The Future of Web Startups

The Future of Web Startups

paulgraham.com
October 2007

(This essay is derived from a keynote at FOWA in October 2007.)

There’s something interesting happening right now. Startups are
undergoing the same transformation that technology does when it becomes
cheaper.

There’s a pattern that we see over and over in technology. Initially
there’s some kind of device that’s very expensive and custom made
in small quantities. Then someone figures out a way to make them
much more cheaply, and orders of magnitude more get built.
And that allows them to be used
in ways that would have been inconceivable before.


Computers are a familiar example. When I was a kid, computers were
big, expensive machines built one at a time. Now they’re a commodity.
And because they’re so cheap we can use them in new ways. Now we
can stick computers in everything.

This pattern has been around for a long time. Most of the turning
points in economic history are instances of it. It happened to
steel in the 1850s, and to power in the 1780s.
It happened to cloth manufacture in the thirteenth century, generating
the wealth that later brought about the Renaissance. Agriculture
itself was an instance of this pattern.

Now as well as being produced by startups, this pattern
is happening to startups. It’s so cheap to start web startups
that orders of magnitudes more will be started. And if the pattern
holds true, that should cause dramatic changes.

1. Lots of Startups

So my first prediction about the future of web startups is pretty
straightforward: there will be a lot of them. When starting a
startup was expensive, you had to get the permission of investors
to do it. Now the only threshold you have to get over is whether
you have the courage to.

Even that threshold is getting lower, as people watch others take
the plunge and survive. In the last batch of startups we funded,
we had several founders who said they’d thought of applying before,
but weren’t sure and got jobs instead. It was only after hearing
reports of friends who’d done it that they decided to try it
themselves.

Starting a startup is hard, but having a 9 to 5 job is hard too,
and in some ways a worse kind of hard. In a startup you have lots
of worries, but you don’t have that feeling that your life is flying
by like you do in a big company. Plus in a startup you could make
orders of magnitude more money.

As word spreads that startups work, the number of startups may grow
to a point that would now seem quite surprising.

We now think of it as normal to have a job at a company, but this
is the the thinnest of historical veneers. Just two or three
lifetimes ago, most people in what are now called industrialized
countries lived by farming. So while it may seem surprising to
propose that large numbers of people will change the way they make
a living, it would be more surprising if they didn’t.

2. Standardization

When technology makes something dramatically cheaper, standardization
always follows. When you make things one at a time they can all
be different, but when you make them in larger volumes it’s more
efficient to standardize everything that doesn’t need to change.

At Y Combinator we still only have four people, so we try to
standardize everything we can. We could hire employees to help us,
but we prefer to be forced to discover ways to do things more
efficiently. We want to be forced to figure out how to scale
investing.

We often tell startups to release a minimal version one as soon as
possible, then let the needs of their users tell them what to do
next. In essense, let the market design the product. We’ve been
doing the same thing ourselves. We think of the techniques we’re
developing for dealing with large numbers of startups as like
software. Sometimes it literally is software, like
Hacker News and
our application rating system.

One of the most important things we’ve been working on standardizing
are investment terms. Back in the old days when there were only a
few startups, investment terms were all individually negotiated.
This was a problem for founders, because it meant raising money
took longer and cost more in legal fees. So as well as using the
same paperwork for every deal we do, we’ve commissioned generic
angel paperwork that all the startups we fund can use for future
rounds.

Some investors will still want to cook up their own deal terms.
Series A rounds, where you raise a million dollars or more, will
be custom deals for the forseeable future. But I think angel rounds
will start to be done mostly with standardized agreements. An angel
who wants to insert a bunch of complicated terms into the agreement
is probably not one you want anyway.

3. New Attitude to Acquisition

Another thing I see starting to get standardized is acquisitions.
As the volume of startups increases, big companies will start to
develop standardized procedures for acquisitions, so they’re little
more work than hiring someone.

