A Deficit of Leadership

Joe|August 6, 2016

Our age is not short of great ideas — of ways new technology can be applied to fix global industries and increase prosperity. But we are starting to notice a serious deficit in Silicon Valley: a shortage of great leaders. A common refrain from startup entrepreneurs is that they have no problem attracting high-energy contributors, but are having difficulty finding talented, driven executives who can lead and inspire. It is growing harder to ignore SV’s leadership deficit as one of the central challenges for companies fighting to scale — and as a central question for Silicon Valley’s impact on the world at large.

Here in Silicon Valley, the term “leadership” is usually discussed with regard to effectively running and managing an organization — both of which are crucial to becoming a successful founder. But great leadership — whether in business, politics, academia or organized religion — demands more than a thin commitment to managerial efficiency. A deep concern of mine is that leaders in the technology sector have not developed a culture that insists upon courage, honor, duty and humility– what we might call a culture of virtue. The great lesson of leadership handed down to us from classical thinkers in every culture is that those who handle power must do so with a deep sense of responsibility for those whose lives they touch. One of my favorite passages on leadership comes from Sun Tzu, who writes:

Leadership is a matter of intelligence, trustworthiness, humaneness, courage, and discipline … Reliance on intelligence alone results in rebelliousness. Exercise of humaneness alone results in weakness. Fixation on trust results in folly. Dependence on the strength of courage results in violence. Excessive discipline and sternness in command result in cruelty. When one has all five virtues together, each appropriate to its function, then one can be a leader.

Creating a billion dollar company is hard, but being a truly great leader is even harder. It requires an acrobatic balancing of commitments to stakeholders and employees with broader commitments — civic, patriotic, and global. A true leader must strive towards a grand vision of human progress, but remember that the minor details of her everyday life really matter to those who look up to her as a role model. Great leaders must understand how to act in such a way that they exhibit all the virtues in unison.

Great leaders inspire incredible loyalty in their followers and subordinates. In the 6th century, Confucius counseled, “Let him preside over them with gravity; then they will reverence him…Let him advance the good and teach the incompetent; then they will eagerly seek to be virtuous”. There are not many figures in Silicon Valley who viscerally attract followers in this way. In the tech sector it is common to find lost souls who hop from job to job, self-optimizing as quickly as possible instead of striving together towards common goals. Many would-be leaders, overwhelmed by promises they’ve made and expanding duties, go silent on allies and retrench on responsibilities. They put short-term practicalities ahead of honor and virtue. Without a conscious culture of leadership and peers to hold them responsible, executives under the increasing pressure of difficult jobs often give in to lower impulses unworthy of their own leadership potential.

Of course there are a few great leaders with legions of proud followers; there are large groups pursuing bold missions, courageously standing up to difficult challenges and making the right decisions. But these men and women are rare finds in the world of technology, and too few here are striving to understand and emulate their values. There are at least one hundred classes and meet-ups on business or tech infrastructure strategy for every one on leadership.

It’s no wonder that when entrepreneurs achieve success, they often arrogantly flaunt their newfound wealth or mistreat others with secretive or unfair liquidation preference-structures, as if their employees or former colleagues are mere instruments to securing greater personal profit. The startup mentality is intensely competitive, and fosters a spirit of “us v. them”. Taken to an extreme, this mentality can manifest itself as ruthless selfishness on the part of founders; of naked, vain ambition rather than the pursuit of a higher purpose. These kinds of viciously imbalanced worldviews reflect a culture that is crying out for stronger leaders. I’m reminded of a line by Cyrus the Great, the wisest ruler in the Persian tradition: “Success always calls for greater generosity — though most people, lost in the darkness of their own egos, treat it as an occasion for greater greed.”

One challenge in building leaders is what you might call the “cult of the engineer.” Our culture strongly (and correctly) emphasizes the importance of developing hard, technical mastery in computer science and related fields. No great companies here are built without a star tech culture featuring a core of elite computer scientists. Meanwhile the more intangible quality of good leadership is brushed under the rug. There is a noticeable gap between most young geniuses who excel in math and science and those who demonstrate leadership ability. It may be that the learning curve to become a sophisticated engineer is so steep that this generation’s brightest don’t have enough time to study the great leaders of antiquity, consider their place in the world from political and philosophical perspectives, or even do things as simple as playing team sports.

