Invest Like the Best with Patrick O'Shaughnessy - Michael Seibel – Lessons from Thousands of Startups - [Invest Like the Best, EP.190]

Episode Date: September 8, 2020

My guest this week is Michael Seibel. Michael is a Partner at Y Combinator, and the CEO of YC's startup accelerator. He was the cofounder and CEO Justin.tv, which eventually became Twitch, and Socialcam. In this conversation, we discuss all Michael has learned reviewing thousands of applications to YC, interviewing countless new entrepreneurs, and watch young companies begin to grow and, occasionally, find product market fit. Listeners will also enjoy when Michael traps me big time in my thinking about AirBnb and his framework for great problems to solve. Enjoy this great conversation with Michael Seibel   This episode of Invest Like The Best is sponsored by Canalyst. Canalyst is the leading destination for public company data and analysis.  If you’re a professional equity investor and haven’t talked to Canalyst recently, you should give them a shout. Learn more and try Canalyst for yourself at canalyst.com/Patrick.     For more episodes go to InvestorFieldGuide.com/podcast. Sign up for the book club and new email newsletter called “Inside the Episode” at InvestorFieldGuide.com/bookclub. Follow Patrick on Twitter at @patrick_oshag   Show Notes (2:22) – (First question) – Emerging trends among founders (6:00) – The long-term impact of Covid on business (7:16) – What an application to YC looks like and what stands out for him (11:46) – What he wants to learn in the interviews (13:54) – Poise in the interviews (15:40) – How the YC experience has evolved and improvements they’ve made (18:38) – How he defines technology             (18:50) – Every Company is Becoming a Software Company (21:12) – His thoughts on non-software companies and how they play into what YC does (23:48) – Why frequency and intensity of the problem matter to him (28:32) – Serving the supplier and building the demand (30:38) – Bravery in founders (36:07) – Partnerships and collaboration in venture capital investing (37:58) – Second time founders focus on distribution (39:23) – Coaching the psychological component of being a founder (44:16) – Learning as a founder vs the education system (46:08) – Customer vs investor focus of founders’ mindset (48:16) – How teams know they are really onto something (52:38) – His being a founder trainable or innate (54:08) – Kindest thing anyone has done for him   Learn More For more episodes go to InvestorFieldGuide.com/podcast. Sign up for the book club and new email newsletter called “Inside the Episode” at InvestorFieldGuide.com/bookclub. Follow Patrick on Twitter at @patrick_oshag

This episode is sponsored by Canalyst. Canalyst is the leading destination for public company data and analysis. I'd heard of Catalyst over the past few years and became more interested after meeting the founder and CEO last year to pick his brain about SaaS businesses. Founded by a former byside analyst who encountered friction in sourcing, building, and updating models, Canalist is now used by over 300 institutions, including the largest money managers in North America and by a number of guests on the show. With detailed company-specific models on over 4,000 public companies, Canalist platform lets analysts update their own models in seconds, complete with KPIs and segment data, adjustments, and restatements. Everything you want and expect in your own models on virtually every investable public equity.

If you're a professional equity investor and haven't talked to Canalyst recently, you should give them a shout. Learn more and try for yourself at canalyst.com slash Patrick. That's C-A-N-L-Y-S-T-com slash Patrick. Hello and welcome, everyone. I'm Patrick O'Shaughnessy, and this is Invest Like the Best. This show is an open-ended exploration of markets, ideas, methods, stories, and of strategies that will help you better invest both your time and your money. You can learn more and stay up to date at investorfield guide.com.

Patrick O'Shaughnessy is the CEO of O'Shaughnessy Asset Management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of O'Shauncee Asset Management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of O'Shaughnessy asset management may maintain positions

and the securities discussed in this podcast. My guest this week is Michael Seibel. Michael is a partner at Y Combinator and the CEO of their startup accelerator. He was the co-founder and CEO of Justin TV, which eventually became Twitch and Social Cam. In this conversation, we discussed all Michael has learned reviewing thousands of applications,

to YC, interviewing countless new entrepreneurs, and watching young companies begin to grow, and occasionally finding product market fit. Listeners will also enjoy when Michael traps me big time in my thinking about Airbnb and his framework for great problems to solve. Enjoy this great conversation with Michael Seibel. Michael, I've been really looking forward to doing this with you. I always try to think of titles for the episodes ahead of them, and one I consider for you is the man who gets to see the future.

And that's true because of anyone in the world, maybe you see more names. nascent new companies and founders being built of just about anybody. And so I thought an interesting place to begin since I know demo day just wrapped up. So I'm sure you've been working your tail off. To ask for what sort of some of the emerging trends, assuming you do believe that you get to see the future in some way that you saw in this most recent batch of young founders. I'll zoom out to the past couple years to generalize. The first trend that I'm seeing is a social trend, I would say. And the way that I would describe it, not social like social media, the way I would describe it is founders having more concern about the impact their startup is having

on the country or on the world. And founders being braver and taking on kind of core challenges, whether it's healthcare, we have companies trying to attack mass incarceration. I think that there's been a little bit of a feeling like if we want these problems to be fixed in our society, we have to be part of the solution. We can't just lean back. And I think that's qualitatively different than when I started in 2006, 2007. Certainly the kind of next big change was not going to be surprised to anyone is B2B SaaS. What's interesting is that like B2B SaaS has been the trend for what, 10 years? Maybe you'd argue 12 years. And I would say that it's not slowing down at all. One sub-trend within that that I find interesting is I'm starting to see a lot of companies