Google is the leader here, as in so many areas of technology. They
buy a lot of startups— more than most people realize, because they
only announce a fraction of them. And being Google, they’re
figuring out how to do it efficiently.

One problem they’ve solved is how to think about acquisitions. For
most companies, acquisitions still carry some stigma of inadequacy.
Companies do them because they have to, but there’s usually some
feeling they shouldn’t have to—that their own programmers should
be able to build everything they need.

Google’s example should cure the rest of the world of this idea.
Google has by far the best programmers of any public technology
company. If they don’t have a problem doing acquisitions, the
others should have even less problem. However many Google does,
Microsoft should be doing ten times as many.

Of course, one reason Google doesn’t have a problem with acquisitions
is that they know first-hand the quality of the people they can get
that way. Larry and Sergey only started Google after making the
rounds of the search engines trying to sell their idea and finding
no takers. They’ve been the guys coming in to visit the big
company, so they know who might be sitting across that conference
table from them.

4. Riskier Strategies are Possible

Risk is always proportionate to reward. The way to get really big
returns is to do things that seem crazy, like starting a new search
engine in 1998, or turning down a billion dollar acquisition offer.

This has traditionally been a problem in venture funding. Founders
and investors have different attitudes to risk. Knowing that risk
is on average proportionate to reward, investors like risky strategies,
while founders, who don’t have a big enough sample size to care
what’s true on average, tend to be more conservative.

If startups are easy to start, this conflict goes away, because
founders can start them younger, when it’s rational to take more
risk, and can start more startups total in their careers. When
founders can do lots of startups, they can start to look at the
world in the same portfolio-optimizing way as investors. And that
means the overall amount of wealth created can be greater, because
strategies can be riskier.

5. Younger, Nerdier Founders

If startups become a cheap commodity, more people will be able to
have them, just as more people could have computers once microprocessors
made them cheap. And in particular, younger and more technical
founders will be able to start startups than could before.

Back when it cost a lot to start a startup, you had to convince
investors to let you do it. And that required very different skills
from actually doing the startup. If investors were perfect judges,
the two would require exactly the same skills. But unfortunately
most investors are terrible judges. I know because I see behind
the scenes what an enormous amount of work it takes to raise money,
and the amount of selling required in an industry is always inversely
proportional to the judgement of the buyers.

Fortunately, if startups get cheaper to start, there is another way
to convince investors. Instead of going to venture capitalists
with a business plan and trying to convince them to fund it, you
can get a product launched on a few tens of thousands of dollars
of seed money from us or your uncle, and approach them with a
working company instead of a plan for one. Then instead of
having to seem smooth and confident, you can just point them to
Alexa.

This way of convincing investors is better suited to hackers, who
often went into technology precisely because they felt uncomfortable
with the amount of fakeness required in other fields.

6. Startup Hubs Will Persist

It might seem that if startups get cheap to start, it will mean the
end of startup hubs like Silicon Valley. If all you need to start
a startup is rent money, you should be able to do it anywhere.

This is kind of true and kind of false. It’s true that you can now
start a startup anywhere. But you have to do more with a
startup than just start it. You have to make it succeed. And that
is more likely to happen in a startup hub.

I’ve thought a lot about this question, and it seems to me that the
increasing cheapness of web startups will if anything increase the
importance of startup hubs. The value of startup hubs, like centers
for any kind of business, lies in something very old-fashioned:
face to face meetings. No technology in the immediate future will
replace walking down University Ave and running into a friend who
tells you how to fix a bug that’s been bothering you all weekend,
or visiting a friend’s startup down the street and ending up in a
conversation with one of their investors.

The question of whether to be in a startup hub is like the question
of whether to take outside investment. The question is not whether
you need it, but whether it brings any advantage at all.
Because anything that brings an advantage will give your competitors
an advantage over you if they do it and you don’t. So if you hear
someone saying "we don’t need to be in Silicon Valley," that use
of the word "need" is a sign they’re not even thinking about the
question right.

