over time. The periods of one’s career with the most hits will also have the most misses. So maximizing quantity — taking more swings at the bat — is much higher payoff than trying to improve one’s batting average.

Intelligence, at least as measured by metrics such as IQ, is largely irrelevant."

I went through an evolution of sorts on this topic.

I started with a variation of the Beard Hypothesis (enthusiasm decreases with age but experience increases, and there’s an optimum cross-over point). This is the easiest viewpoint as you get older and look back at some of your earlier crazier ideas, but notice that that older crowd is very risk-averse. Douglas Adams had a great take on it:

1. "everything that’s already in the world when you’re born is just normal;
2. anything that gets invented between then and before you turn thirty is incredibly exciting and creative and with any luck you can make a career out of it;
3. anything that gets invented after you’re thirty is against the natural order of things and the beginning of the end of civilisation as we know it until it’s been around for about ten years when it gradually turns out to be alright really.
4. Apply this list to movies, rock music, word processors and mobile phones to work out how old you are."

I then moved on to Dean Simonton’s observations, beautifully covered in Marc’s article. My thinking was driven by books like "The Black Swan," "Fooled by Randomness," DeVany’s analysis of Hollywood Economics and Home-Run Hitting, and a casual observation of how Evolution creates things (massive trial and error). Basically, the number of swings at bat, poems attempted, paintings painted, etc. determine the success rate. The more you try, the more you learn, the faster you iterate, the better you get, and the more chances that you have of being productive. Your outcome scales more with the number of bets than the size of the bets. As the violinist Pablo De Sarasate put it, "For 37 years I’ve practiced 14 hours a day, and now they call me a genius. "

Now I prefer a slightly different hypothesis. More of the creative instinct is driven by the sublimated sex drive and the desire to attract a mate than we give it credit for. And more of it is squelched by the demands of family than anything else. An extreme take on it is presented by Kanazawa:

"Scientists tend to ‘desist’ from scientific research upon marriage, just like criminals desist from crime upon marriage."

Marc asks:

"So here’s my first challenge: to anyone who has an opinion on the role of age and entrepreneurship — see if you can fit your opinion into this model!"

When you are young, hungry, and single, you have

• huge amounts of free time (more swings at the ball)
• less to lose (more swings)
• enthusiasm (more likely to swing)
• sublimated sex drive (more likely to swing to stand out from your peers).

As you age, you have

• less free time, more family demands, larger social networks (less swings)
• more to lose (public embarrassment in front of an established social circle means you don’t want to start anything fresh) (less swings)
• experience (if you’re probably going to miss, why bother swinging) (less swings)
• fulfilled sex drive (have sex rather than swing)

"And here’s my second challenge: is entrepreneurship more like poetry, pure mathematics, and theoretical physics — which exhibit a peak age in one’s late 20s or early 30s — or novel writing, history, philosophy, medicine, and general scholarship — which exhibit a peak age in one’s late 40s or early 50s? And how, and why?"

Unfortunately for an aging me, anecdotal evidence aside, entrepreneurship favors the young.

The difference between poetry, pure math, theoretical physics, and novel writing, history, philosophy, medicine, scholarship, is that the former set requires huge (multi-year) intense, focused, almost isolated blocks of free time, whereas the latter set can be picked up and put down and resumed later without too much cost. The first set comprises problems that are solved by an emotional state (poetry, painting), by loading a very difficult single framework into your head (math, physics, coding), and / or competition (driven by sex drive and time-sensitive). The latter set are more rational, are systems problems rather than point problems, and don’t have time-sensitive competition.

Modern entrepreneurship, especially web entrepreneurship, is extremely competitive / time sensitive, requires enormous amounts of iteration even within a single product life-cycle, and often requires solving many challenging technical and business problems one after the other in a public view (with the opposite sex watching). So, it favors the young and single.

Which is not to say that one can’t do it if one is older and settled down. Mathematician Paul Erdos was famous for his prioritizing his work above all else (he remained single, by the way). There are many older successful entrepreneurs who spend tremendous amounts of time away from their families.

…and the rest give up and just become VCs…

At STIRR events, VCs fly business class, but entrepreneurs fly coach I have a similar rule – whenever I go to coffee / lunch / dinner for business, the person who has raised more money pays…

Big things coming on Venture Hacks but we need a great developer to help us out. Trust me, if you’re a great coder and want to do something cool, you’ll love this one.

 Full description on Nivi’s blog here.

The option pool shuffle: beat the game and raise your valuation:

Summary: Don’t let your investors determine the size of the option pool for you. Use a hiring plan to justify a small option pool, increase your share price, and increase your effective valuation.

Focus on your share price, not your valuation

Summary: Focus on your share price and the number of shares you own — metrics like valuation and percent ownership can fool you.

Hope you guys are finding these useful. Nivi is also talking and posting about them, usually faster than me…

I know I haven’t posted recently, but I have been busy! Nivi and I are launching a new site called Venture Hacks, an entrepreneur’s guide to hacking Venture Capital. It’s a “tell all” site that helps entrepreneurs get on an even footing with their better-informed counterparts when negotiating an investment.

Read all about it here.

Update: Coverage at VentureBeat, Brad Feld, Bart Decrem, GigaOm, etc.

The Google / YouTube looks like a win-win all around. Well, almost.

Google:

• Acquire the future of video on the Internet for roughly 1% of your market cap.
• Get $500M in escrow to protect against copyright lawsuits
• These are lawsuits that Google would probably have to defend YouTube against anyway, even if Google didn’t own YouTube. Huh? Let’s see, YouTube stores and serves up copies of videos without copyright holders’ advance permission and removes them when removal is requested, under DMCA Safe Harbor. Google copies books, and serves up copies of pages without copyright holders’ advance permission…

Youtube and shareholders:

• 1 Billion plus reasons to be thrilled
• Uncle Google takes on monetization risk and legal risk

Major labels:

• $50 Million each
• A promise from YouTube that within 6 months, the copyrighted nasties will be gone

Losers:

• Small Labels: Don’t have the money or the resources to mount a serious legal challenge to Google. Didn’t get paid.
• Small video-sharing sites: The major labels are going to sue them out of existence to establish a precedent, doing the dirty work for Google et al.
• Artists: Royalties? What royalties? The $50M to each label is structured as an equity investment, and not subject to royalty splits.

So, Google gets the prize, the labels get the money, YouTube gets the payout, and Google extends its one-time massive copyright violation to build critical mass, while using the labels as enforcers to make sure that no one can repeat the YouTube story.

Yes, you can make money without being evil. But for YouTube’s competitors, small labels, and the artists, evil is relative.

When I was young, I thought the point of the body was to protect the brain. Now I realize it’s the other way around. The brain exists to protect the body.

There are two kinds of animals – those who move and those who don’t.

Animals who don’t move count on a stable and predictable environment and replicate like crazy to compete for scarce resources, and to outlast environmental changes.

Animals who do move have to adapt to ever-changing environments, and therefore need a central nervous system.

We call the first set of animals "plants."

If you move, your environment changes a lot, which means you need a nervous system to detect and respond to those changes. So, your brain exists to protect your body as it moves, and it does this by constantly trying to predict the environment around it.

Stop predicting, and you may as well be a plant, except unlike that plant you haven’t cloned yourself a million times. You were counting on one shot at reproduction with sexual mutation to make up for one million shots with random mutation…and you lose.

So, keep moving, and be alert.

Bill Burnham, formerly an analyst at DMG and CSFB, and then a VC, continues his interesting analysis of the online classifieds market with his take on where Google Base is headed. He has some good predictions, and Vast is mentioned in the piece.

Vast.com has launched a new category, Credit Cards! Why waste your time doing comparison shopping, when you can get what you really want, free stuff! Our “deep” crawler now recognizes and extracts credit card numbers accidentally posted all across the web, and enables you to shop with them. What’s the business model, indeed!

Puzzling Evidence, already one of the funnier and most interesting blogs out there, knocks it out of the park:

“Rael Dornfest and Tim O’Reilly heard about it and, not to be outdone, declared Web 4.0 over pizza last night at Il Fornio.”

As they say, read the whole thing.

For anyone who wants to chat with me or with anyone else looking at this page, I’ve added a Mobber bar to the top of the site – it’s pretty slick. Talk to each other or ping me, or stick Mobber on your own site by pasting the following HTML into your blog or page:

 <iframe src=’http://www.mobber.com/embed/ajax?v=c’ width=775 height=115 frameborder=0 scrolling=no></iframe>

The Vast.com (developer) Preview is finally available! If you’ve been wondering what we’ve been up to, here it is, in a nutshell – we are building a search service that extracts classified ads from across the web, structures them, and then makes them available via an open REST API for commercial and non-commercial uses.

A little more detail:

- We are crawling the web and large parts of the blogosphere with a general crawler, similar to the ones operated by Yahoo!, Google, Ask, MSN, and Gigablast.

- The crawler activates forms, and digs deep to find even dynamic data (although it certainly doesn’t fill in any logins and passwords)

- We automatically recognize classifieds listings – currently cars for sale, job postings, and personals profiles, and extract and normalize the surrounding metadata (make, model, price, mileage, salary, location, title, age, gender, etc.).

Currently, we have some of the largest databases anywhere, of over 15 Million classified listings across these three categories, automatically extracted and structured with no human oversight, from nearly 50,000 web sites and blogs. (We actually crawled many, many times that number, but these are just the sites that have results to date).

If you are an end-user, you should be able to search for that hard-to-find listing without having to visit hundreds of sites, and compare cross-site results, with images, sorting, and statistics.

If you are a web-site owner or web developer, we’re offering a no-hassle API to show this data to your visitors, or to mash it up to your hearts content. You can use it build a huge destination site, an interesting application, or to supplement content and listings that you have today. You CAN use it for commercial purposes, and as long as it’s being shown to real end users, there’s NO LIMIT on the number of queries. Everything you see on the site is built on our API, so you should be able to replicate Vast.com on your own site or blog.