build verticalized software for small business. If you think of a product like Square, they kind of want to revolutionize the POS across all of small business. And I think they've gotten a lot of small business basically onboarded into modern software. And then we've seen a number of YC startups, Squire is one of them, but there are others, who take a chunk of that, like a slice of that small business, Squire's going after barbershops and hair salons, and basically saying, I not only want to be your POS, but I want to try to help you do as many things as possible in your stack as possible. I can help you with your payroll. I can help you with your managing of employees and time tracking. I can help you collect, of course, money from your

customers, I kind of want to be the single piece of software you have to use to run your business. And that battle has been interesting because, of course, Square is trying to diversify and offer more services to the same customer. But it's hard to be the single source piece of software for every type of small business vertical. I would say another massive trend in YC is just the number of founders were funding from outside of the U.S. India, Southeast Asia, Europe, Middle East, Africa, We're now seeing founders everywhere. And we're now basically seeing, I think in the first five to ten years of YC, we were still fairly international, 10 to 20 percent,

but a lot of folks were looking to come here to build their business. I think what we're seeing now is that in a lot of these emerging markets, founders are coming here to raise money, but they're building local businesses. That's becoming a lot more common as well. So yeah, I'll stick to those three. Going back to sort of the role of COVID and all this, it strikes me, you know, the headline tech story is the penetration of e-commerce, which makes perfect sense. But it seems to me like this is way more pervasive than that. And in various ways, whether it's social and people just being

fed up with the status quo or companies that just out of necessity have to rebuild the way they do business, as you pointed out. It sounds like COVID is a huge part of recent trends. Do you think that that will reverse or is that just here to stay? I think that's here to stay. You brought. against another trend that I'm certainly seeing where it's basically wholesale businesses are starting to rethink whether or not they can become both wholesale and retail. And if becoming a retail business is as easy as opening up a Shopify store and now I can suddenly diversify and sell to individuals when most of my business clients are shut down, I think that's something that a lot

of wholesale businesses are exploring. And I don't think they go back. One of the things that I've seen with wholesale businesses is that when they sell their B2B clients, they have to give them credit. When they sell normal consumers, they get paid up front. I think that's a nice feature. Yes. I think that's almost addictive. One of the things I've been most excited to talk to you about is the literal process of parsing first through applications to YC and then second through companies that actually make it. I'm obsessed with investors that just have tons of reps in their particular field. And I think you're probably like the rep king.

We have some reps. I'd love to spend some time on both of those stages. So maybe first you could describe what an application to YC looks like. And then I want to ask questions about what it's like to review hundreds of these things at a time. I'll start with some numbers. Let's take the last two batches. We have this crazy nominclature. So we call it winter 20 and summer 20, which is January through March of 2020 and then June

through August 2020. So combined a little under 30,000 applications to YC between those two batches. We interviewed about 10%. I say in person, half of those were in person and half of them are during COVID, so over video conference. And we accepted about, let's say, 475-ish. So 475 accepted companies out of about 30,000 applicants. So that's kind of the high level.

Maybe beginning on, so there's actually three levels that are interesting to ask about. So first, in the 30,000, the applications, again, having probably been through thousands and thousands of these things personally, what are you looking for in a fairly short application from the founder? What signals or patterns have emerged over the years as interesting to you? And maybe also the inverse, things that are disqualifying. So I think the first motto of a YC application reader is don't be too small. I think there's all of this false conventional wisdom around being able to see the future,

being able to look at an idea and tell if it's a good idea. Just the concept of a quote unquote good idea. And I think that we're all kind of imbued with this somehow through popular culture and you basically have to unlearn that. These founders are shooting for a point 10 years from now and many, many things that look like a bad idea now look like a good idea 10 years from now. Almost the first thing you have to do is kind of let go of your prejudices and opinions about ideas. The other thing, which makes that even more important, is that a huge percentage of the companies change the problem that they're working

on or how the product works. And so if you key in on their idea too much, you might be missing out on the pivot. The number one thing that I look for above all else is that the team who's applying has the ability, ability to build and launch the first version of the product. And the second and very closely tied to its item is I want evidence of forward motion. Given the amount of time the founders have been working on the company, I want to be impressive what they've done. And I don't care if that amount of time is two weeks. I don't care if it's two years.

I just want the sum of what they've accomplished during that period of time to be impressive. And I think this is a hard concept for people to understand. I think that everyone is trained on school, where they're these absolutes, what was your SAT score, what was your GPA? School doesn't really measure trajectory at all. Whereas like with us, it's really the only thing we care about is trajectory, is how much forward motion and momentum are you creating as opposed to starting position. And so I really want to see evidence that a team is intimidating me with their progress. And then the last thing that I want to see is some evidence of a strong relationship between the co-founders. In the early stages of the company are ridiculously stressful,

and companies literally can break from the pressure. What holds together a company, I think too often when you analyze a company, I think people start thinking about complementary skill sets, and that's a very mechanical way of thinking about it. Whereas when I describe a startup, I basically say, like, you've signed up to get punched in the face every day, forever. in the early days, who's going to be the partner that you're going to cry on their shoulder

and they're going to cry on your shoulder when you're both getting punched in the face every day? And that emotional component is very hard, is very important to survive. So I'd say like those are the three things. The first one kind of translates into some sort of technical ability. The second one is like, what kind of progress are you making, given the amount of time and working? And the third is what's the relationship you have with the co-founder? When you do the actual interviews themselves, now having whittled it down, I think you said, to 10% from the 30,000 applicants. What, if any, different things are you looking to learn