Building a startup that outclasses the competition may require a myopic focus on developing a sound product, but leading a company that will change the world requires just the opposite. Henri Fayol — one of the pioneers of management theory — wrote at the turn of the 19th century that “a leader who is a good administrator but technically mediocre is generally much more useful to the enterprise than if he were a brilliant technician but a mediocre administrator.” This is because leadership requires an imaginative awareness that grasps one’s environment as completely as possible, even if only imprecisely. To borrow a phrase from Isaiah Berlin, great leaders have “instinctive skill”; the power to make “inspired guesses” at the best methods to influence others and bring about their vision. George Washington, Benjamin Franklin, and Winston Churchill all possessed the power to understand the world in a broad, interdisciplinary ways — and this power to synthesize information from every quarter made them extraordinary leaders. We witness the same capacity in titans of industry and remarkable CEOs — Andrew Carnegie, John D. Rockefeller, and Steve Jobs all certainly possessed it. For an engineer gifted at coding with mechanical precision, a transition to a pure leadership role will involve a transition to a very different mode of perception — as well as a host of new interpersonal skills.

Silicon Valley needs to address its deficit of leadership. Initially, this will mean raising dialogue about the issue in various forums: technology summits, universities, and individual discussions. Young engineers who want to be successful on a macro-scale should understand that leadership is a skill to which they must aspire — however fuzzy a concept. For those of us in positions of leadership here in the valley, the issue demands both reflection and action. We need to help train and mentor younger leaders at the same time that we think hard about how we can best emulate history’s great leaders and heroes. What can we do to be better leaders ourselves, and to inculcate these values in our organizations and young talent? I hope this is something we can discuss more openly and more often, as Silicon Valley becomes more influential around the world.

There is an enormous literature on leadership — here are a few books we highly recommend, ranging from classics to modern leadership texts:

“Xenophon’s Cyrus the Great: The Arts of Leadership and War.” Ed. Larry Hedrick. St. Martin’s Press, 2006.

Marcus Aurelius. “Meditations.” Trans. Gregory Hays. Modern Library Edition, 2002. Print.

Sun Tzu. “The Art of War.” Trans. Lionel Giles, Chiron Academic Press, 2015.

Benjamin Franklin. “The Autobiography of Benjamin Franklin.” Dover Publishing, 1996.

Herman Hesse. “Siddhartha.” Trans. Joachim Neugroschel. Penguin Books, 1999.

Dale Carnegie. “How to Win Friends & Influence People.” Simon and Schuster, 1936.

Peter Drucker. “The Effective Executive.” Peter F. Drucker. Harper Collins, 1967.

Steven Covey. “The 7 Habits of Highly Effective People.” Free Press, 2004.

John Wooden. “Wooden on Leadership.” Ed. Steve Jamison. McGraw Hill, 2005.

Great thinkers the world over and from every time period have reflected on the concept of leadership. Here are some of our favorite quotes on the subject:

“The highest type of ruler is one of whose existence the people are barely aware.
Next comes one whom they love and praise.
Next comes one whom they fear.
Next comes one whom they despise and defy.”

-Lao-Tzu (5th-4th century BC)

“Whoever wants to become great among you must be your servant, and whoever wants to be first must be servant of all.”

-Jesus Christ, (Mark 10:43)

“The source of this predominance was not barely his power of language, but, as Thucydides assures us, the reputation of his life, and the confidence felt in his character; his manifest freedom from every kind of corruption, and superiority to all considerations of money.”

-Plutarch, writing of Pericles (1st century AD)

“There is nothing more difficult to take in hand, more perilous to conduct, or more uncertain in its success, than to take the lead in the introduction of a new order of things.”

-Niccolo Machiavelli (16th century)

“Strive to be the greatest man in your country, and you may be disappointed. Strive to be the best and you may succeed: he may well win the race that runs by himself.”

-Benjamin Franklin (18th century)

“If your actions inspire others to dream more, learn more, do more, and become more, you are a leader.”

-John Quincy Adams (18th century)

“The greatest moments in the struggle of single individuals make up a chain, in which a range of mountains of humanity are joined over thousands of years.”

-Friedrich Nietzsche (19th century)

“To be a king and wear a crown is a thing more glorious to them that see it than it is pleasant to them that bear it.”

-Queen Elizabeth (20th century)

“One’s philosophy is not best expressed in words; it is expressed in the choices one makes… and the choices we make are ultimately our responsibility.”

-Eleanor Roosevelt

“If you want to build a ship, don’t drum up the men to gather wood, divide the work, and give orders. Instead, teach them to yearn for the vast and endless sea.”

-Antoine de Saint-Exupery (20th century)

“If you just set out to be liked, you will be prepared to compromise on anything at any time, and would achieve nothing.”

-Margaret Thatcher (20th century)

“Management is doing things right; leadership is doing the right things.”

-Peter F. Drucker (20th century)

Tech Bubble or Golden Age?

Joe|July 27, 2016

There is a tide in the affairs of men
Which, taken at the flood, leads on to fortune;
Omitted, all the voyage of their life
Is bound in shallows and in miseries.
On such a full sea are we now afloat;
And we must take the current when it serves,
Or lose our ventures. — William Shakespeare, Julius Caesar.

