The Future of Web Startups

[The Future of Web Startups]

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| Want to start a startup? Get funded by
Y Combinator. |

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.

It's a pattern we see over and over in technology. Initially
there's some device that's very expensive and made
in small quantities. Then someone discovers how to make them cheaply;
many more get built; and as a result they can be used in new ways.

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.
Now we can stick computers in everything.

This pattern is very old. 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. 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 is courage.

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
much more money.

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

We now think of it as normal to have a job at a company, but this
is 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 in large volumes you tend
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 could hire employees, but we want to be
forced to figure out how to scale investing.

We often tell startups to release a minimal version one quickly,
then let the needs of the users determine what to do
next. In essense, let the market design the product. We've
done 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 system.

One of the most important things we've been working on standardizing
are investment terms. Till now investment terms have been
individually negotiated.
This is a problem for founders, because it makes raising money
take 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 that make acquisitions 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 do ten times as many.

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.

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