during an in-person or virtual interview that you couldn't in a plain application where you're not interacting with the person? And I'm also just fascinated by what kind of questions or vectors of questions tend to carry the most free. One of our partners, Paul Bouhite, he was one of the people who have trained me to do interviews. There were kind of two things that always stuck out from his lessons. One was that a founder who truly understands what they're working on is able to explain it to a layman. So the ability of the founder to clearly communicate their ideas in verbal form is extremely important. The second one that he always taught me is that founders should know, in almost all cases, they should know more about their customers and

their problem than you do. So you should learn something. You should learn something. You should learn something. You should leave an interview knowing something you didn't know before. I think those are the two ways that founders can kind of distinguish themselves positively. I think negatively, you get a sense for how a team works together or doesn't work together in an interview. And you actually get a sense of whether the founders like each other, believe it or not. When two people have to be in the same space, either physical or virtual, for 10 minutes communicating, it's hard for them to hide how they feel about each other. I think we're learning what the virtual tells are, but I can tell you having many more reps on physical interviews, the physical tells are like hilarious and obvious. If you can avoid it,

you'd rather not fund a team that hates each other. Give a favorite physical tell for hating each other. I don't want to give up too many secrets, but I actually think that might be a lesson that applies in other parts of business. It is strikingly obvious if you're looking for it. And in a typical interview panel, there are three or four of us interviewing two to four founders, and it's only 10 minutes long. A lot of the time, you're not the one talking. So you can be watching and looking and be the extra set of eyes, which is really fun. How much do you think poise matters? Because I have to imagine, and I mean poise in a different way than the ability to communicate clearly. I imagine it could be quite intimidating to be grilled by a panel of experts that have done this so much. How often do you

see people sort of nervous and does that matter to you at all? I would say nerves only matter if they get in the way of those two things. Otherwise, we don't particularly care. I will say that what's funny, and this is actually something that I feel like I don't remind Demo Day investors enough, is that these are pretty impressive people. Their companies might not work. You have to be pretty impressive to even want to start a technology company. And then you have to be pretty impressive to be stack ranked in the top 10% of a YC applicant pool. This is not just a straight cross-section of people on the street. And so generally, everyone who comes in the interview has something to be confident and

proud of, something to draw some way that they're special or better than most of other people. And it's funny because I'm constantly reminded of this. I think that when investors look at a batch at the end of Demo Day, they want to immediately stack rank people and discount the bottom 10% based on whatever criteria or the bottom 30% or whatever. And I think what's so interesting is that they don't spend enough time thinking that if our acceptance rates under 2%, the quote unquote worst person in their stack rank was better than 98% of the people or companies who apply to that batch. Can you really tell that they're not going to end up being the good one? Can you really perfectly,

distinguish the top 2% who's good, who's not. I would argue that's very, very hard. And that's why I like our model where we don't try to. The final stage of this, of course, is actually being accepted and then building something in earnest with that final batch of participants. And I'd love to hear just a bit about how that process has evolved, again, across 15 years of doing this. What have you found to be the most important maybe improvements? I know you talked about already just today, the importance of just execution speed, like getting stuff done. But what else is you? to sort the best from the worst, if you will, during the actual period of building together. Well, you know what's funny is that once we invest, we're in. A lot of my sorting muscle

kind of goes away. This comes back to I don't want to be too smart. There are many examples of companies that did not look very good during the batch that turned out to be very good. I mean, hell, my company during the batch was an online reality TV show. 2014, it sold to Amazon for a billion dollars. You got to be careful about being too smart. But how has the batch changed? I mean, the wealth of resources that are available to the founders today versus when I did YC, I think that's the big difference. It's stupid. What's funny about YC is that it's been imbued with former YC founders as people who are helping to run it. So we always get to ask ourselves the question, like, what do we wish we had? I did YC in 2007 and 2012. In 2007, they were

barely any YC companies that had raised more than a Series A. There were barely any YC companies that are making more than a couple thousand dollars a month in revenue. There was barely any investors came to Demo Day, early days. YC didn't get any respect from investors. It wasn't clear that it was a good filter. Today, there's an alumni network of 5,000 people, everyone from CEOs of public companies to major executives and major technology companies. There are a wealth of deals. I mean, companies give our founders special deals to get the needs our software. There's millions of dollars of discounts and perks and credits and so and so forth. There's an entire database of everyone who writes checks in the valley with peer reviews from other YC founders immensely valuable. There is, and COVID

accelerated this, almost all of the advice we give to founders is documented and written. So if you didn't catch something or you remember hearing it, but you want to go back, that exists. There are programs to help you raise money, raise your Series A, raise subsequent rounds. There's a directory where you can basically sort and find companies that might be great customers. Companies in the YC Network might be great customers. It's a different world.

There's a forum where you can ask questions and poll the audience of alumni and important issues. There's a whole job site where we help you recruit engineers. And we give companies more money now than we used to. Back in the day, the standard deal, we give companies around $20,000. Now it's 125. So yeah, it's crazy. I'm excited for all the stuff we're going to come up with in the next 15 years. I'd love to hear a bit about how you define and think about what technology means,

assuming that sort of technology companies is the thing that YC focuses on, kind of for all the reasons you just laid out. I think it was Jay Krepset Confluent that wrote that great post about how every company is basically a software or technology company. Increasingly, we're just encoding everything into software. And therefore, I'm interested in what is technology or even software really mean to you? And do you want to intentionally stay on the frontier or sort of ride this trend of everything becoming software? I almost want to attack it from a different direction.