Since the recovery from the dot-com crash, doomsday prophets have consistently warned of a bubble in the private technology company ecosystem. This may sound like a valid concern to Silicon Valley-outsiders confronted with a spectacle of far-fetched startup ideas, wild blow-ups, and the transfer of large sums of money into the hands of audacious twenty-somethings. But we are not in a tech bubble. Iterative, trial and error experimentation is the mechanism by which firms drive the evolution of the market economy; it is the natural adaptation of industry to new technological paradigms. Moreover the amount of money involved in this vital discovery process is a tiny fraction of total economic output. Like any industrial revolution, the present era is one of rapid flux of the economy in response to new technological possibilities. Economic historians looking back on the present period will characterize it as the early innings of Golden Age of the information technology revolution.

In Technological Revolutions and Financial Capital, Venezuelan economist Carlota Perez points out that our era’s first four technological revolutions all follow the same basic pattern: the eruption of the new technology, a feverish speculative frenzy, a recessionary economic collapse, a prosperous Golden Age, and a maturity phase of slowed economic growth once the technology has fully penetrated the market. Collectively, these stages result in what Schumpeter calls the “creative destruction” of the old technological paradigm. In the “installation period” leading up to the crash, the new technology disrupts and permeates friendly markets. The “deployment period” following the crash sees the dissemination of the technology into hold-out markets, rejuvenating legacy infrastructure in these industries. The standard cycle takes 50–60 years. There have been five major technological revolutions in the last 250 years: the first Industrial Revolution; the Age of Steam and Railways, the second Industrial Revolution, the automobile era, and now the Information era.

We often use Perez’s model as one guide for understanding what’s going on in the macro-economy, and what possible technological breakthroughs are on the horizon. Perez’s framework suggests that we are now in the latter half of the fifth technological revolution. The IT wave arguably began when ARPANET adopted TCP/IP in 1982, as the spine of the Information Technology revolution is the Internet. The eruption of the Internet in the 1980s phased into the dot-com bubble of the 1990s, which burst catastrophically at the dawn of the new millennium. Internet mania is an excellent example of a true bubble. Technology stocks soared 300% from 1997 to 2000, and accounted for 35% of total public investment at the peak. P/E ratios were at astronomical levels, and paper fortunes were rapidly being made. But many stocks had zero profits and valuations were disconnected from discounted future cash flows. The crash was the turning point for the IT revolution.

If the crash of 2000 represented the turning point, then 2016 is the Golden Age of the information technology wave. Each wave lasts for around 50–60 years, and we are now in the middle of the deployment period. In the deployment period, the current technological paradigm will fully commercialize. Technology producers will control an increasingly large share of resources as they work to transform old business infrastructures and improve the lives of consumers. We are transitioning from the speculative, “casino economy” of the 1990s to a period where financial capital reconnects with builders and doers — those who scale functional platforms to create real value in an economy. As we move into the deployment phase of this IT wave, angel investing will become less profitable than growth-stage investing, as the real opportunity for capturing value creation will occur as young but growing enterprise companies expand to their full potential. Venture capital will continue to consolidate into those few larger firms poised to aggressively scale their novel, industry-winning data and workflow platforms.

The unique thing about the current technological revolution is that a series of new innovations have “lifted” or “bumped” the possibility curve upwards and exaggerated the shape of the normal technology wave. If the Internet were a standard technology curve, then a post-2000 world would see the deployment of similar kinds of companies that existed pre-2000, perhaps with small iterations. But something different has happened. In the last 16 years, there have been several other inventions that have compounded the growth of the Internet era and pushed the bounds of what is possible. The invention and commercialization of the smartphone is one such example. In 2000, before the iPhone came to market, there were only 50 million people on the web. Today, there are 3 billion people online, with the majority of traffic driven by mobile.

Perhaps most importantly, the technology underlying the IT paradigm continues to rapidly increase in capacity. Since the dot-com crash of the early 2000s, the continual miniaturization of transistors and the compounding exponential growth of computational power has progressed so far that it has massively distorted the shape of the curve. Companies can now host their data on cloud providers such as Amazon on Microsoft, where they can spin up or down their storage as necessary. Paired with the commoditization of big data analytics frameworks such as Hadoop, this shift has opened the door for organizations to process and analyze hundreds of millions of data points in seconds. Companies can now solve complex, non-linear problems in ways that were not possible with the software built at the beginning of the IT wave in the 1970s and ’80s. The consequence of this extension of the installation period of the IT Revolution is what we have elsewhere been calling the “Smart Enterprise” wave.

