An interview with investor Paul Graham of Y Combinator

An interview with investor Paul Graham of Y Combinator

September 2 2006

 Paul Graham believes we're not in a bubble, that startups shouldn't worry about their business models and the best companies are the ones with potential to kill old monopolies. Graham is a partner at Y Combinator, a Mountain View firm that invests in very early tech startups. Companies that Y Combinator has funded include the social news site Reddit, online form creation tool Wufoo (our coverage ), and the online calendaring startup Kiko, whose controversial sale on eBay last month ended with a quarter million dollar winning bid. The next Y Combinator funded company to launch will be loopt, a mobile presence service also funded by Sequoia. Y Combinator's site says, "We're the right choice for a group of two or three young hackers who have an idea, and want some money and advice to get it launched."

Graham is known for making strong statements about innovation and economics in technology. He's the author of three books, most recently Hackers and Painters, published by O'Reilly. His essays can be found at PaulGraham.com. The picture of Paul on the left is from his keynote talk at this year's RailsConf.

In the following short interview, we talked about the growing trend of small investments in tech companies, Paul's thoughts on startup business models, Kiko, the bubble and Web 2.0.

Marshall: One of the dilemmas that some startups face is that VCs only want to make large investments and small startups aren't always interested in that – Digg most famously. Some people believe that's changing though. Do you think that small investments in very early stage startups represent a growing trend, and if so why?

Paul: There's definitely a trend toward smaller investments, because it costs so much less to start a startup now. And if you take less money initially, you keep more options open. Once you've taken a VC-scale investment of two or three million dollars, you give up the option of an early acquisition.

You're also under more pressure to grow fast, which can cause you to make design errors. It may not be a coincidence that both Flickr and Del.icio.us avoided the usual VC route. Both had to get a lot of subtle, social things just right. You're more likely to do that if you can evolve organically.

You mentioned Digg as an example of a company that took VC money. They took $2.8 million, whereas reddit, their closest competitor, has taken only $88,000. (I know because Y Combinator funded them.) And yet reddit is not only able to compete, but has a visibly more authentic, participatory feeling. I read that the top 100 Digg users submit 56% of the frontpage stories. The frontpage stories on reddit are much more widely distributed. And that may be because reddit grew organically, through word of mouth, like Flickr and Del.icio.us did.

Whatever the causes, it's an interesting data point that a company with $88,000 in funding can even compete against one with $2.8 million. That could not have happened before the web.

Marshall: You've said that having a good business model is not important for startups because the good ones are liable to change models several times anyway. Yet many people believe that the absence of viable business models is one of the primary indications that we're in a bubble. Do you disagree with that?

Paul: What I tell founders is not to sweat the business model too much at first. The most important task at first is to built something people want. If you don't do that, it won't matter how clever your business model is.

Of course you have to have a business model eventually. But experience so far suggests that figuring out how to make money from something popular is a lot easier than making something popular.

I get a lot of criticism for telling founders to focus first on making something great, instead of worrying about how to make money. And yet that is exactly what Google did. And Apple, for that matter. You'd think examples like that would be enough to convince people.

Is this another Bubble? I don't think so, not so far. There may be a lot of lame startups being started, but that's not the definition of a bubble. A bubble is when a lot of money is being invested in lame startups, and that's not happening yet. The reason so many new startups are getting started is that the cost has gone down, not that funding has gone up.

Marshall: What kinds of companies or particular technologies are you most excited about right now?

Paul: There are so many. I especially like things that take advantage of the power of networks. As Sun used to say, the network is the computer. Except now it's the Internet plus the phone network, not just your local LAN, and that changes everything.

Frankly, even though I'm supposed to be an investor, the ideas that excite me most are not necessarily the ones that make the most money, but the ones that blow away evil old monopolies. For example, I love collaborative news sites not so much because they make a lot of money– though they might– but because they've shown what a bad job the "old media" were doing.

Most people don't understand what a social force startups can be. There are a lot of changes that can only happen through companies. One startup I dream of funding is the one that kills the record companies. You know your business model is broken when you're suing your customers. The new business model must be out there somewhere, and my guess is that the way to beat the bad guys is not through political action (or at least, not only that), but by inventing
whatever replaces them.

Marshall: You were an investor in online calendar startup Kiko, whose founders recently sold the company on eBay. When the company was initially put up for auction you said that the release of Google Calendar and its integration with GMail was what nailed Kiko. You wrote that the best lesson for startups was probably to stay out of Google's way and that the best way to do that was to not start something that Google employees would use at work – have I got that summarized right? I know I've given some more consideration to my initial statement that Google killed Kiko in light of the things made possible by the Google Calendar API. Do you think the game is over for startups making online productivity apps?