I think that as software has kind of pervaded a lot of forms of life, one of the things that I start hearing is that it's less valuable. There's a trend in the startup world for what people will say is this is just a software enabled startup. And that's kind of code for, oh, this. software that we use is commoditized. And I hate that. I aggressively fight against that. I don't think that software can be commoditized. If I have two companies to fund and they're starting at the same position and they're going out to the same market and one believes software is commoditized and the other

believes that they can build best in class software, I am always funding the second one. Always, always, always. To me, when I think about kind of founders I'm excited about, I think of founders who are excited to build best in class software and to have a software advantage over their competition. When it comes to the cutting edge, I think the cutting edge is a very interesting thing because I think that it is poorly defined in the present and well defined in the past. I think that every year, every six months, there's a new, this is what the cutting edge of software is going to be. And it's really not my job to believe or not believe. Just as often as that kind of thesis is correct, it's not correct. And it's not really my job to care. It's my job to support founders

who are going to have a vision of how software is going to be used 10 years from now. And I never want my vision to cloud theirs. If smart, talented people believe this is where software's going, I've got their back. Right or wrong. I never for a second believe that I'm shaping where software is going or I'm deciding or that I have some magical insight on where software is going. No. How do you think about the world beyond software, maybe hardware technology? I know YC will sometimes back companies in that space as well. You mentioned things like healthcare. I'm actually really curious about the mass incarceration example you gave. To what extent are non-software technology businesses rising or falling in their prevalence in what you do in your batches? I think it's tricky.

I do feel like I can split the world up into software and not. And it's a little, it's a little, when you start kind of zooming in, there's a gray zone. But I do think that the kind of frontier tech, the Tesla-inspired startups are far more popular now than, of course, when I was starting. And on one hand, I like that because I feel as though Tesla-grades makes great products. I feel like in some ways it's helping move society forward, those types of companies. On the other hand, I think that a lot of times there are investors who are extremely disingenuous about how much more challenging it is to build a not software company. And I think they're also disingenuous around what the fundraising environment is for non-software companies. I would say

Silicon Valley, by and large, is built to fund software companies. And the further away you get from that software core, the less reliable it is is a funding mechanism. And it's not a surprise that most of the kind of larger, more hardware, more infrastructure-focused companies, Tesla being a great example, SpaceX being a great example, were government funded. And I feel like people don't talk about that enough. So if you're trying to be a founder of one of those companies, I would argue that the world isn't as different as it would have been 20, 30, 40 years ago. It's different. Certainly, you have a lot of better software to use to build your company, so it should be cheaper. But your funding sources are not as clear cut. Whereas if you're trying to build a software

company, I think the world is massively different for you now versus 40 years ago, like in almost every way. And I think that there's a community here that's willing to fund you. And I think the cost of making software has just dropped incredibly. I think that it's really important to point out that distinction, whereas I think that maybe there should be, and I'm going to get these ratios wrong, but maybe there should be like 10 to 100x more software companies now than there were in the 90s because of the costs have decreased. In my mind, on the hardware side, maybe that's only 2x more because the availability of more private funding. But it's nowhere close to the same scale as software. I'd love to talk a little bit. I've taken to heart your lesson of don't try to be too smart,

of talking a bit about the nature of problems being tackled by these young entrepreneurs. And I think this discussion will be applicable to any kind of business. I've heard you say before that Variables like frequency and intensity of the problem are important things to consider. Say a bit about those two variables and any other variables around the type of problem being tackled that you think are important or interesting. Frequency intensity and willingness to pay are three things that I tell founders to think about. Here's a thing. The base thing that I want a founder to have is some special or different insight about the problem

that they're trying to solve. And I want to be clear, not necessarily a special, or different insight about the solution. Solutions come and go, solutions change, they get iterated. Solutions are something that really get molded by the user. But some special or different insight about the problem, I think, is really important. What happens in my job a lot is that a lot of founders kind of come to me and they say, I don't know which company to start.

I don't know what problem to attack. And part of my job is to help them kind of help guide them through a process analyzing the problem. Now, I think that there's kind of a surface approach and a deeper approach. The surface approach is kind of almost academic, where I can tell someone, hey, take your ideas, take the problems that you have maybe in your life or that you witness your friends have or you have at work, and use these three heuristics, frequency, intensity, and willingness to pay to try to stack rank them. The stack rank isn't as important. What's actually more important is just being able to look at a problem and understand, is it significant?

at all. And I think more often than not, founders just kind of, when they use this tool, they start realizing, oh, like, I guess this doesn't matter as much. That is important to me. And I think it also kind of, it helps them unlock what are the problems that they're really passionate about. If you're really passionate a problem, you're probably more likely to have some insight on how to solve it or some special way of looking at it because you've experienced it. Really, that's what I'm trying to get them to do. And I think what's tricky is that there's kind of, of a prevalence of what we would call scenesters, people who are kind of more interested in being the startup scene than actually identifying a problem, falling up with the customer and trying

to fix it. And what I'm really trying to do is kind of reform the seamsters and say like, hey, if you're going to be in the scene, can we at least get you to work on a problem you give a shit about in some way? And a problem that if you solve it, people are going to care. And I think that that's been my attempt to trying to get people to that final endpoint. I love the filters, those three filters for thinking about types of problems. I always wonder about the opposite. As you were talking, of course, it's a YC company. So I could bring it up. Airbnb pops to mine where I would think both frequency, intensity, and willingness to pay. It would fail all three of those tests. You have walked into a track that I have laid through. Excellent. I think in many marketplaces, people have a misunderstanding of the customers. A massive misunderstanding. who the customer is. I think everyone assumes they're the customer. Are you an Airbnb host? Nope. I would ask you the question, if you were an Airbnb host, how frequently would you want to make sure your home, apartment, vacation rental was booked? Always. How intense is that need?