Borrowing Perez’s terminology, each of these minor technological developments generates a kind of miniature installation period and market craze of its own. Successive inventions are creating new applications for the Internet as new devices and software connect to the cloud. In the present Golden Age, installation and deployment dynamics operate in tandem. Collectively, this process is fueling new opportunities to capitalize on the IT wave. Some of our partners and friends disagree with us on the question of whether new paradigm shifts will take place in the next decade. For instance, futurist Ray Kurzweil suggests that the rate of innovation is itself accelerating, and that new paradigms will occur at ever closer intervals in the future. Our view, however, is that the Smart Enterprise paradigm will remain the dominant one for the full generation predicted by Perez’s model, and that no upcoming paradigm (e.g. virtual reality, artificial intelligence) will be as transformative to the overall economy for quite some time. If our view is correct, then the best opportunities for putting capital to work will be at the growth stages of Smart Enterprise companies. That is not to say that there won’t be good opportunity for angels to capture in the Installation Phase of the next paradigm, or at the tail end of the Smart Enterprise wave. But the best opportunities will more and more skew towards Smart Enterprise companies with signs of early success and with 99% of the market left to capture. Consistent with this view, we are launching a co-invest fund to fuel companies poised to aggressively scale their platforms.

A technological revolution is like a rock thrown into a placid pond. It takes time for the ripples to reach the pond’s edge. As Perez notes, techno-economic paradigms “are highly uneven in coverage and timing, by sectors and by regions, in each country and across the world.” The Internet/big-data splash rippled through the consumer space in the 1990s and early 2000s, generating companies like Google, Facebook, and Amazon (the “Consumer Wave”), and creating enormous value. As depicted in the graphic below, it is now impacting a variety of formerly sequestered industries such as energy, finance, and government. These are trillion dollar industries with archaic information systems, employing human beings as middleware to perform routine data-processing and communication tasks. Perez explains that “institutional recomposition” occurs in the deployment period. Indeed, in our era, inefficient back-end infrastructure is being updated with state of the art information gathering, structuring, and analytics techniques– i.e. “Smart Enterprise” software.

The next generation of Smart Enterprise companies will create network effects by concentrating anonymized data from across the entire industry such that the more users there are, the better the industry data will become. Storage and cloud-computing will continue to become cheaper, more data will be created and processed, and progress in deep learning, neural nets, and AI will oust more and more human middleware. The Smart Enterprise wave will thus free up human minds for tackling questions which demand high levels of abstraction and creativity. Still, though, there will need to be a layer of human decision-making in core business processes for the foreseeable future.

In the excitement of Silicon Valley speculation, it’s important not to lose sight of the grander narrative of technological progress. The vast majority of the economy has yet to be transformed by the IT revolution — we are nowhere near the exhausted, fully-saturated markets of Perez’s “maturity” phase.Unlike the early consumer platforms, which have now attained behemoth status, the first flight of Smart Enterprise platforms have only touched a fraction of the major parts of the economy they are destined to impact. It is likely that Silicon Valley has already developed many if not the majority of the breakthroughs relevant to the current technological generation, and that Smart Enterprise companies are beginning to transition from adolescence to early adulthood. Over the coming decade, the most compelling opportunities will increasingly be these scaling-phase platform ventures, which will raise large amounts of capital and grow at high rates for years longer than most expect — generating exceptional financial returns. While the current zero interest-rate macroeconomic environment suggests that we may be in a macro-economic bubble, the technology sector is not a culprit. Perez’s model helps demonstrate that we are instead in the most productive period of the IT revolution, or in the words of the Bard, “afloat on the full sea of fortune.”

Joe Lonsdale
Partner, 8VC
Founder, Palantir and Addepar

Reid Spitz
Investor, 8VC

Clay Spence
Writer, 8VC

Mentorship and Problem Solving with Secretary George Shultz

Joe|July 7, 2016

Secretary George Shultz, born 1920, great American economist, statesman, and businessman.

Secretary Shultz is one of the great men of our age, and I am lucky to have gotten to know him over the past several years during his time at the Hoover Institute at Stanford. Born in 1920, he has lived an extraordinary life and is still actively working on some of the most important problems of our time including nuclear non-proliferation and mentorship of government leaders.

Shultz hardly needs an introduction — an economist, statesman, and businessman, he has served in four Presidential administrations in a variety of roles including Secretary of Labor, Director of the OMB, Secretary of Treasury, and Secretary of State. He is an extraordinary polymath; a man admired by many leaders from all backgrounds.

Zac Bookman — my co-founder of OpenGov and the company’s CEO — and I visited him at his office recently to show off the progress at OpenGov and to get his advice in other areas. The Secretary is an advisor to OpenGov and we are excited to hear he plans to visit our team again soon. We were proud to show him that we have deployed the technology to over 1000 cities and districts, from 0 when we first discussed the idea with him, and to see his excitement about programs we are rolling out to make government work better. Although OpenGov was one topic, I was so inspired by other parts of our conversation and by the Secretary’s stories that I thought it would be fitting on America’s Independence Day this year to share some of this great American’s wisdom.