Paul: Yes, that's a pretty accurate summary. I wouldn't advise competing with Google in things they're good at. So what is Google good at? As a first approximation, making things their own developers use at work. So they'll do a better job on an online calendar than a video sharing site, for example, because their employees are probably not supposed to be sitting watching videos at work.

Another weakness of Google's is that they're a big company. I've heard some real horror stories from hackers there about the bureacratic obstacles to getting stuff released. That means they're unlikely to do anything so novel that it frightens the bureaucrats.

So a startup could compete with Google if they had an idea so wild that it would freak out the internal gatekeepers, no matter what area it was in.

Unfortunately for the Kikos, there's probably not as much room for wild ideas in calendars as in other applications. We all knew Google Calendar was coming, of course, but we hoped it would be the Orkut of calendars. Unfortunately it seems more to be the GMail of calendars, and it's clear now why– because Google Calendar and GMail are the kinds of applications Google hackers use at work, and Orkut isn't.

Marshall: What's the new startup you funded from the Kiko team?

Paul: I can't say yet, but it is certainly the most entertaining idea we've ever funded. In fact, insane might be a better word. But it's what they wanted to do.

Marshall: What's your take on the question of whether most Web 2.0 technologies only appeal to a relatively small niche? If you could share any of your thoughts on what you think helps a technology stick and gain a viable foothold in the market, I'm sure that would be much appreciated by our readers.

Paul: To me "web 2.0″ translates to "web." And web technologies don't appeal only to a small niche. Web-based email services have hundreds of millions of users. The network (in the broader sense of the Internet plus the phone networks) pervades everything now.

We're pretty open about what we think makes a technology stick. We print it on T-Shirts: "Make something people want." If you had to reduce the recipe for a successful startup to four words, those would probably be the four.

The easiest way to make something people want is to make something you want. What do you wish existed that doesn't? For example, back in the early 90s a friend of mine wrote some software for converting voice to data so he could talk to his girlfriend in Taiwan without paying for long-distance phone calls. That would have been a great project to turn into a startup.

If you're a little older and/or have some particular domain expertise, you could try making something that you yourself don't want, but you think other people do. This is a much riskier path, though. Most of the great startups seem to have begun with something the founders wanted: Google, Yahoo, Apple, even Microsoft.

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Comments

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  1. NeoTechie

    Thanks for the insight Paul. We are not in a bubble. Rather, we are in a great era; companies have realized that they have to build services for various communities that visit and patronize them. In Web 2.0, everyone has the opportunity to offer something useful on the web. The innovation must not and should not only come from big companies.

    What will you offer to Web 2.0?

  2. David G

    Good interview Marshall,

    I would love to see more of these VC interviews. Though it may not appeal to your core audience. As an entrepreneur I find these conversations fascinating, especially when it goes counter to current thinking (Bubble or not, Business model or not). Perhaps you should have a VC Crunch!

    Best,
    David Gratton

  3. Jawad Shuaib

    I agree. I don't think we will ever hit a bubble again since each time a company gets funded, alarms go off. Investors are too cautious to make the same kinds of mistakes they made in the past.

  4. Jessep

    After this article/interview, I hereby forgive you, Marshall, for that story you did a couple of weeks ago that got everyone worked up .

  5. Ryan Nichols

    Yeah the VC interview is great. Best quote: "The easiest way to make something people want is to make something you want." I've seen the CEO's who are 'passionate' about building something they won't even use themselves.

  6. Skeptic

    Paul, I have no business model but I think I can take on Microsoft since they are so established. Can I have some money now please?

  7. Jessep

    Their funding cycle seems a bit slow. The application for Winter 2007 funding is in Oct 06. By the time any one group gets funding for an idea, the freshness will have long been passed.

    I'm very interested in seeing more VC companies like this, though, that want to seed young startups.

    One novel idea (started by http://www.flucid.com I believe) is to take the incubation and collaboration process online. How cheap would *that* make it?

  8. Startups.in/India

    "That means they're unlikely to do anything so novel that it frightens the bureaucrats. So a startup could compete with Google if they had an idea so wild that it would freak out the internal gatekeepers, no matter what area it was in."

    such as? Any examples?

  9. Skeptic Too

    No business model != business
    No business model == gamble

    I think it's quite dumb to tell a founder that they don't need to worry about the business model when they get started. Building something popular isn't that difficult when you give stuff away for free. I have millions of great ideas that could never be monetized. Having 20 million people using your service is worthless if you have no idea on how to monetize them. As such, a service with a smaller number of users led by a management team that knows how to monetize those users is, in a sane world, worth a lot more than a service with a large number of users that has no idea how to monetize them.

    Apple, Microsoft, Google. Nice names to rattle off. These are the exception, not the rule. And while it's true that many companies change business models several times, it takes an experienced (or intelligent) management team to adapt quickly. The barrier to entry in Web 2.0 doesn't exist. You may not have time to change your business model when a new competitor that did think develop a business model comes along. Starting off with nothing is not way to start a BUSINESS. There are plenty of great ideas out there. Not all of them are great BUSINESS ideas. And don't VCs invest in businesses, not ideas?