Hi. And are you willing to pay 12% fees for people to book your place? Just for the audience to know, we arranged this whole show parade ahead of time. I think that there's this weird thing in these two-sided marketplaces. My canonical example is always car buying sites. The average person owns a car for seven years. Yet they think they're the customer on a car buying site. When, like, once again, almost always it's the person selling the car who needs to sell cars every day. And I'm not the Airbnb customer.

I'm just saying that if I were trying to figure out who I'm helping more, it's clear I'm helping to host more. Don't get me wrong. People have built businesses in areas that are infrequent. I never try to create rules around what kind of business you should start. Every business is a bit of a miracle is a little different and breaks some rule that existed before. I just try to kind of like do this exercise to give people this kind of, sometimes people will choose ideas and we go through this exercise and they come out of it being like, oh, no one cares.

And it's like, oh, okay, well, if you can't identify anyone who cares in this mix, maybe you should move on. Both of those really neat counter examples where you caught me in a bear trap. It's an emphasis on the supply side, which I think is really interesting, contrast to some great conversations that I've had with Bill Gurley and others about owning demand. So is that a common theme where you see a unique problem identification is really to serve the supplier and then maybe a lot of the work is building the demand? Typically, when we have a two-sided marketplace, it really depends on what. what stage of investor you are.

Like when you're super early stage and you're trying to get a company from zero to one, it's very different than when you're later stage. But the typical advice is that you should try to cheat supply. And that's a really fancy way of saying you should try to hand recruit valuable supply. Because if you have viable supply, the hand recruit portion is important because valuable supply shouldn't want to sign up. There's no demand. You have to actually one by one solicit and cajole viable to supply to sign up.

but there's no way to collect demand without something to show them. Usually the kind of the stereotypical devices, you know, cheat supply. And in the kind of early days of Airbnb, that's exactly what they did. Their early viable supply were vacation rentals in New York City. And there were international travelers with kids who wanted to stay in an apartment instead of a hotel. There were people who were traditionally in vacation rental business in New York who didn't like the existing tools.

That was the actual kindling that got caught. Airbnb was a fire that was lit a number of times before they really got it going. And that was the real kind of kickstart of it. And to be honest, as much as people argue that Airbnb was some unique idea, like, it wasn't, VRBO existed, couch surfing existed. It wasn't a unique idea. It was very clearly an iteration, Craigslist existed where this was happening. It was very clearly an iteration of what was already happening. And their first investor knew that. A guy named Greg McAdoo. He understood the vacation rental market. He knew this was happening. So I feel like when the Airbnb story is, is told, it's told as like, oh, people would never understand each other's houses. That's crazy.

And it's like, no, that was happening. It's not crazy. That was happening before Airbnb started. Airbnb did not kick that thing off. They just built better tools than everyone else. They made it easier. You used a word earlier that I want to go back to, I don't think it's a word I've heard often in these conversations, which was brave or bravery. In many ways, the easy thing to do might be go build one of these vertical SaaS solutions for a smaller industry or a medium-sized industry and kind of run that playbook. My sense is that some of the the things you mean when you say brave, are founders putting themselves out there a little bit more in these recent batches. I'd love to hear some specific examples, if not named by name,

just by theme, and what you find interesting about that bravery. There are different kinds of bravery. I actually think that going after a vertical is very brave because investors will tell you square is got it sewn up. Your game over. But what I'll key in on more is the bit about solving problems that can be intimidating to solve, where solutions are not necessarily obvious. We have this company that went through IC a couple years ago named Promise, and two founders who stated a goal was to reduce mass incarceration in America. At first blush, an investor's going to think, that's a nonprofit or that's a social impact. I don't give a shit about that. But this was very much a company. And they kind of went through two iterations, and it was so much fun watching them do

this because the founders are just forces of nature. Like whatever they're appointed at, they're going to get shit done. So the first thought was that people are getting thrown in jail before they're convicted because government is not good at getting people to come to court. So if you cannot afford bail, the easiest way to make sure you come to court is to put you in jail into your court date, which seems pretty fucking stupid, but hey, that's the game word. Their first thought was we're going to actually work with prison systems, with counties and their prison systems to make it easier for people to get to court without having to pay bail. So simple things, like we'll put an app on their phone, swing over there are, we'll send them text messages,

it's their court date, make it one click so they can get a lifter and Uber. Just the basic things so that you can actually not put them in jail so that you don't have them lose their job or lose their car, basically have them slide into a much worse life situation for a crime that they didn't even commit or certainly isn't that significant. So they started doing that. And they were so powerful that they literally, everyone says, oh, GovTech, it's impossible to the government. They sold the government.

They got counties signed up. They started getting their software deployed. And they started realizing that the part of the government they were selling into, this prison kind of police system, was very much oriented around kind of good and evil, right and wrong. If you're in our system, it must be because you did something bad. And the role of our system is to punish you so that you won't do something bad again. As they started speaking to these people more, they realized that the more efficient they made it for these systems to run, the more people they thought these systems might try to incarcerate or try to pick up on the

street. And they were like, this is not part of our mission. Now, let's be clear, they were getting contracts. They were getting paid. But, But because it wasn't part of their mission, they said, we're going to take a step back. And we're going to look at this a different way. What they then did was really awesome. They then went back to the root causes, and they said, a lot of people get mixed up in the criminal justice system based on some type of fine or fee or something that they didn't pay. So then there's a bench warrant, then at some point they get pulled over, and then bang, they're in jail. You're a working class person.

