Great Ideas are Fragile
That’s what Sam Altman, CEO of OpenAI and the former president of Y Combinator, said on Tyler Cowen’s podcast. Did you know that he doesn’t know how to read a balance sheet or build financial models? Just when I thought I knew enough about Altman to like him, he delighted me once again. I guess they aren't skills required to build one of the world’s effective venture capital funds.
Misalignment in the VC Model
Altman pointed out how most VCs tell their entrepreneurs to build network effects yet they don’t do it themselves. YC builds a network effect through the incubator structure of its cohorts, alumni funds, and brand — among others.
I think it makes sense for investors who instruct entrepreneurs to build network effect businesses to be building a business like that themselves. VCs can argue they have network effects in people they know. But I imagine it’s weak for the majority who rely on “who they know”.
The typical pitch I hear from VCs is that they build something already so they know what to do. If they were any good as entrepreneurs, would they have become a VC? At the early stages, it appears to be a game of empathy and it is no wonder that a VC relying on their past achievements and knowledge cannot empathize with the present day struggles of the entrepreneur.
Co-working Kills Great Ideas
Altman noted great ideas sound dumb at first. It’s so simple but I hadn’t thought about it that way before. They will seem silly to most people. This is why they need to be protected. It’s like an infant. That’s one reason why YC doesn’t have co-working spaces for their cohorts.
I found it hilarious when Altman spoke about all the YC copycats that said “we are like YC but we also have a co-working space”. To which Altman retorted something like this: “Do they think we never thought about that? Have they considered not having a co-working space is a feature and not a bug?"
Consider that. The collaborative elements of an office or co-working space are often emphasized as a benefit and the result of creative solutions. I would lean on the negative on such a statement.
Infrequent collaboration and meetups are great. This is why YC’s cohorts meet up infrequently to share ideas. But the founders spend majority of their time tinkering and building in the solitude of their one bedroom apartment that is often home to three mattresses.
Entrepreneurs colliding frequently results in the crowd killing ideas. Doubt and fear creep in when people cluster and rationality will inevitably stop entrepreneurs from tinkering and exploring. Furthermore, Altman noted how co-working spaces led to less work being done.
It’s no different from an office environment. The instant distraction of coworkers stops me from actually sitting down to do any deep work. I would purposely go into the office to hang out with coworkers instead of doing my work at home. Entrepreneurs face the same “resistance” Steven Pressfield talked about in The War of Art and a co-working environment will inevitably provide a source of distraction.
Popular belief touts the benefits of physical environments and their collaborative nature but they are valuable when infrequent. Work is best done in solitude. It is a prerequisite for daring work and that’s what YC needs its founders to be doing.
Management Incentives & the CEO’s Board.
Mike Mitchell shared some interesting anecdotes on what he learned from John Malone on the Value After Hours podcast.
Stock Options Aren’t Bad.
Mitchell highlighted stock options as another tool that could be effective when used well. My bias was to view large stock options pay for management as negative. But Mitchell shared Malone’s use of far out of the money options to incentivize his CEOs to change my mind on the topic.
Let’s say the stock price today is $100 and the management makes $30m if they get the stock price to $400. Yes, they will get paid a lot of money but so will you —the investor— if the stock price goes up 4x. Shouldn’t they get rich for making you rich? It’s a direct alignment of incentives with you and the management you are investing with.
Malone stated if the management team is any good, they will hit the targets. In the name of meritocracy, a management team that can achieve something difficult should be compensated for it. Don’t you want to incentivize your own managers with ungodly rewards for ungodly success? If my management team becomes billionaires for giving me a 10x return I don’t care. You want a win-win system.
CEO’s Pick Their Board
Things to remember with the board of directors: Non-exec board members rarely have any clue to what is going on in the business, directors that rely on the board fee as a source of income are not independent, and the CEO will place friends on the board.
Good CEOs will pick people with integrity and intelligence. They might even pick people who can challenge them and bring in a different perspective. But they will pick people that will support them. The CEO is running the company and trust in the board is more important than hitting some ESG metric that won’t do anything but be a PR checkmark.
It’s not a matter of whether you are for or against the CEO picking friends on the board of directors. You have to accept it as fact. If I was a CEO, I would 100% pick friends and people I trust on the board too. It’s hard enough running a business, who in their right mind will put in people they don’t know and don’t trust to challenge them just because it hits some diversity idea? This being so, the competence of the CEO matters for the composition of the board as well. Great CEOs will probably pick great boards and vice versa.