    "Frankly, even though I'm supposed to be an investor, the ideas that excite me most are not necessarily the ones that make the most money, but the ones that blow away evil old monopolies. For example, I love collaborative news sites not so much because they make a lot of money– though they might– but because they've shown what a bad job the "old media" were doing."

    Isn't every VCs wet dream to fund a company that becomes an evil monopoly? Maybe Paul should become a philanthropist. In any case, when speaking of collaborative news sites I'm assuming he's talking about Digg and Reddit. From my use of these services, many of the news stories being "dug" are written by old media. Quite funny isn't it?

    I love how Paul completely sidesteps Marshall's question about the criticisms that most Web 2.0 services are too niche. Paul apparently doesn't understand the concept of niche and tries to obfuscate the fact that for most people Web 2.0 does not translate to "web technologies" as a whole. Here's an example Paul:

    Online photo sharing: appeals to a huge number of people
    Online photo sharing 2.0 (tagclouds, geotagging, portals, etc.): appeals to a very small subset of the photo sharing market

    Flickr is a perfect example. It's a cool service but in the overall photo sharing market, it has a very small marketshare. Many of its features only appeal to a small niche of mostly techies.

    Let's take Paul's example: web-based email. Very popular. This isn't a Web 2.0 service, but I have an idea for a Web 2.0 email client. I'll take Hotmail, add AJAX, tagclouds, geotagging, a built-in wiki for all the topics I've ever discussed in my emails, etc. Think I'm going to overtake Hotmail? Write me a check and I'll build it for you.

    "Make something people want."

    The problem, Paul, is that too many of these startups are creating things that the majority of the people don't want. Let's look at 3 of the investments I know you have made:

    Kiko: Enough people didn't use it.

    Wufoo: Online form builder. 1998 called. This is a commodity.

    YouOS: Your site links to the Slate article on this startup. Look at all the comments. Slate and the comments people posted point out the flaw: very few people will use this. How'd you invest in something that broke your golden rule?

    There are an infinite number of things people want. Many VCs are investing in things most people don't want. And when a VC does invest in something people want, shouldn't they be investing in a business that knows how to make money off of it?

  10. nat.

    I think people need to take affordability into consideration.

    if, i'm saying if there's an economic crash somewhere down the road…
    then many pros of web 2.0 or even the entire web….would become less influential.. what do you think?

  11. Peter

    my bad. i thought i'd read the "make something you want" part, but couldn't find it when i went back to re-read.

  12. nat.

    there should be some more "solid" stuff on internet….not just ideas, ideas won't worth a lot to you when you are having trouble finding things to eat.

    i think in my lifetime there's definitly 1~2 economic crash….

    but if we can link cryonic with the internet…or quantum computer, then things may be a little different.

    I know this is too crazy but this is what I do or at least heading to do…

  13. nat.

    I quite agree with [Skeptic Too] post #9, it's good to be idealistic but bad to be optimistic about idealism….

  14. Marshall Kirkpatrick

    "it's good to be idealistic but bad to be optimistic about idealism…." a person could chew on that one for a long time!

  15. Sal

    Anyone can trade a $100 bill for a $99. A VC on a major tech site saying to founders no need to worry about a business model when starting a business is the best indication how big and fragile the bubble is.

  16. gazzle

    Skeptic Too. Love your points. I have a few to add.
    Paul loves to mince his words (as you have pointed out that Web2.0 = Web when in fact Web2.0 it is not). Heck I'm a Techcrunch junkie and I don't even use Flickr or Delicious.

    Regarding bubbles… sure we may not be having an investment led bubble, but the idea of getting customers without a business model reeks of the previous dot.com bubble. Remember the 2000-ish mantra "as long as we got eyeballs, making money is not important"?… well how do you get eyeballs? Build something people want and give it away for free!

    Bubbles are formed when people do crazy things that they can't really explain but can refer to some other crazy people who just happen to have it go their way.

    i) Buy a stock of a company because it ends with a '.com'… because it could be the next Amazon.com and eBay.com.

    ii) Buy houses in inflated markets with outrageous mortgages because 'home values will only go up'.

    iii) Start a business without any clue how to make money because "Apple and Google" did it.

  17. Vincent van Wylick

    I think there's a difference between no business model and really no business model. What Paul Graham wants is radical ideas, which can then be transformed into a business. Anything too radical will be rejected, of course. The reason why venture capitalists exist is not only to fund but also to give business advice. If every start-up had a valid business model, venture capitalists wouldn't exist and banks would be funding a lot more start-ups.