You go to jail. You lose your job. You can't pay your rent. You really fucked that person's life and their family's life. they asked themselves, what happens if we can make it easier to pay the government? They did this awesome trick. They basically were like, look, we're not going to start with a deal with the government. It takes too long.

We're going to set up a website where you can pay your ticket or you're fine. And if you want to pay with the credit card, you can. We'll accept credit cards, unlike a lot of jurisdictions. If you want a payment plan, we will give you one on the spot online. You don't have to call anyone or go into some office or sign some forms. And let's be clear, we're not associated with the government. government, we can't even enforce these payment plans. We're just going to see what happens. They basically built the front end for this, and on the back end, they would just pay your ticket for you.

And after a couple months, they had no defaults. They were getting no defaults or very few defaults. Everyone was paying. Everyone was on the payment plan, was paying. When people missed a payment, they like apologize. They explained when they would make the next one. Everyone was acting in a way that I think oftentimes institutions don't treat them. They were acting like responsible adults. So they went and they talked to some city, and they talked to the Treasury Department, because the Treasury Department is what handles this kind of money collection, not the kind of criminal justice part of the government. And the Treasury Department's like, you've got better collection rates than we do. And the only thing we care about is how much money we get. If doing it your way gets more money, we're down.

Like, we don't perceive our role here as punishing people by making it hard for them to pay. We just don't have any good software. And so if you can get us more money, we're happy to try to do it. And so they're in the process now of what I like to kind of call stripe for government. Every time a citizen has to interact with government to pay something, how can that process be citizen friendly? They're going to build a very successful company, but it's also going to make America a better place. And I certainly see it in YC applications a lot more now, which is exciting.

It's fun. One of the things I'm seeing a lot more of in the investing world writ large is, is just more collaborative investment partnerships, meaning like the actual partners at YC in your case. Obviously, it's been an incredibly interesting and impressive group of people across that business over the years. Say a bit about how you work with that group of partners to sort of tackle this big problem you're trying to solve of sorting through these young businesses. How do you interact with other partners? And what have you learned from that experience? Somewhat unique about our partnership. I think benchmark does this as well, made it before us,

is that we have an equal partnership. And then the last, thing is that any YC investing partner can get a company into YC. We call it a strong yes. Anyone can strong yes a company who's an investing partner at YC. There is no consensus required. And what's funny is that I think a lot of people think that that rule, it's actually a rule that was named after a former YC partner, a guy named Gary Tan. A lot of people think that rule exists because, oh, the best ideas are controversial and there's going to be debate, which I love. The reason why that rule existed was because in our kind of YC lingo, we have votes when we're voting in a company interviews. It's a strong yes, weak yes, week no, strong no.

It used to be the case that a company with three week yeses would get into YC. And when we started to analyze the companies that were not doing well, there was this massive trend of no one was the strong yes. Everyone was like, oh, maybe. No one could kind of imagineer this thing working. So we implemented this rule that someone's got to care enough to be the big yes. And I think it was good for the culture of YC because, you know, it prevents arguments and kind of stupid fights. But I think it was also good for the investing in YC because if someone can't dream this thing to be something, it probably won't be. There's a fun idea that I've been thinking a lot about that I'll share and I'm just curious for your reaction.

The idea is that first-time founders tend to focus on product and second-time founders tend to focus on distribution. When you think of that? I do think that's correct. I've observed something in no way conflicts with that, but is slightly different. I think that older and more experienced founders tend to be more comfortable with execution risk,

meaning I know there's a need in the market, but I don't know whether I can fill it. Younger and less experienced founders tend to be a little bit more interested in product risk. I'm confident I can build it, but I'm not sure people want it. I find that very interesting because successful companies have been built in both areas. But I kind of, to me, it's a bit of a, and I'm making overbroad generalizations when I say that it's younger, more experience, and that's a over generation. But I kind of feel like it's a peek into the founder's psyche. It's kind of like every founder has to fundamentally lie to

themselves, convince themselves to do a startup. And it's really interesting to, explore, are you more able to lie to yourself about people wanting something that might not want? Or are you more able to lie to yourself about you being able to build something that you have no qualifications or no clear logical argument why you should be the one who can build it? It's funny, right? Airbnb is a product risk company. Stripe is an executioner's company. The fascinating part about the area that you operate in is, like you said, the low survival rate. working with these founders, objectively speaking, most of whom will not be successful in the way that they all want to be. Say a bit more about the psychological component of this that you've learned

to help coach people building things and taking big personal risk to do so. I think that my style is to be, some founders would describe it as a little brutal. I kind of describe it as like very real. and I don't want to lie. When we kick off the founders, one of the traditions that Paul Graham, the founder of YC, started, was this phrase,

there'll only be, and back then the batches were much smaller, there'll only be one or two of you who actually solve the problem you want to solve, really serve your customers, and build a successful business. We can't tell who it is, but it'll only be one or two of you.

And I always love that because it was honest. This startup game is very different for most career games. Imagine if the first day you went to Yale law school, the professor told you, like, only one or two of you are going to become lawyers. You'd be like, wait, why am I paying all this? We're like, this is not what I signed up for.