If you have a classifieds site or a blog and would like your ads to be included in our results, you shouldn’t have to do anything. Just post like you normally would, and we’ll find you. If we’re not getting your results or not getting them all, drop us a note at help – at – vast – dot – com and we’ll try and fix it.

We’re going to keep this site and the API as open as possible, and like a good net citizen, link directly back to the results. We don’t compete with the people that we crawl by taking direct listings. We don’t rely on explicit tagging. And we do an enormous amount of de-duplication and spam filtering to keep the results clean.

Of course, this is a search service, not a listing service, so you can expect some spam and mis-classified results will sneak through. Some links will break due to changes, expirations, and finicky databases that were not designed to be “deep crawled.” In those cases, the cache is your friend. There’re also rivers of pornographic content that had to be filtered out, and occasionally, we miss a few. Please help out by reporting bad results using the links next to each result.

We will be adding more sources, better crawling, improved classification, and many more categories over time – this is just a start. We want to support the web community that wants to take highly-structured content and build applications on top of these massive data flows. When we start making revenue through syndicating this data, we will share it with the developers and sites distributing it via the API.

What more would people like to see? How can we help or improve?

Update: Some coverage of the launch and reviews from TechCrunch, Paul Kedrosky, Peter Ripand CNet.

Rich Skrenta dissects why Craigslist is so effective, in a must-read piece. Now it’s time to consider exactly how effective it is.

If the Genie of the Market were to offer you all of the future earnings from EBay or Craigslist, which would you take? I’d take Craigslist.

Note that I’m talking about the strengths of the business models here. I’m fully aware that EBay owns 25% of Craigslist, so to say that Craigslist the company is worth more than EBay the company, I’d be saying that the capitalized Craigslist business model earnings are equal to twice the capitalized EBay business model earnings, and that is not what I’m saying. For evaluating the above numbers, look at the earnings generated by the business models, or assume that EBay owns 0% of Craigslist.

Estimating Valuation by listings

Craigslist currently carries 6M ads per month. At least 200,000 of these listings are job postings. They are in close to 200 cities (looking at their home page). They probably only have critical mass in about ten of those cities or less (from some casual browsing).

Currently, Craigslist charges only for Job postings, and only in three cities. Taken from Craigslist itself, we can see the rates:

And now they are adding fees for apartments in NY, and jobs in Washington DC, San Diego, Boston, and Seattle. Basically, as soon as a category in a city hits unassailable critical mass, look out!

So, jobs alone is today worth about $5 Million per month ($25 * 200K). Craigslist isn’t monetizing it all, but the direction and the intent are both clear.

Of course, Craigslist will eventually be able to charge for jobs, apartments, real estate, cars, a little bit for personals, vacation rentals, services, big local items, and in some countries, small EBay items. Notice that online, each of those 7-8 other categories is on the same order of magnitude as jobs, or bigger. The EBay items part may need some clarification – in countries where the development of the Internet precedes the development of a reliable postal system, more product commerce will happen over a Craigslist-style local system than over an EBay-style national system.

If Craigslist only monetizes half of these, that’s $20M per month. All of them and it’s $40M per month.

But Craigslist is still growing. A LOT.

Here are some stats that Craigslist itself has been handing out (these are about three months old):

Growth

Overall Page View Growth Rate (all cities combined) for last 12 months: 195%

Raleigh, NC: 13M pages/month +800% last 12 mos
Vancouver, BC: 21M pages/month +675% last 12 mos
Dallas, TX: 22M pages/month +650% last 12 mos
Minneapolis: 21M pages/month +625% last 12 mos

Can they double in size within a year? Easily. More likely, Craigslist will triple or quadruple in size before growth starts slowing significantly. Our previous range of $20-$40M / month now goes to $40 – $160M / month (as we make more guesses, our accuracy goes down, of course). The midpoint has us at $100M in revenue per month, or about $1.2B per year!

Try it another way: Take 6M listings a month. Multiply by 10 as they hit critical mass in 100 cities, as opposed to approximately 10 cities today. Multiply by 2 since existing cities like NY, LA, SF will continue to grow. Charge for a mere 10% of the listings, and charge $10 per listing (that’s a steal compared to the newspapers, and lower than Craigslist’s current rates. It’s also an average charge of $1 per listing). That’s $1.4 Billion in revenue per year. Their cost is near-zero (no content, no marketing, community-based customer service, a dozen engineers). After taxes, that’s still $1B in profit per year. Give them EBay’s P/E and it’s worth $50+ Billion.

I’m not adjusting the P/E for the fact that they are growing much, much faster than EBay (although that will inevitably slow down), or that their international opportunity is larger than EBay’s (that pesky postal system thing again).

Traffic Check:

Here’s another fun way to look at it. Alexa and other ranking sites mis-classify Craigslist as a community site. It has a traffic rank of 33 on Alexa (up from #40 when I wrote my first draft of this article last November!!), but if you were to consider it as a commerce site (it’s classifieds, after all), it would be the 4th largest one, right behind Amazon, Ebay, and Yahoo.

Craigslist’s growth has actually picked UP. How many big, successful companies are doing that?

2005 has been a great year for Craigslist.

Of course, for the other classifieds sites, it’s a massacre:

So, will Craig take the money? Well, 25% of the company already belongs to EBay (they bought it from a co-founder of Craig’s). Of the remainder, undoubtedly some is in the hands of employees. Craig is probably somewhere between 50% and 60%. He may want to give some of it to charity. Or family. Inevitably, he will own less than 50%. At that point, you can bet that the company will embrace capitalism and the virtues of liquidity.

Craigslist is a dot-org no more. It’s a supercharged monopoly in the making for the single most monetizable category in the world (high-ticket items and classifieds), tripling or better year-over-year. And Craig Newmark, Customer Service Representative, is worth more than Larry Page or Sergei Brin.

The real story is that Craig is well on his way to building an EBay / Yahoo! sized business with no venture capital, no big-shot management, no marketing, no patents, no real technology, etc. He’s taken all the value from newspapers with none of the cost. And everyone loves him for it (probably because he’s leaving the money on the table). That’s the power of the Internet.

“Say, that’s a nice ad business you got there. It’d be a real shame if something were to happen to it…”

Sneak peek of IE7 Dialog

Ok, so I Photoshopped this. But, when Microsoft decides that it doesn’t want Google’s revenue stream as much as it wants Google gone, why wouldn’t it do this? And what’s wrong with helping consumers filter out unwanted content on the Internet? 

Update – I’ve created a monster. Abhishek ran off and wrote a Firefox extension to do this. Then again, Customize Google has been around for a while. Actually, this is hitting Mozilla, not Google. You know the Firefox default home page with Google search inside? Well, rumor has it that all of the ad revenue from it goes to the Mozilla foundation – that’s over a billion dollars to fund their fight against IE 7!

Update 2 – IE 7 breaks Adsense! (Hat tip to Ram).

“If you want to build a ship, don’t drum up the men to gather wood, divide the work and give orders. Instead, teach them to yearn for the vast and endless sea.”

Antoine de Saint-Exupery

Job Title: Senior Software Engineer
Salary: Competitive
Location: San Francisco, CA

Cute young startup seeks dashing hacker to work on large-scale computing problems.

Candidates must be:

Brilliant
Architecturally oriented
Driven to succeed
Self-motivated
Addicted to the web
Precise industry experience, languages used, and years spent slaving away are far less important.

In exchange, we offer:

Great team
Ridiculous levels of responsibility
Fun travel
San Francisco location
Lots of stock, market or above market salary
No face-time
Broad roles
Training to start your own company after this.

Send code, links to sites that you have built, and pointers to projects that you have contributed to, to myfirstname at mylastname dot com.

I like Venture Capital. I really do. And even in the current bubble, Vijay, the World’s Most Desperate Venture Capitalist is a little exaggerated.

But what am I supposed to do when I put a job posting on Craigslist and get the following response?

“My name is XXXX XXXX, and I am a Principal with XXXXX, a venture capital firm based in XXXXXXXX. I learned about your startup on Craig’s List. My firm manages just north of XXX million in active funds. We invest in early-stage software and Internet companies, and I would be interested in learning more about your project.”

You can’t make this stuff up.

Actually, I have to hand it to the guy. One of the three things you need to succeed in Venture Capital is proprietary deal-flow (the other two are access to capital and good judgement). By hitting Craigslist early, these guys are doing legwork that others eschew – they’re hunting for the next Skype actively rather then putting their feet up on Mahogany desks and waiting for the deals to come pouring in. Welcome!

Barry Diller wants Ask.com to grow market share. I’m sure there’s lots to be done on improving distribution deals, the crawler, back-end algorithms, etc., but how about starting with some simple, obvious UI fixes? Here are the results of a search for “Search Engine” on the 4 majors:

At 1024×768, the UI differences are glaring. I’ve marked the ads in red and the information of dubious value in blue. The green checks indicate relevant, high-quality results.

To the average surfer, the info in white is all that matters. Note to everyone else except Google – fix the UI first – it’s the low-hanging fruit.

There’s a lot of talk and angst about what Web 2.0 is or means. Isn’t it obvious?

Web 1.0 was the time period between Netscape’s IPO and the March 2000 dot-com crash. It was exemplified by irrational exuberance, over-funding, and massive hype, but also by the mass-deployment of fundamental consumer-facing technologies, the birth of huge, high-margin businesses overnight, and a massive creation and transfer of wealth. In short Web 1.0 was the first bubble.

Web 2.0 is the second bubble.

There’re a lot of things being mish-mashed under the Web 2.0 umbrella, but it’s a sense in the air, a time, not a place. It’s that air of optimism (a little more cautious), that river of funding (a little less), the startup hype machine (slightly more subtle), and the birth of huge, high margin businesses (a few less).