  18. Sheamus

    Terrific interview… Wonderful questions (kudos) and thoughtful answers (kudos). It is intersting to note that this morning Hugh MacLeod's Gaping Void referenced this interview and quoted Paul's comments. On a separate note, I value Techcruch and read it daily as it introduces (on a very timely basis) fresh technological ideas and innovations and… The writing is first-rate!

  19. me

    Con artist, he sold a product to Yahoo that was junk and acquires geek karma by talking about his ARC, which no one has seen.

    Just another business type pretending to be a geek so he can enslave your sorry ass.

  20. Get Bought

    I think people are likely missing another path out for Paul to make money on his investments: getting bought.

    When he brings up flickr and delicious, those sites weren't making any money, but they were ramping up at tens of thousands of users per month at the end of their indy days. The lights at Yahoo then went a buzzin' and they both got bought. I think this model is actually more predominant in his head than "long term viable business" with a business model. Build something people want, ramp up your user base, and have someone buy you because they are in a holy war with the other media companies and want users.

    But let's get real. This model too is indeed a risky proposition because out of the thousands of start-ups, how many are getting bought by Google/Yahoo, etc.? Most likely a lot of the start-ups now WILL flame out in 12-24 months, but in Paul's world, the folks in motion are in their early twenties and will live to tell about it. His model wouldn't work with a bunch of 40-something married with kids types.

  21. Alan Wilensky

    What's it like working with Paul Graham and Ycombinator?

    See:

    http://bizcast…./kiko/kiko2.mov

  22. Alan Wilensky

    oops wrong segment:

    Working with Ycombinator:

    http://bizcast…./kiko/kiko4.mov

  23. dH

    Kiko.com could be the best online calendar.
    But, these times, Google Calendar is that. Poor Kiko.

  24. Alan Wilensky

    Some of the longer and more pessimistic, vitriolic comments regarding Mr. Graham exhibit a quality of transparent jealousy that I haven't seen in a while.

    Providing mentorship and seed funding to small teams who work directly on their own code and working prototypes, helping transitioning them to fully realized works, is a laudatory, Johnny Appleseed model for the VC community.

    A small direct investment in teams that do the work themselves, in an environment of innovation, is just like a greenhouse for great things of the next web.

    I really get kick out the folks here who pooh pooh Paul Graham and Ycombinator – picking out each venture and flippantly disparaging each startup like a Monday morning quarterback; feh on you.

    This is what we need – the freedom for small teams to get the rent paid, buy food and office supplies, hire that one other team member – this is what Ycombinator does.

    One only has to walk down that tree-lined neighborhood in Cambridge MA, and walk through te doors of Paul's incredible incubator of ideas, and breath in, deeply, the aroma of new and great ideas.

    Here's to you, Paul Graham, here;s to you.

  25. Dimitar Vesselinov

    Should we listen to Paul Graham? When was his last big hit? 1998?

  26. Alan Wilensky

    The above comment as to whether we should "listen" to Mr. Graham is to narrow the scope of the issue of technology incubation and completely ignore the viability and wider dispersion of great ideas that are fostered in environments like Ycombinator.

    It's not the top 40, it's not all about IPO's, it IS about successful products, teams, and companies; a longer view should take into account the total legacy and genealogy of all the startups and the intellectual capital that is spun off – no matter where they started from.

  27. Philip Tadros

    "The easiest way to make something people want is to make something you want."

    even better, cause i want a site that isn't myspace but everyones on, i want a site that's craigslist with faces, an interactive yellow pages and digg in my backyard with feeds and seeds all pointing to metroproper'

    long story short, i like what you said, thanks for sharing;]

    the proper network

  28. Paul Graham

    Though the intro calls me a VC, that's not really accurate. In the business, "VC" has a very specific meaning. VCs run funds, like mutual funds; they invest on behalf of the investors in their funds. At Y Combinator we invest our own money, which makes us closer to angel investors.

    VCs and angels have very different personalities. VCs are mostly MBAs, while angels are generally tech people.

  29. Marshall Kirkpatrick

    Thanks Paul, got that corrected.

  30. Business2.0

    I tend to agree that you definately need at least some sort of business model when you set out to start any start up you are building and I definately thinking that going into the start-up environment with the whole "advertising is my revenue model" is not the best way to go.

    Im sure that Google or Yahoo didn't rock up on a VC door and go "oh yeah we have created this awesome search technology and we believe it will be driven by advertising". Somehow, I think they got there search technology right, then the everything else was a spin-off from this. I read a post off Blogger.com from a start up in Australia that I found, named Ayamae, and their CEO seems to have an interesting strategy to Web 2.0 on his "Bus Adventure". Not sure what you guys think? http://www.ayamae.com/blog/

    Either way, I'm all for innovation, just not for getting there with no clear strategy.

    My 2 cents anyways.

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