When Ideologies Clash, Focus on Problem Solving vs. Principals

In the early seventies, President Nixon put Vice President Spiro Agnew and Secretary Shultz in charge of getting rid of school segregation in the seven states that resisted earlier court rulings. Agnew didn’t want to touch the topic because he saw it as politically destructive, so Secretary Shultz jumped in and started working on the problem. Emotions were high and confronting this sensitive issue was tough going at first, but Shultz persevered and set up multi-racial commissions of leaders in each of the seven states. When he met with the commissions, he’d steer them away from ideological conversations and instead talk about the problems that needed to be solved — he would have them agree on the problems and discuss possible solutions.

“People are great problem solvers — it’s what we do,” he told us. By applying his leadership and persuasion and getting people to agree on a problem and work together to solve it, versus arguing about principles, groups overcame their differences and successfully eliminated segregation in many of the most stubborn parts of the southern US.

Make It Their Idea, and Work Behind the Scenes

It almost seems like a fantasy in this day and age, but when Secretary Shultz came up with a tax reform idea under President Reagan, he was able to get it passed 97 to 3 in the US Senate.

The reform lowered the tax rate in the top tax brackets for corporations but was revenue-neutral as it eliminated a lot of loopholes. Rather than take credit for the idea, which he knew would lead to opposition by the Secretary of Treasury and others in the White House, he convinced President Reagan to make it his idea. Then he worked behind the scenes with leaders on the left, found what was important to them, and got them to propose something similar. By having dialogue with both sides and empowering each to push forward what they wanted, his leadership and the trust he had from all sides enabled him to guide the reform through with nearly unanimous support.

Secretary Shultz never got credit for much of what he did, but he did earn great respect from many people on the inside. This is what true leadership looks like, and we can’t help but wish we had more men like him in government today.

Not Bi-Partisan, Mr. President — Non-Partisan

When Shultz and Henry Kissinger were visiting President Obama at the White House to discuss nuclear non-proliferation, the President commented that it was great to see much needed bi-partisan work being done. The Secretary corrected the President; the work wasn’t bi-partisan, it was non-partisan. Partisanship had nothing to do with it — some issues are just about what’s best for America and the world, regardless of parties. Rather than always see the world through the lens of parties and the goals of both sides, which leads to a constant “us-vs.-them” mentality, it’s good to carve out as much as you can and work together to achieve common goals.

The perspective of non-partisan goals and accomplishments is a refreshing paradigm; one that is emblematic of an older style of American leadership that would be very welcome in today’s hyper-polarized political environment.

The Shultz Rule

Another great American, our friend and investor Sam Reeves, took my 8VC partner Drew and my father and I golfing at his club at Cypress Point for father’s day this year. Many of the members knew and admired Secretary Shultz, so the golf course came up when I saw him the next week.

He asked how I did on hole 16, which is either played as an easy par 4, or else a particularly challenging 230-yard par 3 over a beautiful stretch of California ocean and cliffs. I went for it twice in a row, and the first ball bounced off the cliffs 220 yards away, but the second one ended up on the green. The Shultz Rule, created amongst his friends, says that if you take the risky and daring shot and go for the green, you get a mulligan (one free do-over) if you miss. By his logic, I was on in 1! His rule encapsulated a few things about the great man — both his bold nature and playful spirit… as well as his sense of diplomacy. It’s worth trying for greatness — and it’s worth having fun!

We are really lucky to have a man like Secretary George Shultz in our lives, and his lessons are particularly apt for today’s leaders.

Pittsburgh: A New Tech Hub?

Joe|July 6, 2016

Pittsburgh, which was founded two centuries ago in 1816, was one of the great economic centers of the United States. It was the 8th biggest city by population in 1920, and it peaked at over 700,000 in the 1940s. A geographic center where the rail lines met between cities including Chicago, Cleveland, DC, and New York, Pittsburgh was the home of great industrialists including Mellon, Heinz, Frick and Westinghouse, to name a few who many of us still recognize today. During the second world war, Pittsburgh itself produced as much steel as each Axis power and was at the heart of American industrial success.

But to my generation that grew up in the 1980s and 90s, the word Pittsburgh evokes an image of abandoned giant metal factories, rusting bridges, and a huge dying city. As the mills closed at the end of the 1970s and unemployment spiked to enormous levels, the job of the city leaders became one of managing decline for many years; the population has steadily dwindled, down to 305,000 today.

Joe Lonsdale and Mayor Bill Peduto, at Pittsburgh City Hall, built with extreme grandeur in 1916 for the city’s centennial;. The mayor commented that some of the exotic wood used by the talented craftsmen is now extinct, and speculated what citizens would do to him were he to try to spend tax money on a building like this today.