And while startup hubs are as powerful magnets as ever, the increasing
cheapness of starting a startup means the particles they’re attracting
are getting lighter. A startup now can be just a pair of 22 year
old guys. A company like that can move much more easily than one
with 10 people, half of whom have kids.

We know because we make people move for Y Combinator, and it doesn’t
seem to be a problem. The advantage of being able to work together
face to face for three months outweighs the inconvenience of moving.
Ask anyone who’s done it.

The mobility of seed stage startups means that seed funding is a
national business. One of the most common emails we get is from
people asking if we can help them set up a local clone of Y Combinator.
But this just wouldn’t work. Seed funding isn’t regional, just as
big research universities aren’t.

Is seed funding not merely national, but international? Interesting
question. There are signs that it may be. We’ve had an ongoing
stream of founders from outside the US, and they tend to do
particularly well, because they’re all people who were so determined
to succeed that they were willing to move to another country to do
it.

If the seed funding business turns out to be international, that
could make it hard to start new silicon valleys. If startups are
mobile, the best local talent will go to the real Silicon Valley,
and all they’ll get at the local one will be the people who didn’t
have the energy to move.

This is not a nationalistic idea, incidentally. It’s cities that
compete, not countries. Atlanta is just as hosed as Munich.

7. Better Judgement Needed

If the number of startups increases dramatically, then the people
whose job is to judge startups are going to have to get better at
it. I’m thinking particularly of investors and acquirers. We now
get on the order of 1000 applications a year. What are we going
to do if we get 10,000?

That’s actually an alarming idea. But we’ll figure out some kind
of answer. We’ll have to. It will probably involve writing some
software, but fortunately we can do that.

Acquirers will also have to get better at picking winners. At the
moment they generally do better than investors, because they pick
later, when there’s more performance to measure. But even at the
most advanced acquirers, the process of identifying companies to
buy is extremely ad hoc, and completing the acquisition often
involves a great deal of unneccessary friction.

I think acquirers may eventually have chief acquisition officers
who will both identify good acquisitions and make the deals happen.
At the moment those two functions are separate. Promising new
startups are often discovered by developers. If someone powerful
enough wants to buy them, the deal is handed over to corp dev guys
to negotiate. It would be a lot better if both were combined in
one group, headed by someone with a technical background and some
vision of what they wanted to accomplish. Maybe in the future big
companies will have both a VP of Engineering responsible for
technology developed in-house, and a CAO responsible for bringing
technology in from outside.

At the moment, there is no one within big companies who gets in
trouble when they buy a startup for $200 million that they could
have bought earlier for $20 million. There should start to be
someone who gets in trouble for that.

8. College Will Change

If the best hackers all start their own companies after college
instead of getting jobs, that will change what happens in college.
Most of these changes will be for the better. I think the experience
of college is warped in a bad way by the expectation that afterward
you’ll be judged by potential employers.

One of the most obvious changes will be in the meaning of "after
college," which will change from when one graduates from college
to when one leaves it. If you’re starting your own company, why
do you need a degree? We don’t encourage people to start startups
during college, among other things because it gives them a socially
acceptable excuse for quitting, but the best founders are certainly
capable of it. Some of the most successful companies we’ve funded
were started by undergrads.

I grew up in a time where college degrees seemed really important,
so I’m alarmed to be saying things like this, but there’s nothing
magical about a degree. There’s nothing that magically changes
after you take that last exam. The importance of degrees is due
solely to the administrative needs of large organizations. These
can certainly affect your life—it’s hard to get into grad
school, or to get a work visa in the US, without an undergraduate
degree—but tests like this will matter less and
less.