This is a bit of a navel-gazing bubble though. We collectively thought that the biggest effect of the Internet was the consumer web – it wasn’t. It was the doubling of the global labor force that Internet-enabled offshoring enabled. It seemed like the real monetary pain came from bursting dot-com stocks. It didn’t – it came from the overleveraged telecom sector.

In the same vein, the real bubble to be afraid of is not the Web Bubble 2.0 – it’s the massive run-up in asset prices, real estate and stocks, post the Fed-driven increase in liquidity of the last five years. If that one pops, watch out.

Just take a look at the domain name sales on DNJournal – Fish.com goes for over $1 Million! Alarm clock, otherwise a great resource, is still living in the pre-bubble days, when domain sales of $100k were news.

Time Bray has it right. In the future, every site can carry search. All Microsoft has to do is to give the revenues from any potential search to the site carrying it. Two big assumptions:

• MSN Search has to be as good as Google search (not there yet, but possible)

• Microsoft is willing to forego the Google ad revenue stream in exchange for severely crippling Google. Right now, it seems like MS wants the revenue stream rather than to eliminate it, but that seems unlikely.

Microsoft bundles its Office applications. Record Labels and Game Publishers bundle cash and distribution. Silicon Valley Venture Capital bundles Advice, Control, and Money. In lean times, you, the entrepreneur, have to buy the bundled good.

Want Cash? It comes bundled with an Advisor on your Board of Directors, like it or not. And they take Control.

Want Advice? VCs won’t take Board seats without putting in Cash – it’s the only way to get enough leverage. And they take Control. Always the Control.

Smart entrepreneurs in times of plenty (like our current financing bubblet), serial entrepreneurs, and those with profitable businesses break apart these bundles. To un-bundle, you must have multiple bidders (that’s a longer entry), and you must have the ability to refuse capital (on Sand Hill Road, collusion is just a lunch away).

Let’s break apart the bundle.

• Cash – you want this on the best terms possible. The brand is irrelevant here. Kleiner Perkins and Sequoia have built their brands by generating huge returns for their investors first and foremost, but at least a portion of that comes from undervaluing your startup. Best terms means a great valuation, small up-front option pool (you can always issue more later, diluting everyone, not just the pre-money common), small liquidation preference (1X, non-participating), and weak anti-dilution. You do have to be careful in that your investors will block exits that don’t make them a certain minimum rate-of-return on their investment, so you probably shouldn’t take money at a valuation higher than 1/3 of what a modest exit looks like.

• Advice – Suppose that you have a brilliant investor on your Board. The in-demand investors are on about 8-10 Boards. They spend about half their time looking for new deals. And being older and having money, they usually spend more of their time on philanthropy, social events, vacations. Meaning that, if you’re lucky, they allocate one solid business day per company per month, and usually not even that. That’s barely enough time to keep up-to-date with what you’re doing, let alone “build the company.” Be pragmatic and select your investors for good judgement, unity of vision, and for their humility and willingness to treat you as peers (you’ll have to look long and hard for that last one). If you want “Value Add,” that can be purchased more cheaply elsewhere – an external Board member can be hand picked and will cost a small fraction of what an expensive VC will, and comes without the Control. If you’re looking for someone to “open doors,” that almost never works. Big companies deal with you based on your merits, momementum and timing, not based on which big-shot happened to introduce you. A side-note: the individual VC partner on your Board matters a lot more than the firm’s name does, so write the partner’s name into the termsheet, and if that partner leaves the firm, make sure that you have to consent to the replacement.

• Control – Ay, here’s the rub. A once-a-month part-timer with mis-aligned incentives (different class of stock) and an MBA, who controls your destiny. To minimize control, assemble your investor syndicates yourself, retain Board majority if you can, or at least give the outsider seat to a truly unbiased advisor, and don’t be afraid to exert independence when needed. If you’re moving around Powerpoint formats to please your Board members, you’ve already lost this one… Realize that even minority shareholders can sink future financings by not participating, so VC investors will always have more control over the company than you might like, so you have to constantly work at keeping an alignment of incentives.

Google did a masterful job with this – Larry Page and Sergei Brin raised money at a high valuation, insisted on the best advisors (Doerr and Moritz – no unbundling here), and kept control of the company, the CEO recruiting, and the going-public process throughout. Rumor has it that at one point, the VC investors, un-accustomed to taking a back seat, were offered their money back! Needless to say, they didn’t take it.

I realize that I’ve used a lot of industry jargon here. If you’re unsure of the meaning of something, or have questions, just post a comment below.

At some point when you have a startup, probably when raising money, you’ll HAVE to get a corporate lawyer. Most are hideously expensive and infuriating. A few tips:

• Don’t just go with the lawyer that the VCs insist upon. These lawyers will work with the VC on a hundred financings and with you on only one. Where do you think their loyalties lie? Get your own lawyer, and don’t budge.

• Watch out for the bait-and-switch – this is when you interview the gregarious, smart senior partner, who then swaps in the less popular, less experienced partner once you’ve signed them up. And the new person might be cheaper, but not much cheaper.

• Put them on fixed-fee per job, especially for closing a financing, and especially for lawyers for the other side (one of the old great VC tricks is that startups pay for the VC’s attorneys in closings! A ridiculous practice justified as being “standard”)

• If you have issues with the bill, resolve before paying. Possession is 9/10ths…

• Make your lawyers do the heavy lifting of drafting the financing docs. The drafting side wins all of the small points, by default

• Finally, good lawyers are advisors who weight pros and cons when giving advice that has a financial impact (which almost all of it does). Bad lawyers are whimpering insurance salesmen – and will encourage you to spend yourself to ruin by covering against every possible risk. Risks can and should be quantified whenever possible.

Let’s get serious. Nobody works eighty hours a week. Not eighty real, productive hours. Look closely at workaholics (and I’ve been one, and worked with ones), and a lot of the time is spent idling, re-charging, cycling, switching gears, etc. In the old days this was water-cooler talk. In Silicon Valley, it’s gaming, email, IM, lunches, and idle meetings. Let’s drop the farce, ok? Even when you had to work eighty hours, you didn’t, really. In economic terms, there is lower diminishing marginal productivity beyond some point. This point hits differently for different problems (some, like software engineering, require a lot of startup time to load a complex problem into your working memory).

In fact, your best work was probably done in tremendous, focused bursts, surrounded by long periods of dullness and inactivity. So, let’s try to figure out how to maximize the probability and productivity of such a burst, rather than try and force it to be predictable and prolonged.

First, measure outputs, not inputs, in yourself and your organization. Otherwise, you will be fooled by the modern knowledge worker, who is highly adapted to spend time at the office and manage upwards.

Second, measure productivity over a longer time-scale, say weeks and months rather than days. Some of the most creative and productive people that I have ever met work in multi-week bursts and then have weeks where they just idle with little done. It’s the nature of the human animal.

Third, introduce peer pressure into the mix. This is often done in software via “Extreme Programming” or in business by “Teamwork.” Whatever. Get two productive people in the same room on the same problem, and as soon as one hits the upward oscillation and is ready to work, odds are that he / she will inspire the other one and move them along.

Fourth, create a physical environment conducive to oscillatory productivity – eschew offices for non-traditional settings, let people have space, and let them keep their own hours.

Lastly, be ruthless on accountability and output over the long term. Nothing damages a startup like a mediocre and reliable performer.

Now go work harder…

People hate immigration and immigrants as it’s seen as competing with newcomers over finite resources in a zero-sum game. This argument is flawed on many economic levels, but let’s overlook that for a moment. Let’s give everyone a stake.

Suppose that we gave every US citizen an extra passport – a blank one. Within certain common-sense restrictions (i.e., no terrorists) each person could sell their extra passport to a would-be immigrant. You could give it to someone deserving, or patriotic, or brilliant, or whoever would just pay you a lot of cash. You could perhaps exchange it for a foreign one. Likely, markets would emerge to value and trade these things, and people would pay or promise future earnings streams (personal IPOs in the best case, indentured servitude in the worst) to get into desirable countries.

But now think what would happen if a country enacted bad trade or tax policy. The sum of all of the value of the passports would equal the capitalized value of the government of the country. Poor policy that reduced this value would result in the demand, and therefore the price, of passports falling. Your passport and your extra one would probably be your most valuable possessions, worth millions of dollars. Poor government policy would lead to massive negative feedback from the citizen-shareholders.

In fact, certain un-monetizable policies would now reveal their costs, and we could see the value of pro-choice v. pro-life, certain environmental policies, etc. If your government isn’t doing things the way that you want, you can always sell your passport and get out, but likely the poor government would be ousted by citizen-shareholders first.

Finally, in the fanciful stretch case, countries that have shown themselves to be astute economic managers could engage in hostile yet peaceful takeovers of the publicly-traded passports of poorly managed countries. If each passport entitled you to one vote in a democracy, China could buy India, put it on the same economic program that has worked well for the Chinese, and perhaps even sell it off for a profit later!

A lot of the Web 2.0 startups getting started these days are of the variety where their risk is completely unquantifiable a priori. Mostly, these are highly social applications which require a large group of people to change their behavior slightly or to adopt a new behavior to work. The list includes peer-to-peer lending, social networks for recommending things, new group communication systems, downloadable photo sharing clients, etc.. While some similar schemes have worked in the past (notably, MySpace, Flickr, EBay, Skype, Craigslist), the set that have failed are much much larger.

The problem with starting one of these businesses as an entrepreneur is that you basically have to get up the adoption curve before any rational VC will think about investing in you. Sure, if it works out, these businesses can have phenomenal network effects, but in advance of user adoption, it is nearly impossible to quantify the adoption risk in any way, and so it becomes a very very hard sell to VCs. Even if one partner believes that service will be adopted, he / she cannot convince the rest of the partnership with any data. As such, the few of these kinds of companies that get funded tend to either get funded because of a celebrity entrepreneur, or because of bubble-investing mania.