Despite this trend, many signs of revival are emerging from the ashes of this rust belt giant. Great universities such as Carnegie Mellon (CMU), University of Pittsburgh, and Duquesne still attract top talent–CMU, for example, is currently ranked the number one U.S. graduate school for Computer Science (CS). Google has hired over 800 people in the city; Uber is building its self-driving lab and testing cars on closed streets; Oculus, Microsoft, and tens of others are building offices. Palo Alto may be an attractive tech center, but Pittsburgh has a not-insignificant cost of living advantage; single-family homes go for around $70,000 and extraordinary mid-century mansions with ten bedrooms and tiffany windows go for $400–500k… twice that amount, a million dollars, barely gets you a one-bedroom starter apartment in Palo Alto.

Pittsburgh has remained an interesting place to live as cultural institutions sponsored by endowments left behind from great industrialist families have continued to support art collections, design programs, and other city life; the mayor and his staff says it was a combination of the universities and these endowments that kept the city alive through the toughest times. And now it is starting to bloom again.

Our entrepreneur friend Matt Michelsen got to know Pittsburgh Mayor Bill Peduto and his staff, as well as the CS deans at CMU, and my partners Alex, Kimmy and I and other teammates were excited to spend time with them this last Friday on the way back to CA from NY. The city has put in meaningful tax incentives that make it interesting for young companies to open up offices in Pittsburgh, and we’re excited to talk to to our companies about them. It’s refreshing to talk to city leaders who care about helping businesses get what they need, whether it’s a test track for Uber or the right connections with the city’s robotics centers and experts.

Mayor Peduto (right) leads Alex Kolicich, Tayler Cox, and Joe Lonsdale, on a tour through the city archives.Until the 19th century, the city council was divided into a Commons Council and a Select, much like the House of Lords and House of Commons in Britain, or the original Senate and House of Representatives in the U.S. federal government.

CMU helped create the field of machine learning and artificial intelligence, and the amount of talent and leadership at CMU that is eager to engage with top companies and apply their ability to solve important problems is amazing. Andrew Moore is a very respected technologist who built a machine learning group for Google in Pittsburgh, and is currently one of the CS deans at CMU. His vision and leadership made the excitement of the city and innovative energy of the university palpable. The deans were excited to structure more of the projects going on around the university as mission-driven startup companies, and as the city and its talent becomes more connected to the technology economy, this seems likely to happen at an increasing pace. Smaller amounts of funding seem like they can go really far here, and 8VC’s angel investors are already following up with several of the professors.

Of course, high-end metalwork and industry is still a big part of the local economy. We also discussed our company Hyperloop One, which we thought should explore the talent and capabilities in these industries as it expands to new offices in the coming years. Today, of course, everybody gets around on airplanes. But were 700 mph + train routes to be installed on the eastern seaboard, Pittsburgh would once again be at the center of a lot of the most important cities in the area, and suddenly, within easy (<1 hour) day trips of each, would would make it a very interesting place to base operations for a variety of businesses.

The Tower of Learning at the University of Pittsburgh, an Art Deco masterpiece built during the Great Depression.

Many people who read about rust belts and decline may not realize that Pittsburgh is an aesthetically beautiful place. Some of the soaring old industrial spaces that can be rented for very little would be really fun to set our designers loose on to make into hip startup offices; probably much cooler than anything we have in California. And in general, there may be some rusting bridges, but the great buildings and city landscape were created at a time when American architecture was at its peak. It’s perhaps a blessing in disguise that the city wasn’t building as much during the brutalist period, or erecting the strip malls and boxed buildings that were thrown up all over America from the 70s through the 90s; Pittsburgh instead retains a charming, mid-century feel. The city hall, built with elements of the Pitt family crest as its theme for the 1916 centennial celebration, evokes the confidence and grandeur of a leading city of America’s past. Speaking to the deans at CMU and the mayor, and seeing talent and ambition start to move back into this old industrial city, one cannot help but feel that the grandeur and pride isn’t just relevant to the past, and that Pittsburgh may yet again play a significant role in our nation’s future.

Practice Safe Financing

Joe|April 26, 2016

This article first appeared on TechCrunch.com

The convertible note is a useful and common financing structure in Silicon Valley. It’s a form of debt that is really more a type of equity — one where the valuation hasn’t been determined yet.

It’s helpful because sometimes you want to align a new investor or bridge a company with extra capital, but not argue about the valuation or have to price the round yet. Many bureaucratic institutions, for example, would make you do all sorts of studies to justify any particular valuation — and you are busy building your business. You want the investor aligned (or want their cash, at least), but prefer to price the round a little down the road.

So the investor loans money to the company at some low rate of interest (usually 3–10 percent) and has all the senior protections of a debt-holder if anything should go wrong. When the next institutional round of capital is raised — usually defined by an investor coming in with at least several million dollars in a priced round — the note and interest converts into that round at some pre-determined discount to its price (usually 10–20 percent). The note holder becomes an equity holder with shares that have the same rights as those in the new round, at a slightly better price.