As well as mattering less whether students get degrees, it will
also start to matter less where they go to college. In a startup
you’re judged by users, and they don’t care where you went to
college. So in a world of startups, elite universities will play
less of a role as gatekeepers. In the US it’s a national scandal
how easily children of rich parents game college admissions.
But the way this problem ultimately gets solved may not be by
reforming the universities but by going around them. We in the
technology world are used to that sort of solution: you don’t beat
the incumbents; you redefine the problem to make them irrelevant.

The greatest value of universities is not the brand name or perhaps
even the classes so much as the other students you meet there. If
it becomes common to start a startup after college, people may start
consciously trying to maximize this. Instead of focusing on getting
internships with companies they want to work for, students may start
to focus on working with other students they want as cofounders.

What students do in their classes will change too. Instead of
trying to get good grades to impress future employers, students
will try to learn things. We’re talking about some pretty dramatic
changes here.

9. Lots of Competitors

If it gets easier to start a startup, then it’s not just easier for
you, but for competitors too. That doesn’t erase the advantage of
increased cheapness, however. You’re not all playing a zero-sum
game. There’s not some fixed number of startups that can succeed,
regardless of how many are started.

In fact, I don’t think there’s any limit to the number of startups
that could succeed. Startups succeed by creating wealth, which is
the satisfaction of people’s desires. And people’s desires seem
to be effectively infinite, at least in the short term.

What the increasing number of startups does mean is that you won’t
be able to sit on a good idea. Other people have your idea, and
if it gets easier to start startups, they’ll be increasingly likely
to do something about it.

10. Faster Advances

There’s a good side to that point, at least for consumers of
technology. If people get right to work implementing ideas instead
of sitting on them, technology will evolve faster.

Some kinds of innovations happen a company at a time, like the
punctuated equilibrium model of evolution. There are some kinds
of ideas that are so threatening that it’s hard for big companies
even to think of them. Look at what a hard time Microsoft is
having discovering web apps. They’re like a character in a movie
that everyone in the audience can see something bad is about to
happen to, but who can’t see it himself. These big innovations
that happen one company at a time will obviously happen faster if
the rate of new companies increases.

But in fact there will be a double speed increase. People won’t
wait as long to act on new ideas, but also those ideas will
increasingly be developed within startups rather than big companies.
Which means technology will evolve faster per company as well.

Big companies are just not a good place to make things happen fast.
I talked recently to a founder whose startup had been acquired by
a big company. He was a precise sort of guy, so he’d measured their
productivity before and after. He counted lines of code, which can
be a dubious measure, but in this case was meaningful because it
was the same group of programmers. He found they were one thirteenth
as productive after the acquisition.

The company that acquired them was not a particularly stupid one.
I think what he was measuring was mostly the cost of bigness. I
experienced this myself, and his number sounds about right. There’s
something about big companies that just sucks the energy out of
you.

Imagine what all that energy could do if it were put to use. There
is an enormous latent capacity in the world’s hackers that most
people don’t even realize is there. That’s the main reason we do
Y Combinator: to let loose all this energy by making it easy for
hackers to start their own startups.

A Series of Tubes

The process of starting startups is currently like the plumbing in
an old house. The pipes are narrow and twisty, and there are leaks
in every joint. In the future this mess will gradually be replaced
by a single, huge pipe. The water will still have to get from A
to B, but it will get there faster and without the risk of spraying
out through some random leak.

This will change a lot of things for the better. In a big, straight
pipe like that, the force of being measured by one’s performance
will propagate back through the whole system. Performance is always
the ultimate test, but there are so many kinks in the plumbing now
that most people are insulated from it most of the time. So you
end up with a world in which high school students think they need
to get good grades to get into elite colleges, and college students
think they need to get good grades to impress employers, within
which the employees waste most of their time in political battles,
and from which consumers have to buy anyway because there are so
few choices. Imagine if that sequence became a big, straight pipe.
Then the effects of being measured by performance would propagate
all the way back to high school, flushing out all the arbitrary
stuff people are measured by now. That is the future of web startups.

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