Basically, if you don’t have a track record and are starting a Web 2.0 company which requires a critical mass of users to do something that there is little evidence of people on the web doing to date, then you’re either going to have to bootstrap it for a while, give VCs some other proxy to go on (celebrity entrepreneur, core technology development), or find an individual angel who believes (easier said than done).

The flip side of this is that entrepreneurs who are doing hard-core technology development with relatively deterministic value tend to look at the successful businesses in social networks / P2P with tremendous envy. The latter seem to have unbreakable monopolies, organic growth, and no complex development requirements. However, this is just survivor bias at work. The odds of complete failure in the social / P2P businesses is much higher, which is not obvious just by looking at the winners.

Almost everything that women like in men seems to have some reproductive fitness signaling value. What about humor? Note that it’s not enough to say that “humor is a stress reliever.” The question is, why would it relieve stress?

The best guesses that I have:

• Humor signals contextual intelligence in quick, bite-size forms. You have to know about the local social environment and be intelligent to be spontaneously funny.

• Humor is the mechanism via which the brain can engage in some self-observation (nearly impossible for the brain to do otherwise) by noticing how much of our environment is actually predictive guesses based on pattern matching. Obviously false pattern matches (which a lot of humor is based on) show that we can be wrong about serious things, and so we take them, well, less seriously. This can reduce stress.

• To make jokes, you must play with patterns and make them incomplete on purpose. To do so, you have to be able to complete patterns as well – the ability to reason. Therefore a humorous animal is a reasoning animal. Do non-human animals laugh and joke around?

• Any others?

Looking out of an airplane window, it’s quite obvious what structures are natural and what structures are manmade. The natural structures are curvy, chaotic, yet recursive. They take very, very complex patterns and project them to us in a very simple way. The man-made structures are the opposite – they take simple underlying shapes (squares, straight lines, perfect circles) and combine them in haphazard, unpredictable, and hard-to-encode ways. Looking at them is to look at a chaotic jumble of ordered elements.

By the way, this is also what mathematicians mean by an “elegant” solution – a simple formula that encodes much complexity and variance underneath.

Of course, beauty is relative because we have different patterns stored that we can match against. Therefore it’s possible for a pattern that seems elegant and simple to one versed in Middle-Eastern art to appear overly complex and non-recursive to one who is mostly used to Western Art.

The brain loves to complete patterns. We do it for survival value all the time to predict the environment around us. But it also completes patterns for play (I suspect that we can’t turn this ability off). There is something aesthetic in completing a pattern in a casual, easy way. That’s why we enjoy listening to music – we can predict the next note, which seems just right, before it occurs. Once we know the song too well and the thrill of completion goes away, the music is “stale,” and we have to move on. Some of the best music is recursive on many levels, so that the patterns extend in time, amplitude / volume, across instruments, across sections, etc.. Engaging multiple senses heightens the experience – for people who know how to dance to a given beat, their brain can complete the patterns across the aural and corporal senses simultaneously. For those of us who can’t dance, the frustration of one pattern which cannot be completed overwhelms the joy from the other.

I still don’t get a lot of modern art though. It seems that after the invention of photography, painting lost its objective measure (realism) and devolved into inbred conversations between generations of artists and successive responses (as philosophy has been doing for centuries).

Free wifi in the airport, need I say more? Ok, what is stifling about airports and modern travel is the lack of control. Stand in line. Wait. Sit on the plane. Fasten your seatbelt. Put away your tray table. Close the windowshade. What is web-surfing? Here’s a blank location bar – now go, wherever you will. As in the Matrix, when your body is confined, the mind wishes to roam. Many a government could ease the suffering of its citizens by offering them mental freedom when it imposes physical confinement. The web is powerful and American in its origins in that it exports the one classic American virtue – freedom.

AngelList Scouts find high-quality startups for the angels on AngelList. When a Scout tells us to look at a startup, we pay attention.

Update: Liz Gannes covers this story for GigaOM.

We look at every startup that applies to AngelList — whether or not they have social proof — but a little social proof makes it easier for us to say yes. And the social proof of a Scout is especially interesting to us.

Why? Because the average Joe usually doesn’t get anything when he makes intros for a startup. He might get some advisory shares but that’s rarer thank you think.

The Scouts program is different. First, the Scouts are getting AngelList profiles with badges that display how many high-quality startups they’ve referred to the community. With the startups’ permission, we’ll list the names of the startups too. And most important: the Scouts will be able to send startups directly to AngelList, under their own names, without us in the middle.

Who are the Scouts? Each of these Scouts has sent us one high-quality startup that was good enough for AngelList. And most have sent more.

Los Angeles:

J. Grubb (@jonathangrubb), Founder of Get Satisfaction

Seattle:

Tony Wright (@webwright), Founder of RescueTime

Chicago:

Harper Reed (@harper), Former CTO of Threadless

New York:

David Lifson (@dlifson), CEO of Postling

Silicon Valley:

Jamie Quint (@jamiequint), Founder of Snaptalent

Gagan Biyani (@gaganbiyani), Founder of Udemy

Sam Odio (@sodio), CEO of Divvyshot

Jason Putorti (@putorti), Mint designer, Votizen advisor

Boston:

David Hauser (@dh), Founder of Grasshopper, Chargify

London:

Brendan Baker (@brendanbaker), Oxford MBA

And here’s a Twitter list of the Scouts: @angellist/scouts.

How do you get to be a Scout? Refer one high-quality startup that’s good enough to share with AngelList (tell startups to list you in the referrer field). Then get in touch with us, tell us you want to be a Scout, and we’ll start a conversation. I’m sure we’ll modify these guidelines over time, but it’s a good start.

Questions? Contact our Scout @brendanbaker and cc me @nivi.

If you’re a startup that’s trying to contact the angels on AngelList, consider getting in touch with one of our Scouts. They can help.

We’re recruiting a product designer for AngelList. Here’s how we’re doing it and what we’re learning. (If you’re interested in working with us, details are at the bottom of this post.)

I didn’t start by putting up a job post. I figured if everybody else is doing it, I need to take a different approach. So I called the smartest designers and entrepreneurs I knew and asked them for advice. Here’s what I’ve learned:

• We want a product designer. This job post from Quora defines a product designer as “Extraordinary product, interaction, and visual design talent [with] a curiosity and passion for crafting amazing experiences.” Product design encompasses visual design, interaction design, branding… it’s the whole user experience.
• A small team like ours should hire designers who can build what they design. At a minimum, that means building HTML, CSS, perhaps JS, perhaps beyond. See these posts by Jason Putorti and Rebekah Cox for more info. Also read Rebekah’s Early Quora Design Notes.
• Quora has the best job postings I’ve seen in a long time — they’re muscular and much better than all the quirky job postings in the world.
• Consultants are good if you want to build the product. Full-time people are good if you want to build the team. We want to build the team.

The opportunity for product designers

AngelList is a community of angel investors who make it fast and easy for worthy startups to raise money. These links tell the story better than we ever could:

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In short, the 250+ angels on AngelList are bringing startup funding online — in fact, they’ve already funded about 40 startups (here’s a few of them). This is a very high-impact and difficult problem… and a giant opportunity to help the industry that funds the startups we know and love: Facebook, Google, Twitter, Apple, you name it.

What’s in it for you? Investors throughout Silicon Valley and the world will use your product daily. You get to lead the product and company by turning vision into product, with no managers in your way. Your title will be the same as everyone else on the team: Venture Hacker. You’ll work with a founding team of investors (Twitter), founders (Epinions), students (life), and advisors (billions served). And you get to push the envelope of what is possible with product design on the Web.

We’re committed to building a high-impact and long-lasting team. If you’re a product designer who’s irrationally interested in this problem and wants to work with us full-time in San Francisco, send us a few links (we don’t need/want anything else), and please let us know if you have any questions.

This Xconomy article by Wade Roush does a great job of telling the AngelList and Venture Hacks story:

In Seed Funding Race, AngelList Sorts the “Junk” from the “Maybes”

I hesitated to link to it because these articles always make you look more handsome than you really are. But Wade does a great job of rounding up the state of the art of angel investing and placing AngelList in that context. Here’s a choice quote:

“I think the way to get into angel investing is, first, you obviously have to have money; you have to have a brand, otherwise you are not going to be differentiated and you are not going to see good deals; and you have to have a network of angels to work with, so you can move in packs and find other people to help you with due diligence,” Ravikant says.

It’s only then that AngelList can help. “The final thing is that you need to have good deal flow, so that you can see when the good things come along,” Ravikant says. “We will bring you deal flow, make it easy to syndicate deals, and we’ll show you deals that hopefully over time matches up to your interests.”

Check out the rest of the thoughtful article.

Quora is a Q&A site. We were planning on posting a question asking startups and angels to share their AngelList experience. But someone beat us to it:

What do people think of AngelList?

I can’t think of a better piece of marketing than this thread. There’s nothing we could say better. I want to replace the AngelList homepage with this thread.

Quora spam

Quora’s goal is “to have each question page become the best possible resource for someone who wants to know about the question.”

The Quora community will kill you if you fill it with rubbish. You have to have a lot of very happy users to try Quora marketing. And you have to expect negative reviews too. Quora’s looking for the best answer — not your answer.

Hating Quora

I’ve resisted Quora since they were in closed beta. Partly because everyone was raving about it. Partly because I thought the user experience was insane.

Now I’m hooked. And I think they’ve created a new class of user experience.  It’s a “go with the flow” experience. Don’t try to load a model of the site in your head — it’s too complicated and they’re constantly redesigning it. Just expect things to be there when you need them. And expect that you can do a lot with each piece of data on the site (suggest revisions, revise it, revert it, vote on it, eat it, thank the author…).

Quora’s a lot like The Wire, you’ll hate the first 5 episodes — then something will happen in your head and you won’t be able to shut up about it. Follow me and Naval on Quora and check out the AngelList thread already.