Our startup game is a lot more like sports. The Duke coach can probably say, only one or two of you are going to ever have a real starting rotation job in the NBA. And damn, you got to Duke. You're already like pretty good. I think it's just really important to emphasize that point. And then the point that comes right after it, which is that to win, you have to reach for extraordinary. And one of the things I really

try to motivate folks to do, and it's something that Dalton called by one of our partners says a lot, is that like you have to be a couple standard deviations away from average in order to have an extraordinary outcome. One of the things I think about a lot is that if you're a smart kid and you put yourself in a community of smart kids and you're operating average, you tend to do well. If you're one of the smart kids and your average, you'll get into a good college. If you're an average smart kid, you'll get into a good professional school. You'll get a good job. You don't have to worry about paying your bills. So I think a lot of people are kind of programmed to think, put myself in a group of people and then acts like them. Start up. YC Batch is extremely talented people. But if you are the average player, you lose. And so a lot of the times we try to really push people to think, how are you going to be different? How can you not see? set your internal expectations based on the people around you because if you win, you're going to be orders of magnitude different, your numbers, your progress, how much the problems that you're solving for your customers, the magnitude of your impact is going to be so much higher than

the people around you. You have to kind of think that way. One of the great things about the Airbnb founders is that they thought that way. They thought very early on, we're building a company that will be around for a very long time. Most founders don't think that way. That wasn't the average of their peers. It was exceptional. I think I made many of these mistakes. When I think about how do you deal with the founder psychology, the first thing is you prepare them with facts, the real reality. This is how hard it's going to be. And then I think the second thing is you acknowledge that you need to develop tools to manage your emotions. We have a number of talks on this. You know, our former batch director at YC, a woman named Amy Bueller, she was a trained therapist and she's now a founder coach. And she's just kind of

created a philosophy for us that's been really helpful. And it's kind of had, the primary part is, how do you manage your relationship with your co-founder? And so we spend a lot of time kind of trying to explain that to founders because the co-founder is your primary support system. If that, it's a lot easier to manage your emotions when you have that rock next to you. And the other thing that we kind of emphasize is honestly health. And we talk about that a lot, but what I hate is when people talk about one and not the other. There's a lot of conversation about like, how hard should you be working and how hard is it healthy to work? I don't think it's particularly healthy to start a successful company. One of the things that I tell young people considering

startups is that I actually think there's probably something a little different or off you might describe as wrong with people who are very motivated to start companies. I don't think they're normal. I'll bring it back to what I said before. Would you sign up to get punched in the face every day? Does that sound like a perfectly logical, rational thing to do? Most people wouldn't. I think that it's just really important to be honest with people about how hard it's going to be and that it's okay if you don't want to do it. And it's okay if you want to give up. And it's okay if you're not a failure because you weren't successful at becoming an astronaut. There's so few people who become astronauts. And so try to set things in that context as opposed to normal career contexts.

I'd be curious whether you think it'd be fair to compare the outcome in education, even for one of the, it's obviously high variance, the outcomes you talked about this versus law school or maybe even business school at Harvard. Do you still think there's a credible case maybe to make that you might stand to learn more as a YC batch person, even if your company is going to fail relative to one of the traditional, even high-end business schools? Learn more? Oh, fuck yeah. That's not even a question. Go on. I think that we can debate on whether your kind of life earnings and what job you can acquire. We can debate on that. And I don't know that I have an extremely strong answer, but like, learn more. Yeah. People learn by doing. You don't do at school. It's that simple. You can learn on best

practices are to fire someone, or you can have someone in your company who's not performing and who hasn't been performing for six months. And every time you look at them, your stomach hurts because you know you need to fire them, but your stomach hurts more because you're too scared to. That's when you learn. That's learning. School's not learning. I think that there are certainly certain technical skills that are very viable to acquire in school if you use school for that purpose. Otherwise,

I think school is great for building relationships with smart people that you can then work with in the future. But one of the things that we have to tell founders all the time is that if you're going to succeed at this, you're going to learn the whole time. Things you are not good at now, you're going to have to become good at. So this is not a situation where you go to business school and acquire the skills

and the company you go use them. That is a complete wrong way of looking at it. No, it's like you are going to start learning skills because there's a gun to your head. And if you don't have the skill, someone's going to pull a trigger. And then you learn. And then you do that enough times. You dodge enough bullets. Maybe you make a good company. You have another really interesting framework for thinking about how companies deal with investors. I think from what I've seen you say, there's lots of thinking for how do you interface with investors. And your clever take on this is like, the best way to do with that is by spending that time with customers instead. Could you walk us through just kind of the customer versus investor-centric nature of the founder's mindset?

There is another pop culture misconception out there that the path to creating a company is you think really hard to come up with a clever idea. I would emphasize clever because it's really helpful if people think it's cool idea, preferably people who don't even know anything about the problem. Then you pitch investors and you raise money. then you build the product and launch the product and then users use it and then you're successful. I think that's kind of wrong on almost every front. I think that's kind of what people absorb out of American society. I think that in the age of software, for much less money, you're able to have much more confirmation from your customers as to whether or not you're solving a problem that they have.

so that when you go to an investment meeting, you actually have leverage in that meeting. When you're pitching an idea and you have no background or no experience, you have almost no leverage over an investor. You're basically praying the investor falls in love. Anyone who goes out and tries to find a significant other, you know that's a low percentage chance of winning. The folks who can basically get a product up and running in some way, shape, or form

and get a couple of customers, the first-time customers, to love the product and pay for the product, they have far more leverage when trying to convince an investor that this product might be a thing. They're demonstrating that they can build a product. They're demonstrating that they can sell customers. They're demonstrate they can collect money. They're demonstrating that this company will exist. This company is not dependent on the investor to exist.

Yeah, I love that idea of leverage in all things. And the software itself literally is leverage. I think that's Peter Thiel's definition of technology, like just do more with less. and such an interesting conception. My last batch of questions is really around, it's for builders everywhere, not just startup builders, and understanding when what you're building is when you're really on to something. In kind of the Silicon Valley world, this is often called product market fit. There's lots of names for it.