At a high level, there are two types of notes: capped and uncapped. You should (almost) never raise a round on an uncapped note, as it pits the incentives of the investor and the company at odds with each other.

We use convertible notes a lot at our fund, 8VC — so often that we just call them “notes” to save time. Capped notes are a great alternative to a priced seed round, and a great way to align relevant people in your community or business vertical in between your A, B, C or D rounds. They’re also sometimes a life-saver (or at least a cap-table saver) for companies who use them as a financial bridge to get their ducks in a row and give themselves a few (or more) extra months to hit an inflection point before pricing their next big round.

Of course, companies will generally pretend they are doing the alignment thing rather than admit they needed a few extra months of runway. (Don’t tell anyone, but “We are looking for some strategic partners who can give us advice before we do our next round, and are using this convertible note to align them financially,” is often Silicon Valley speak for, “We need some extra cash so we have the runway to show some better progress before we try to raise a big round.”)

A capped note means there is a maximum valuation at which the note will convert. A typical cap on a seed round note is $10 million. This is fair, as is $5, $8 or $20, incidentally, depending on the group and what they are doing. What’s ridiculous is an uncapped seed round. If the company doesn’t get strong early traction, the investment might be worth nothing, yet many of us have also heard of a company like this taking off and stories of the first priced round being raised at $100-pre. Instead of getting 10 percent or 5 percent for your first $500,000 if you’re an investor, you might now be getting less than 0.5 percent of the company.

Of course, there’s nothing unethical about this — it just means you were bad at structuring your investment. You should have insisted on a cap, or else a priced round. Usually, a good entrepreneur wouldn’t have done this to you — it’s not how almost any of the top people in our ecosystem treat others, as the true talent knows this is a repeated game and that honor and reputation is worth more than whatever percentage points they can get from chicanery.

But the thing that makes uncapped notes especially bad is that the incentive of the investor and the entrepreneur should always be aligned.

It’s wrong to put an investor in a situation where they are deciding between helping their ownership stake versus helping the entrepreneur.

When we invest in a company at 8VC, it’s our job to make that company as successful as possible — from an internal product and strategy perspective, but also in terms of who it is able to hire, what its customers think about its product and its mission, what the media says (but not until that matters) and what other investors think about it. The goal is to help the entrepreneur put their best foot forward in the way that’s the most positive and true to the company and its mission.

Entrepreneurship is in large part about building something from nothing, which means creating a cause. And causes are not created in isolation — great investors are fully aligned with their entrepreneurs and do what they can to push forward the cause along with their most relevant touch points in the community at any given time. Backing a company is a serious business.

Now go back to our $500,000 investor in that uncapped seed round. As he sees the company take off, what are his incentives? At some point, it’s not clear. Maybe he realizes these are amazingly talented entrepreneurs who are on to something, but he secretly hopes a couple of the early attempts will stumble so that they’ll have to raise money at a lower valuation than what they’d get otherwise, so he can convert in.

What does he say to the star designer who is interested and who he knows by joining might drive their valuation even higher before his note converts? And maybe he looks down and mumbles instead of playing them up to a top investor who is excited to invest at a really high valuation, in order that he gets in at a lower price. Or maybe he doesn’t, because he’s honest to his principles and he wants to be aligned with the entrepreneur even against his own interests.

With an uncapped note, you are often creating an incentive for an investor to hope you do well enough that you are going to win in the future, but maybe have some struggles and raise at a relatively low valuation next time.

In our view, a great investor should never have to face that conundrum. It’s wrong to put an investor in a situation where they are deciding between helping their ownership stake versus helping the entrepreneur. I’d like to think I’d always side with the entrepreneur in this situation — it’s who we are and it’s our mission at 8VC — but I’m also driven to win for my LPs who are betting on me: I know my partners and I feel strongly about being good players and role models in the ecosystem, but we are also fiercely competitive to do as well as possible for our IRR.

“Power corrupts” wasn’t just written about madmen who take over governments; it’s true for all of us, and it happens in small ways. Incentives and spheres of influence are powerful things, so it’s critical we keep them as aligned as possible.

There is one scenario wherein it can make sense to do an uncapped note, but even then the note should never be truly uncapped. This scenario is the insider-led bridge round, where the note is expected to be short-lived. If an investor already has equity in a company, she is aligned to make the company’s valuation go up, but she might want to bridge the company; that is, give it the money it needs to keep operating until it completes its next raise.

If the next round is imminent (within the next month or so), the cap on the note can interfere with a pricing discussion. In this case, doing something that ladders is right. For example, you could offer a note with terms of no cap if the round is done within two months, but with a cap and a discount if the round is done within four months, a bigger discount at six months and so on and so forth.