Last week, Naval and a slew of angels shared their investing advice with an audience of angels-in-training at AngelConf 2010. Here’s the video (each talk is 7 minutes long):

Wade Roush at Xconomy took detailed notes on all the talks and published them here and here.

7 angel investing tips

Naval’s 7-minute talk starts at 26:00. Here are Wade’s detailed notes:

“1. Don’t move in a herd, but do be a pack animal. Not everybody has all the information. One angle might know the market, one might know the founder, one might know the customer base. Every time an angel comes into a round, they bring a piece of information. Ride on their coattails.

2. Say no early and often. You should be doing one deal for every 20 to 30 that you see. If you do more than that, you’re overinvesting.

3. You need to have a brand. The really great deals are obvious, and everybody wants in, and if you want to get in you need a brand. That could be that you have been successful with great companies in the past. And building a brand does not mean taking coffee meetings. Shallow connections do not mean much. If you have a fancy office on Sand Hill Road or Market Street, the best deals are not going to come to you. If you’re not out there running around getting to know people, then you are really just practicing the VC model.

4. Humility. When you’re sitting there all day and people are asking for money and more often than not you are saying no, it eventually goes to your head. The problem is that when a Mark Zuckerberg walks in, those guys have more offers than they have room for. If you come across as arrogant, they will drop you.

5. Your job is to be a little dispassionate. Don’t try to run the company. Don’t even take the power—if you don’t have it, you won’t be tempted to use it.

6. Filters. Every winner is unique by definition, because what they’re doing is new. But the losers tend to cluster around common mistakes, such as investing in a company with one founder. You will find you can establish filters, even one as simple as “Do what you love.”

7. There are many paths to success. You have to be very careful about taking your limited experience and trying to shoehorn your companies into it.”

I haven’t watched all the angels yet but I’m making a mental note to watch it while I brush my teeth tomorrow morning.

7-minute abs

If you’re not an angel investor, watch this instead:

I use Twitter favorites to keep track of AngelList testimonials. I just favorite the testimonials I like. It’s super easy:

And it’s trivial to embed them anywhere:

Paul Graham says “The future [of funding] is no fixed amount, no fixed closing date, and no lead.” In other words, the future of financing is continuous, not discrete.

This post explains how to raise a seed round with no lead, no fixed amount, and a fluid closing date. The process is called mass syndication, or a party round.

Paul proposes eliminating rounds altogether, but we’re not there yet. Mass syndication is a single continuous seed round and I think it’s the state of the art in continuous fundraising.

We originally offered this interview exclusively to AngelList applicants — now it’s available to everyone.

Another future

The future of funding is also finding the right investors for your startup, quickly. Not just picking from the investors you can get introductions to.

How? You want to get instant meetings with any investor you want. And you only want to meet investors who are genuinely interested in your startup. That’s what AngelList is for. One danger of this approach is that your round is oversubscribed.

Despite the name, you can use AngelList to request intros to any subset of investors on the list — you don’t need to send it to the whole list.

Leads aren’t going away

Fred Wilson writes “If you don’t want a lead investor, then don’t knock on my door because I don’t know any other way to be.”

This interview explains how to raise a seed round with the conservative assumption that a lead won’t step forward — but it doesn’t preclude you from changing course if a lead appears.

1. Interview

Video: Interview with chapters (for iPod, iPhone, iTunes)
Audio: Interview without chapters (MP3, works anywhere)
Transcript: Below

2. Outline

Here’s an outline and transcript:

1. You can close an angel round with ‘mass syndication’
2. Start with terms and valuation below market
3. What you want in your term sheet
4. What you don’t want in your term sheet
5. Should you have a board seat for seed investors?
6. This isn’t comprehensive term sheet advice
7. Memorize the term sheet before your first meeting
8. How do you set your valuation? Price it to move
9. How do you bring up the terms in a meeting?
10. Describe how the terms are investor-friendly
11. A preferred round is a good way to set up good initial terms
12. Does a small seed round need protective provisions? Pros and cons.
13. Get feedback on the terms in the first meeting
14. Drop names to build social proof
15. Social proof works differently in a Series A round with VCs
16. See if the “interest” includes a dollar amount, intros, and name-dropping (a.k.a. soft circled)
17. When do you need a lead?
18. Approach the financing as if you won’t find a lead
19. What’s a lead investor?
20. If they say “find a lead,” ask why
21. How to create a deadline
22. Raise the money when you don’t need it
23. Send two emails to the angels
24. Do a rolling close: the cash comes in just- in-time
25. Mass syndication can fail if a very high social proof investor drops out
26. Use AngelList and StartupList to get intros to angels
27. What do angels look for?
28. Advisors are good for getting your foot in the door, not in a pitch
29. Get advisors by going to events or talking to entrepreneurs
30. Before you raise a seed round, you need a product in the marketplace
31. Use customer development and lean startup techniques to get to market with less
32. Pitching hacks free chapter: Advice on getting investor intros
33. If you need money to get something in the marketplace, pitch idea investors
34. Pitch incubators or do your startup on the side
35. What are the different types of seed stage investors?
36. If you’re talking to a VC, make sure they really do seed stage rounds
37. Potential concerns with pitching multi-stage and seed-stage firms
38. Get intros to seed investors with AngelList/StartupList

3. Transcript

Music: Squarepusher

Nivi: Hi there, this is Nivi from Venture Hacks.

Naval: And Naval from Venture Hacks.

Nivi: And we’re going to talk about how to close an angel round, how to put together an angel round, or in other words, how to herd a motley crew of angel investors and turn those meetings that you’re getting into money in the bank.

I think we’re going to start off by talking about mass syndication, which is an approach that I think more entrepreneurs should be taking to close their angel rounds.

You can close an angel round with ‘mass syndication’

Nivi: I think entrepreneurs make two typical mistakes when they’re doing an angel round, and they come from what they’ve read online about how to close a VC round. So, there are two things.

One: they don’t name drop enough. They don’t mention who else is interested.

Two: and I guess more importantly, they’re looking for a lead, which you don’t necessarily need in an angel round.

When you put those two together and combine them with a term sheet that you essentially write yourself, you’ve got a new way to close an angel round which we call mass syndication, which I’ve done personally. And Naval, maybe you can talk about how often you see that happening, or if you don’t see that happening, or whatever.

Naval: It happens fairly often these days. Especially the Y Combinator companies, which are well trained by Paul Graham and crew, will exercise mass syndication a lot. So, they take the standard term sheet that they’ve been given and they go out and do a rolling close of various convertible notes. And it generally works pretty well.

The keys are that you have to set the terms and the valuation very, very reasonably. In fact, you have to probably price slightly below market, because otherwise the angels don’t trust you, then they want a lead who’s done the due diligence. You have to work with people that you have warm intros with, you have to name drop like crazy, and you have to create forcing functions to get the round to close. You can’t give people all the time in the world.

Start with terms and valuation below market

Nivi: Right. So let’s dig into all that stuff. First off, I think you want to start with a term sheet that you’ve generated yourself.

Naval: I think it’s even better to have a term sheet that comes with someone else’s authority attached. So, it could be one that Wilson Sonsini has put up. It could be one that Y Combinators put up or Founder Institute has put up or Founders Fund has put up, but it’s just better to start with a widely accepted circulated term sheet where you can point to it and say dozens of other startups have used this term sheet, it’s not new.

Nivi: Yeah. And then there are the new Series C documents from Andreessen Horowitz and Ted Wang and other investors, which we haven’t reviewed, by the way. At least, I haven’t.

Naval: Yeah, we’re not endorsing any particular set.

Nivi: Yeah, so I would look at the term sheet first, and I find that a lot of entrepreneurs that I talk to have not really studied the terms that they’re signing onto enough, and they end up using the authority of: it’s a Y Combinator series AA doc, so we’re going to use it because everybody else has used it.

What you want in your term sheet

Nivi: I think there’s some wisdom in that, but at the same time I really want to understand what I’m signing. The things that I look for, personally, in a seed-stage term sheet are: If you’re going to do convertible debt there’s going to be a cap on the conversion price. In the event of an early acquisition you’re probably going to use that same cap to give the investors a non-participating liquidation preference.

Naval: Yep.

Nivi: If the debt matures before the company is acquired or does another round, you want the debt to convert into common or preferred stock, and that’s at the company’s behest.

And I like to have a majority or supermajority of the investors able to amend the documents.

Naval: They have to approve any amendment of the documents.

Nivi: Yeah, they can approve an amendment of the document, so you don’t need everybody’s approval to make some change – to extend the maturity date, or whatever, or to increase the amount of debt you can raise. Off the top of my head, that’s kind of….

What you don’t want in your term sheet

Naval: Yeah, what’s equally interesting and what’s usually not in a seed or angels syndication round is that you don’t have a minimum raise requirement. You don’t have, usually, a board seat or board structure. You often have vesting, but because the company is still controlled by the founders, the vesting is more of a pre-nup agreement between the founders than it is anything to do with the investors. But generally you want to keep it very simple.

Nivi: No option pool, really.

Naval: There can be. Actually, I would say that there usually should be, because you don’t want the situation where an investor starts reading the documents, finds out there’s no option pool, and therefore doesn’t feel like your valuation is properly represented, because these days in the market, people are used to seeing an option pool.

Should you have a board seat for seed investors?

Nivi: OK. And yeah, with the board seat thing, I think too many seed stage companies probably have board seats, especially if there is a VC involved in the round. If you want some normative leverage on that you can go to Marc Andreessen’s blog where they write, essentially, that they don’t think most seed-stage companies should have investors on their board of directors. Right?

Naval: Yeah, and it absolutely depends on the stage the company’s at and how much money you’re raising. If you’re raising a million bucks from institutional investors, you’re actually really doing more of a mini-VC round than a seed round, so you are going to have a board seat at least, although you probably won’t give it board control.