Always just like Andy Rackcliffe's basic idea that the dogs are eating the dog food. I think you've seen every possible permutation of things that aren't this, things that look like this, but aren't things that are this but don't look like it, and things that have both. And I'd love you just to talk through your experience to help builders out there know, what are some of the signs that you're on to something? When should you be pouring fuel on the fire? I hate this question because I have to answer it so much. And I am not sufficiently good at answering it. I had two consumer companies. I'd like to describe what it felt like to have product market fit. So my first company, Justin TV, in the spring of 2008, we believe a man in Morocco pointed his webcam at his television.

And he was watching a local Moroccan soccer game, like a Moroccan league soccer game. And he wanted his friend somewhere else in the world to be able to watch it who wasn't in Morocco. So he pointed his webcam at the soccer game. 3,000 Moroccans from around the world saw this link. watched this game, horrible quality. You can only imagine how bad the quality was. It was the largest stream we had had at the time, and it broke our site completely. That year, our company grew 1,200 percent, and the limiting factor was, can we stay up? Can we keep the video system and the web system operating? That's what product market felt like. It was a sledgehammer to the

freaking jaw. We had no time to sit down and is this product market fit? It's like everything's blowing up all at the same time. Because no one really builds products to scale. You can't pre-build the product to scale. So once you get an overwhelming amount of usage, everything starts breaking. My second company, Social Chem, we had that moment, with more time, I would go into far more detail on how this wasn't exactly product market fit, but a kind of replicated product market fit. We had this moment where we were growing. And when I was going to work in the morning, I said to myself, okay, we're still racking our own servers. This is 2012, and we were using EC2, but for this product, we're still racking our own servers. And I was looking at our growth rates and I was like,

okay, it takes two weeks to order servers and install them. We're going to need to make a decision today whether we're going to order orders or not, because we're growing such that in two weeks we're going to need them. And by lunchtime, it was clear that we were not going to hit the two week window so that we had to move over to AWS within the next two weeks. By dinner time, it was clear that we had to move over to AWS that night. We didn't go home and 6 a.m. the next day, the entire product was moved. Rounds about the entire product moved over at AWS. Once again, there wasn't time to like, you know, philosophize. I had consumer examples.

The reality is that the beautiful thing about a founder is their ability to lie to themselves. And the number one thing a founder lies to themselves about is whether they have product market fit. And the great founders limit the amount they lie to themselves. We're about to have the last dinner for YC, dinner. And in my kind of final parting advice, one of my slides is big text. It says, you do not have product market fit. Keep on drilling people's heads. Because what every founder kind of dream,

of is company building. And if you lie to yourself and tell yourself you have product market fit, then you can start company building. It's what every founder kind of dreams of. They dream of being that Steve Jobs, that Bill Gates. When you have product market fit, you should do company building, but most people never get it. And most people should never be doing company building. And most people should never be investing their investor dollars in company building. They should just be invested in product. That's hard. Product can punch you in the face every day. And sometimes you want something new. You want something different. Hiring, if your products punch you in the face, but you're hiring great people, you can squint, lie to yourself,

and tell yourself your company's doing well. Until you're out of money. Last question on founders is all around execution. I'm obsessed with tests for this. I love how YC emphasizes just progress and velocity and momentum as a key attribute of a founding team. Do you think this is something that people can get better at, or is it something that is innate?

And if you do think they can get better, what are the ways that you've seen all the people pass through YC improve their execution? 100% you can get better. better at it. I think that so much of execution is a mental game and an expectations game. The best analogy that I give is that if you take the fastest person on a high school running team and they train with a college team, they're going to get better. If you take the fastest person on a college team and they train with the Olympic team, they're going to get better. They're going to

run faster than they thought they could run a mere month before. So when you take a founder in isolation and put them in a batch with a bunch of really smart people who are pushing really hard, they're going to accomplish more than they ever thought. You want to know the secret sauce of YC? That's it. It's not the advice or the demo day or yada, yada, yada. It's the batch. And one of the things that I say in the very beginning of the batch

is that the founders make YC, not us. If you were to take all of the kids who are going to MIT right now, move them to the community college down the block, that's one of the number one engineering schools in the world. Our job is to make sure that the batch is high quality and motivated. everyone races to keep up with one another. I can do this with you for a long time. I know we're up against time here,

so I have to move to my traditional closing question for everybody, which is to ask you for the kindest thing that anyone's ever done for you. In 2006, Justin Kahn and Emmett Shear sent an email to our friend group, saying that they were starting a new company and that they were taking a road trip from Cambridge, Massachusetts to San Francisco because they wanted to start their company in Silicon Valley. I was working on a U.S. Senate campaign where we had just lost our primary by three percentage points.

And I hadn't taken a vacation in a very long time. They were 22. I was 23. And I emailed them and I asked them, can I join you on your road trip? And what they didn't tell me is they had packed up Emmett Civic with all their stuff. So to clear out a room in the car for me, they had to basically give away or throw away about a quarter of their stuff. and they said yes. And I wouldn't be here right now without that yes.

Amazing. What a cool story. Well, Michael, I've learned a lot from you today. I'm going to remember a lot of these lessons and apply them. So I really appreciate your time and all the insight. It's great to meet you. It was really great being here, man. If you enjoyed this episode, you can sign up for a new email newsletter sent out each week

called Inside the Episode. Each week I condensed that week's episode to my favorite big ideas, quotations, and more. I've been recommending books to members of this email list for years, and we'll keep doing so in this weekly email. You can sign up at investorfieldguide.com forward slash book club.