In general, the best solution is to place the cap at a valuation in which you are very confident you can hit that is likely below your next round. Contrary to popular belief, a cap is not always a signal for the price of the next round. It’s true that many rounds are raised near their caps, but I’ve had a note capped at $10 million to let helpful friends into my company that raised its next round at $45-pre, and I’ve seen many great entrepreneurs who value their community take care of allies this way.

In our view, there is a huge misalignment with not having a cap on your notes if your investors have any real influence on your business or the technology and investing community — asking an investor to invest into an uncapped note is about the clearest way possible to tell them they are not connected to any community relevant to your success and don’t matter except for their money. And if they don’t, you should probably find better investors.

Joe Lonsdale
General Partner, 8VC

Real World Parallels to Last Night's Episode of Silicon Valley

Joe|April 25, 2016

Photo Credit: HBO’s ‘Silicon Valley’

Although certain TV portrayals are clearly unrealistic or over the top for comedic value, this episode dealt with a lot of issues we face in our industry.

Perhaps the central theme of the episode was the lead investor gaining control of the board and forcing the founder, Richard, into a CTO position.

Control issues like this happen all the time, although it’s rare for it to happen as early in a company as “Pied-Piper” which is about to raise 5 @ 50 million — when a company is seen doing well and has a lot of momentum and excitement behind it early, the founders usually wouldn’t give up that control to an investor. This situation is more rare today, versus twenty years ago where investors typically had more power over entrepreneurs. It was a rare mistake Richard made to accept terms that created an outside board that could replace him as CEO. But at the appropriate time, funds do often try to bring in experienced leadership, and when they get control they often force it.

Some funds are seen to be on one extreme and generally to oppose replacing founders (such as Founders Fund; their name relates to how they want to stand up for founders). Founders Fund believes that truly great companies that keep growing for a long period do so in part by keeping their founders as leaders. Others, such as Sequoia, were historically known for firing the CEO if they believe it is best for the company [a couple of the people who started Founders Fund for example had been fired as CEOs by Sequoia in the past]. Of course, these are sophisticated funds that have done very well and both of them have been on both sides of these issues.

The portrayal of the founder’s ego and suffering in this situation was apt. We’ve seen far worse — intense people sometimes have their lives and identity wrapped up as CEO of the company and perhaps 10% of them are unbalanced, much worse than was portrayed here — not only intense but also psychologically troubled people seem to be attracted at a higher rate to being a founder. In the worst situations it’s not unheard of to have talk of suicide or violence around these issues, and in any situation it’s extremely difficult for a founder. The question of how a team will stand with or against the founder in these situations is also common.

The lawyer’s betrayal of the founder when Richard got emotional and threatened to sue the investor was interesting. Many lawyers are clear they serve the company and not the founder, but others would have been loyal to the founder and resigned if necessary, as they would want other founders to trust them and hire them based on their perceived loyalty in an industry that values the entrepreneur and that is mostly run by other founders. In the episode, the company lawyer surprised Richard by going against him based on his ‘duty to the company’ and was showing that he cared more about what the investor thought about him long-term and was placing his chips there… this wouldn’t always be the best strategy for a lawyer in real life, as founders wield a lot of power in SV and tend to be loyal to each other. But it’s not unrealistic.

The most unrealistic scenes were around the amusing and egotistical speech about firing of a whole group at “Hooli” by their out of control founder, who pretended he was being humble while blaming them and trying to steal some of their upside. Ego issues are definitely an issue with successful leaders and people love to mock them, but no self-respecting engineers would stay and work for a company with a leader that was that obviously out of control. That said, many successful companies in our industry do probably have a lot of inefficient programs and groups they could benefit by cutting, even if it’s not as extreme as people sitting around on the roof hanging out.

The final scene of the show was my favorite — there are a lot of really amazing, successful people around Silicon Valley who we can learn from when we open up to the fact that we don’t know everything. And in real life we mark the passing of one of the great entrepreneur coaches with the memorial service of Bill Campbell today, a kind and insightful man who shared his wisdom and inspiration with many.

When the show’s potential mentor-CEO came up the skepticism of the team making fun of his previous entrepreneurial and leadership success and cancer research efforts was right on for the cynicism of many in SV, and how they might react at first to a new senior person or “outside wisdom”. Being a great founder or early team member is a difficult dialectic — you have to be a bit overconfident and a big ego isn’t always a bad thing — to change the world requires pushing really, really hard and believing you and your team know something others don’t. But the other extreme is also important to embrace — sometimes, experienced leaders are really helpful, and founders can do best by putting their egos aside and finding ways to learn.

I didn’t like how the CEO was forced on the company — that shows an investor not adept enough to manage the company from the same side of the table as the entrepreneurs — but the nod to experience and to the team learning to grow from others who have been successful is great.