On the other hand, if you’re raising $250,000 spread across 10 investors, then you don’t need to have a board seat, although you may want to have an external board member just to help resolve any founder issues that come up, and to get some good advice.

This isn’t comprehensive term sheet advice

Nivi: This isn’t intended to be a comprehensive discussion of term sheets for seed-stage companies, but it’s a good start.

Memorize the term sheet before your first meeting

Nivi: So I think that’s our best advice on the first step, which is generating a term sheet. And you should be able, when you go into a meeting with any of the prospective seed investors you have, to essentially rattle off the major terms in that term sheet.

How do you set your valuation? Price it to move

Nivi: I guess the only thing I would add to what Naval said earlier when he described it as maybe the price is “below market,” I sometimes describe it as “priced to move.” So you want a price where there should be no discussion around the price that you’re putting forward.

We’ve got an article, actually, that you should look up. It’s called How do we set the valuation for a seed round? Let me look it up right now.

Naval: The valuation is a very difficult topic, especially when the entrepreneur is trying to do it themselves. They invariably get it wrong, and usually it’s too high. You just want to talk to somebody who has a lot of data points in the market and can give you those data points.

Nivi: Right. So you need the market data, and then check out this article we have. It’s called How do we set the valuation for a seed round?

How do you bring up the terms in a meeting?

Nivi: OK, so at this point you’ve generated the term sheet, we’re going to assume that you’ve got some meetings lined up, and we’ll get back to this topic of how to get some meetings, but let’s assume that you’ve got some meetings lined up. You do the meeting. How do I bring up a discussion of the terms?

Naval: I think if the investor’s interested, as a final step they’re going to ask you. They’re going to ask what the terms are or who’s in the round, or they’ll ask you to give them some details about the financing. And that’s when you basically say: So-and-so is committed to invest. We have a couple of people looking at it. We’re hoping to close by such-and-such a date, or we are going to close by such-and-such a date. There are x dollars available, and it’s a convertible note and it’s capped at a valuation of x and a discount of y. So, you can just throw the terms out. You can be pretty straightforward with most angels.

If you want to be a little more subtle you can say we’re raising x, and we’re selling no more than y% of the company; but I feel that with most angels you can just be direct and say the cap is whatever it is, and just give the number.

Nivi: Yeah, if they don’t bring it up you should just have a slide that says “Financing” at the end of the presentation, [laughing] and you tell them exactly what Naval said. You drop the names, and we’ll get back into the specifics of exactly how you drop the names.

Describe how the terms are investor-friendly

And you discuss the terms, and you discuss them in a way that shows how investor friendly they are and how sane they are, and frankly, there really should be no room for discussion on them. Not that there’s no room, just that there’s no need because the valuation is priced to move and there are a lot of good investor protections – which the only ones they really care about are some kind of liquidation preference in the event of an early sale. They care about getting the same terms as the Series A investors, whenever that happens, which they’ll get through convertible debt or through one of the other types of mechanisms in a preferred financing. What kinds of mechanisms?

Naval: Essentially, if it’s convertible debt, it’ll just convert into the same security as is being sold in the next round. If, on the other hand, the convertible debt has a term sheet attached to it and has specific rights, then those rights will be negotiated, but that’s pretty unusual. With convertible debt usually you usually just get whatever security is in the next round.

Nivi: No, I meant if there’s a preferred financing in the…. I mean, here’s the question: what percentage of deals do you see being done convertible in the seed round versus preferred in the seed round these days, you personally?

Naval: It’s about half-and-half. The larger the round the closer it gets to just being a preferred round. The smaller the round the more likely it will just be debt.

A preferred round is a good way to set up good initial terms

Naval: Generally, even in the startup side, it’s probably better to do a preferred round because these are the times to set your terms very favorably for yourself, and they form a precedent for what happens when you do later rounds, whereas if you’re negotiating, if your first negotiation is with a VC you’re not going to set yourself the friendliest terms. So there’s nothing wrong with doing a preferred round, it’s just that the expense is slightly higher, but it’s not tremendously higher.

Nivi: Yeah, I guess I’m wondering if there is usually some kind of most-favored nation clause in those preferred term sheets that gets those investors the same terms that happen in the next round.

Naval: No, there almost never are except that there is one game-theory element that comes into play, which is, any subsequent round has to be approved by the current round investors. So if there is some term that the subsequent investor is getting that the current investor is not, very often they will not approve the transaction unless they get that.

Does a small seed round need protective provisions? Pros and cons.

Nivi: Yeah. Actually I haven’t looked at the Series C docs. I think they might not have that in there. My preference is that if you’re doing a small seed round, under $500K, there should really be no protective provisions like in terms of vetoing the next round, vetoing a sale of…

Naval: Well, you kind of have to have some of those because unfortunately these are minority shareholders, so you do have cases where an entrepreneur, for example, will raise money from their cousin at a low valuation, or they will sell a company to an affiliated entity. These things actually happen.

Nivi: Yeah.

Naval: And so that’s why the investors often need to assure that there aren’t linked transactions or need approval. And that’s why you’ve got to know your investors; you’ve got to trust your investors to also do the right thing. People who have a history of investing in good companies and having good exits likely aren’t the types who will block financings or block sales.

Get feedback on the terms in the first meeting

Nivi: You can ask them right at the end of the meeting, after you’ve presented the terms, what feedback they have on the terms, if any. So you could solicit some immediate feedback. My guess is if your terms are structured right you probably won’t get much, if any, but make note of any feedback they give you on the terms.

Drop names to build social proof

Nivi: Let’s talk about what kind of names you can drop at the end of the meeting.

Naval: Yeah, you definitely want to use social proof to build up momentum in closing a mass syndication round. So, every angel who signs up, you should make clear to the other angels that this angel has signed up. Now, you have to be careful about what the definition of “signed up” is. If someone says they’re interested, don’t go around representing them as committed, because angels will talk and if they find out that you’ve been exaggerating or lying it will cost you trust in the whole financing. Basically, the clear indicator is if somebody says they’re in, they negotiate an amount with you, they say they’re happy with the terms, and they shake hands on it. If you want to play it extra safe, if you don’t have a long-standing relationship with this person, then I would also suggest getting an email confirmation.

Nivi: Right. So, just going from the top of the list, if they’ve wired the money, signed the term sheet, and the money’s in your bank account, you should almost certainly use their name, unless for some reason they’ve specified that you can’t. Ok; so that’s an easy one.

Next, if you’re in the process of closing with them and you’re negotiating a term sheet, I think, again, unless they’ve said you can’t use their name, it’s extremely safe to say that you are in the process of closing with such-and-such, assuming they’re negotiating the deal with you in good faith.

Next on the list, I don’t think there’s anything wrong if the angel, at the end of the meeting after you’ve discussed the terms, has said they’re interested, for you to ask: are you interested enough for me to tell the other guys I’m talking to that you’re interested?

Naval: Yeah, that’s perfectly reasonable.

Nivi: That’s what I would do with the guys who you’re not actively negotiating the deal with. Just ask them, hey, is it OK if I use your name?

Social proof works differently in a Series A round with VCs

Naval: Social proof in a venture round works differently because in a venture round you want independent bids because you’re actively negotiating a valuation. Here, because you are setting the valuation and there’s room for multiple players, social proof is much more important than getting independent bids.

See if the “interest” includes a dollar amount, intros, and name-dropping (a.k.a. soft circled)

Nivi: Yeah, the advice for an angel round and a VC round are exactly the opposite of each other. Another way to test people’s interest or to just see how interested they are is to talk to them at the end of the meeting about a dollar amount that they would be interested in investing, and then whether they would be willing to make introductions to other angel investors.

A guy who has given you a dollar amount and is willing to make intro’s – I think that’s basically what I would call the formal definition of a soft circle in an angel round. I guess the third part of a soft circle is they’re willing to let you use their name.

So, the definition of a soft circle is:

1) There’s a dollar amount attached to it.

2) They’re willing to let you use their name with other investors.

3) They’re willing to make introductions.

If you’ve got all three, I would call that guy essentially soft circle.

When do you need a lead?

Nivi: So, we talked about mass syndicating the round, and we’re not done with that, but what are some cases where you would actually want, or let me put it another way, where the angels would actually want a lead in the round?

Naval: Angels will want a lead if they don’t know you and they don’t trust you, or if they don’t agree with the terms and they want the terms renegotiated, but their amount is too low to do it themselves; or if you have a very complex business that requires a lot of due diligence, or a very mature business that requires a lot of due diligence, so someone is going to have to go in there and investigate it; or if the price is just high enough. If you just need to raise a certain amount of money, usually beyond around $500K I would say is the upper limit, then you need an institutional investor and that person is going to be a lead.

Nivi: Do you think the majority of financings of $500K or lower are done without a lead?

Naval: They certainly can be; I wouldn’t say they are. I would say about half and half. It’s always harder to do without a lead because you’re looking for smaller angels. If you find a lead it shortcuts the whole process. You’ll close much, much more quickly, but one may not always want to find a lead, either because one doesn’t want the oversight and that institutional investor mentality that a lead generates, or one doesn’t want to negotiate the terms.

Approach the financing as if you won’t find a lead

Nivi: Yeah, and just to be clear, we’re not saying that you shouldn’t find the lead, but I think you want to approach the financing as if you’re not going to get one.

Naval: Yeah. If a lead steps forward and is willing to negotiate a term sheet and do the bulk of the round, or half the round, then yes, you should definitely entertain it. If they’re someone you like and trust they can short-circuit the whole process for you.

What’s a lead investor?

Nivi: And we’ve got a few articles, actually, on Venture Hacks you can look up, How do I find a lead investor?

What’s the definition of a lead investor? Let me throw one out: They want at least half the round, and often they want the entire thing. If they don’t want the entire round they’ll help you find the other investors. They’re essentially willing to make the decision for themselves, and in the best case they’re willing to put their money in your bank account and close the deal even if all of the money is not signed up yet.

If they say “find a lead,” ask why

Nivi: So, I would say if a sophisticated angel investor, or even an unsophisticated one, at the end of the meeting or in an email says yeah, I’m interested but I need you to find a lead, I would ask why, and why they’re not interested in participating in the mass syndications. And they may end up telling you one of the things that Naval said, for example, they like you, they like the product, it looks interesting, but they don’t know the market well enough to make the decision on their own, they don’t know enough about the terms or they don’t know enough about you to negotiate the deal with you, or they don’t care enough to negotiate the deal with you, they just want to put the money in and not worry about the deal. So just ask why. Don’t take hey, I want you to find a lead, as a great answer. It’s often a way for people to preserve the option to invest in the round, just in case Sequoia decides they want to invest in the round.

How to create a deadline

Nivi: OK, after the first meeting how do we turn all these angels interest into money in the bank?

Naval: This is a very difficult problem because you have to create a forcing function, and really there are two forcing functions that work well. There are some artificial, external ones. It could be the case that your company has some kind of a partnership coming up where you have to make a payment by a certain date or you’re going to go under, so that can create a forcing function, but that’s not necessarily the good kind because it gives people leverage over you.

There are two of the better forcing functions. One is time based where you very clearly say: We’re closing a round at such-and-such a date, the notes are all authorized to close at that date. After that date we will not be able to accept more money, we will be back to focus on our business, and if we raise less than the maximum amount that we’d authorized, that’s fine, we’ll just make do on that amount, and when we go to raise money next time it will be on different terms.

That is the lesser of the two good forcing functions, and that allows you to at least put a time limit on it. Now the problem here is you have to be credible and you have to stick to it and you have to pick good time, because if you arrive at that date with no money, or too little money, you will lose all credibility when you go back and ask for more money.

Nivi: Holidays can be good forcing functions.

Naval: That’s true. Holidays are very good that way. You can say you’re trying to get it done by Christmas or before the New Year, and so on.

Nivi: By Thanksgiving.

Naval: By Thanksgiving. You probably don’t want to use ones like: we’re trying to get it done by Boxing Day, or something like that, or more obscure. [laughs] But certainly if there are trips coming up, or if the founders have to go back to the UK for visa purposes for a month, that would be another way to do it. But the time-forcing function is the lesser of the two.

The better one is over-subscription, where you basically say: We have more people who are interested than we have room for. We like you very much, but we can’t guarantee a spot until you’re committed. Allocations will be on a first-past-the-post basis. And you basically line up more angels than you have room for.

Raise the money when you don’t need it

Nivi: And the third thing I’d add is raise the money when you don’t need it. That can be super tricky, or perhaps impossible on a seed round where you’re trying to build the product, a team, and get a little bit of traction so you can go to the angels with something other than just a product or an idea, with some traction. It’s hard to raise the cash when you don’t need it, but if it’s possible I would do it.

Naval: Absolutely.

Send two emails to the angels

Nivi: So, just very tactically, how do I get the money into my bank account? What I would do, or what I’ve done in the past is collect the names of all the people who are interested, have said yes, they’d like to participate in this round. Send an email to each one with the term sheet, with the same exact terms that you discussed previously. Tell them who else is going to be participating in this round, just as long as the guy has said that they’re interested and they’re willing to let you use their name. I would list all those people in the email. Tell them here’s the day we want to sign this term sheet by – at least put it two weeks out. Ask if they have any feedback on the terms; if not, you’re going to send them the closing documents.

Basically, do they want to invest? What’s their final decision? Do they have any feedback on the terms? If not, we’ll send you the closing docs.

Naval: It can often be a good tactic to send the closing docs through the lawyers, because the lawyers will make it very formal, and they’ll put things like: the closing date is such-and-such date, here are the wire instructions. That creates an air of authority and formality around it, which helps the closing.

Nivi: Yeah. I don’t think I would send the closing docs until they’ve agreed to the term sheet, though. Right?

Naval: Absolutely. Absolutely.

Nivi: OK. So don’t force the closing docs down their throat. See if they have any feedback on the term sheet. If not, I would just send them the final rev of the term sheet that incorporates feedback from all of the investors, as well as the closing docs and the wire instructions all in one email – so this is the second email we’re describing now – again, listing the names of all the angels who have committed to sign the term sheet now, or have seen the term sheet and have approved it.

So this is actually two emails. The first one is term sheet, and please give me feedback on it, with a list of angels who are interested in signing it. The second email is: here’s the final term sheet, the closing and wire instructions, and the final list of angels.

Again, for the first email I would set at least two weeks out for them to get back to you. Do you think two weeks is too long?

Naval: Probably. I would just give a week.

Nivi: OK. I guess I would do a week. I would expect to blow that deadline in my limited experience, though. [laughs] And you’ll have to send a few emails to these guys, just bugging them a couple of times with: hey, do you want to invest or not? kind of emails. Put it nicer than that, and also always include one sentence on something great that has happened in the meantime to the company, just so you can show momentum.

Do a rolling close: the cash comes in just- in-time

Naval: This is where the concept of a roll-in close comes in, which means that investors don’t have to put their cash in all on the same day. All of the investors don’t have to commit all at the exact same time. As they get to your email, sign the docs, get their account into the lawyer to set up the wire, the money comes in. And that money can come in over the course of, say, a week or two in practice.

And you can also set up the documents so that even when all the money’s come in, there is still room in the documents to raise another 50 or 100 or another $200K using the same, exact documents.

So you can do this first roll-in close, and then you can do a subsequent roll-in close if you find some new investors you want to bring in on these same terms.

Mass syndication can fail if a very high social proof investor drops out

Nivi: Have you ever seen this mass syndication approach blow up at the end?

Naval: Mass syndication could fail at the end. It would fail, most likely, if some very high social proof investor drops out. That’s probably the single biggest reason it could fail, but it’s pretty unlikely because here you have sort of a diffuse group, so it’s unlikely that any one person would blow up the deal.

Nivi: It’s really a question of how effectively you’ve read their interest in your round when they say they’re interested. Again, I would use those signals that we put forth before, in terms of are they a soft circle or not? Did they say you can use their name? Did they talk about a dollar amount? Did you discuss the terms with them? Are they introducing you to other investors?

Use AngelList and StartupList to get intros to angels

Nivi: OK. Let’s talk about how to get intros to angels. I’ll start off.

Naval: Angel List.

Nivi: Angel List is one thing. We’ve got a list of angel investors. It’s called Angel List. You can contact a lot of the angels directly or through referrals.

Read the free chapter from Pitching Hacks for tactical advice on getting intros

And then we’ve got something called Startup List, where you send us your pitch, and if it’s a good pitch we pass it on to the angel on Angel List.

What do angels look for?

Nivi: When we look at the applications for Startup List we look for a few things: Social proof – essentially who have you convinced to let you use their name as an advisor or investor or team member. We look for your traction.

Naval: We look at your bio – who you are, what you’ve accomplished. Plus we look at your product if it’s a web-based product. We like to see the demo or the alpha or the prototype. It’s very hard to actually send something out to Angel List without having seen some evidence of the product.

Nivi: Right. If I had to boil it down to two things, I’d say social proof and traction. And if I had to boil it down to one thing, I’d just say traction.

Naval: Yeah. I’d say in order of importance, it’s probably traction then team then social proof then product.

Advisors are good for getting your foot in the door, not in a pitch

Nivi: Right. And VCs and other folks like to make fun of people’s advisor slides that they tend to put too much emphasis on when they pitch, which I think is right, but I think advisors and social proof are a great way to get into the door. When you’re in the door I don’t think it’s important anymore, but it’s a good way to get in the door.

Get advisors by going to events or talking to entrepreneurs

Nivi: And by the way, how do you get advisors? Go to events. We recently talked about this thing called Startup Digest, which is the best events in 27 cities or so. It’s a curated email list. You can subscribe to that. It’s called Startup Digest.

Naval: You can ask other entrepreneurs.

Before you raise a seed round, you need a product in the marketplace

Nivi: And I think we already answered this question a little bit, but what do I need before I raise a seed round? I would say you need your product to have been prototyped in some way or another, and it needs to have been put into the marketplace in one way or another and have some traction.

Naval: Yeah, and obviously that differs on the product type. For a consumer web product you should probably have launched it or soft launched it. For an enterprise product or something that requires a lot of money and a big team to build, you may at least want to test the market demand.

I would define traction as quantitative evidence of market demand.

Use customer development and lean startup techniques to get to market with less

Nivi: Yeah, that’s good. And look up SteveBlank.com for customer development techniques. Also look up Eric Ries’ blog, StartupLessonsLearned.com for lean startup techniques. It’s basically how to get more traction with less work.

Pitching Hacks free chapter: Advice on getting investor intros

Nivi: For some really tactical advice on how to get meetings with angel investors, we’ve got a whole book on that topic called Pitching Hacks. Look it up. You can buy it for $9.00. I think it’s worth it. You can check out the testimonials from smart guys like Adam Smith, the founder of Xobni, or Aaron Iba, the founder of EtherPad. And the chapter on how to get introductions to investors is actually free online, so you can get the PDF of that chapter for free.

If you need money to get something in the marketplace, pitch idea investors

Nivi: If you need money just to get to the point where you can apply to Startup List or talk to angels, essentially to get to the point where you have some product, some team and some traction, my recommendations are friends and family investors. So those are your actual family or people who know you and are willing to essentially back you. So it might be a boss that you worked for for 10 years who has enough disposable income to write you a check for $5K or $10K or $25K. And finally I would say people who just see the same problem that you see, and they believe in the product and the market. Like, they’ve had that same idea themselves and they don’t have the time to pursue it themselves, but they’re willing to put a little bit of money behind the guy who does have the time to do it. I call those three groups of people idea investors.

Pitch incubators or do your startup on the side

Nivi: An alternative to raising that idea money is to apply to one of the Y Combinator style incubators, like Y Combinator, TechStars, DreamIt, there are a bunch of them now. Just do some web searches. They will back you on the basis of essentially an idea alone, but in general you need to have a team of people who can get things done. It can’t be all just business guys.

Another option is to keep your day job and do your startup on the side, which you can find lots of great posts on, online, if you just do some searches. We’ve got a post on it on Venture Hacks called Half-Assed Startup, written by Tony Wright from RescueTime.

What are the different types of seed stage investors?

Nivi: I guess the last topic is what are the different types of people who invest in seed rounds? You’ve got your independent angel investor who’s investing his own cash. You have angel investors, or let’s call it a seed-stage fund, which is investing an LP’s cash. They have other investor’s cash that they’re investing. And that seed-stage fund may be represented as a fund, like first round capital, or it may be represented as more of a person, like Naval, say.

Naval: Yeah, generally the way a seed-stage fund will differ from a pure venture fund is they’ll be investing smaller amounts, they will be willing to do convertible debt with a cap, and they also will not require board seats or require heavy oversight. They can also probably decide a lot more quickly. Most seed-stage funds, although not all, don’t have the concept of a partner’s meeting. Usually when you’re talking to one or two people, you’re talking to everyone.

Nivi: Right. So I guess another example of a seed-stage fund that presents as an individual is like Jeff Clavier. Is that right?

Naval: Yes.

Nivi: Seed-stage funds that present as firms are First Round Capital. Who else?

Naval: Founders Fund.

Nivi: Founders Fund are more multi-stage aren’t they?

Naval: Ah, fair enough. True Ventures.

Nivi: True, right. And now we’re getting into the topic of multi-stage funds, so now you have classic VC funds, or new ones like Founders Fund, that invest across a broad range from incubation all the way to Series E.

Naval: Right. Charles River Ventures has a very active seed program, all the way from 25,000 to a quick start of 250,000 to Series A and Series B.

Nivi: Yeah, and other firms that don’t have specific programs like Sequoia Capital, for example, do seed-stage investments all the time, although they don’t have a specific program for it.

Naval: Correct.

If you’re talking to a VC, make sure they really do seed stage rounds

Nivi: I think if you’re talking to any VC that does multi-stage investing, you really want to ask them: When was the last time you made a seed-stage investment? How many have you made in the last year, essentially, and more importantly, what did the company look like when you made that seed stage investment? Their definition of what the company looked like may be 5 million uniques a month coming to the website and they still call it a seed-stage investment, while you’re struggling to release your product. So you want to ask them what their definition is of a seed-stage investment.

Potential concerns with pitching multi-stage and seed-stage firms

Nivi: I want to talk about two things. One: what are the things to be concerned about when you start to bring seed-stage firms into your angel round, and multi-stage firms into your angel round? And two: a lot of these firms are acting more like angels these days, and let’s talk a little about that. But let’s talk about the concerns first.

Naval: The concerns are that you don’t want to have a process that’s a VC process, so you don’t want to go through too many rounds of meetings and due diligence and so forth. You don’t want to have governance that’s VC governance, so you don’t want to give up board control; you don’t want to have regular board meetings; you don’t want to have to concentrate too much on financials at this stage. And finally, you want to be careful about firms that may have negative signaling value – so, people who often do invest in subsequent rounds and sometimes don’t – because if one of those people invest in your financing and then does not follow on in the next round, it can be a signal of death, a death knell to the other prospective investors.

Nivi: Right, so the ones to worry about most on the signaling value are the multi-stage firms who are investing in seed rounds mostly to have the option to invest in the next round, and maybe a little bit about the seed-stage firms that present as firms.

Naval: Seed-stage firms generally don’t lead or invest in following rounds, so it’s less of an issue.

Nivi: Not even for pro rata? I’m talking about a First Round.

Naval: Yeah, it depends on the firm, but yes, for example First Round probably normally does pro rata so that signal is important. But someone who is investing and doesn’t seem to care about the valuation at this time, but wants a contractual option to invest in the next round, there you’d really have to worry.

Nivi: And they don’t even need a contractual option. It doesn’t matter.

Naval: Yeah, it’s just an even stronger signal with the contractual option if they don’t exercise it.

Nivi: Yeah. I guess the other thing to worry about if it’s a multi-stage firm, is if they don’t own enough in the seed-stage round.

Naval: Yes, because then they’re going to want to invest maybe more than their pro rata in the next round, and that can create strange dynamics where they’re trying to bid your valuation down.

Nivi: Yeah, and the bottom line is if they’re trying to increase their percentage ownership in a subsequent round of financing, they have an incentive to drive down your valuation in the next round. You might ask if they don’t always have that incentive. No. If you want to do your pro rata or decrease your percentage ownership in the next round, you’d no longer have that incentive. If you want to just do your pro rata, you’re indifferent on the valuation of the next round, and if you want to decrease your ownership you actually want to increase the valuation in the next round as much as possible.

What do you see when these seed-stage and multi-stage firms participate in terms of leaving room for angels, taking half the round, just participating as like 25% of the round like another angel?

Naval: The good ones will leave room, and it’s up to the entrepreneur to dictate. Probably one of the biggest mistakes you can make in doing a syndicate is where you don’t leave enough room for individual investors, and you give everything up to one or two lead investors. The amount of help you get out of a person is relatively fixed. There might be slight variations around the edges, but you’re passing up most of the advisory benefit of having angels if you don’t do a mass syndication to a large group.

Nivi: Another bit of advice I would give is if you’re going to raise money from a fund in a seed round that has signaling power in the next round, don’t raise money from just one, get a couple in there.

Naval: Yeah, it helps to diffuse that signal.

Get intros to seed investors with AngelList/StartupList

Nivi: OK, thanks for listening. Nivi and Naval are signing off.

A last plug for our products is Angel List, which is our curated list of angel investors and what they’re looking for and how to get in touch with them, and Startup List, which is where you apply to us, we look at your pitch, if we like it we pass it on to whatever angels you want us to pass it on to, or we’ll pass it on to all the angels on Angel List if you like.

The metrics on that, to date, are pretty good. The whole idea is about five weeks old. We’ve had about 25 investors ask for intros. The other cool thing about it that I like is the investors come to you and ask for an intro, but great investors like Jeff Clavier, and Ann from Mike Maples’ fund, and guys like Matt Mullenweg, and Jon Callahan from True – just a great bunch of guys – are asking for intros. About 15 startups have gotten intros and we’ve even gotten one startup funded so far, and probably more coming online pretty soon.

Naval: One that we can talk about right now.

Nivi: One that we can talk about, yeah, where Matt Mullenweg, the founder of WordPress, invested, and we hope to announce some more success stories about Startup List soon.

Thanks for listening! Bye, bye.

Today we’re announcing that LearnBoost has raised money with AngelList.  LearnBoost makes an “easy-to-use online gradebook for teachers.”

LearnBoost was referred to us by two-time Power Broker Harper Reed. They used AngelList to contact George Zachary and Jeff Fagnan who invested:

George Zachary (Investor in Twitter)

Jeff Fagnan (Investor in Songbird)

George then introduced LearnBoost to AngelList members Bill Lee, James Hong, and Othman Laraki who also invested:

Bill Lee (Investor in Tesla Motors)

James Hong (Investor in Slide)

Othman Laraki (Founder of Mixer Labs)

Finally, here’s a few of the investors who sourced LearnBoost without AngelList and invested:

RRE (Investor in Venmo)

Bessemer (Investor in Postini)

Update: Read more about LearnBoost’s fundraising experience on the LearnBoost blog.

About LearnBoost

What is LearnBoost? In their own words,

“Our Teacher Gradebook is the best gradebook software on the web.

“Beautiful design and wonderful user experience makes you wonder why you’ve been using other gradebooks. Plus we’re free. Your new found productivity means you can spend more time doing what you do best: teach.”

Update 2: Learn more about LearnBoost in this detailed Xconomy profile: LearnBoost Bets on Better Tools for Teachers.

Startups: Get intros to AngelList here.
Angels: Join AngelList here.
Everyone: Get AngelList updates via Twitter and RSS.

Today we’re announcing that Thumbtack has raised money with AngelList.  Thumbtack is “your marketplace for local services.”

Thumbtack got their first commitments at Open Angel Forum, from Joshua Schachter, Cyan & Scott Banister, and Jason Calacanis. Then they used AngelList to contact Ariel Poler and Auren Hoffman who invested:

Ariel Poler (Investor in AdMob)

Auren Hoffman (Investor in Aardvark)

Thumbtack’s CEO, Marco Zappacosta, sent me this very nice email about his AngelList experience:

“Both Ariel Poler and Auren Hoffman came from AngelList. And Auren introduced me to Scott Fabor and Mark Britto who are also now investing. Joshua Schachter & Jason Calacanis are also on the list but I was first introduced to them through Jason’s Open Angel Forum.

“The value of AngelList goes beyond the money, though — the introductions have been killer, even when they didn’t net a check. I got to meet with Keith Rabois, Bryan Schreier, Floodgate, First Round, Jeremy Levine, and others: relationships that I would not have been able to initiate without you guys.”

Read more about Marco’s fundraising experience on the Thumbtack blog.

About Thumbtack

What is Thumbtack? In their own words,

“Why can you go online right now and buy any product you want but you can’t do the same for tutors, handymen, dog walkers, or other local services? Thumbtack is changing that.

“Thumbtack isn’t like typical local search directories that simply return business listings with ratings and reviews, leaving you no better off than the paper Yellow Pages.

“Instead, Thumbtack gives you the ability to vet, contact and book service professionals the moment you find them.”

Sounds like a service I need to try.

Startups: Get intros to AngelList here.
Angels: Join AngelList here.
Everyone: Get AngelList updates via Twitter and RSS.