Black Swan Farming: Technical Appetite

Paul Graham is one of my favorite writers in this new Hi-Tech world. He released an essay today which struck a chord with me, you can read it here.

Essentially, Paul argues, much like Peter Thiel, that Startup returns follow a power-law distribution. That is to say that 75% of Y-Combinator’s returns have come from 2 startups: AirBnB and DropBox. When you think about the many startups Y-Combinator has funded, it seems sort of odd that only two startups would’ve contributed so much to the overall returns, yet this theme is actually repeated throughout the ecosystem.

Simply identifying which startups have a chance at succeeding is not enough. What matters, is identifying which startups will succeed in spectacular fashion. The problem, then, is not just to determine which startups may survive and flourish, but which startups will be meteors; which startups will change the world in a wildfire of innovation, a wildfire of change.

Silicon Valley has lost the appetite for Technical Innovation. If you look at funding and exits, the majority of investment is being aimed squarely at the places where most investors have already made allocations. Pushing more money into an already large pile of money isn’t necessarily the best way to create returns at a higher rate than the market. That is to say, no one is betting on Black Swans.

It is much easier for a VC to put their money in another camera startup after Instagram gets sold for $1B, but it makes little sense to do so. The truth however, is that firms don’t make a name for themselves by following trends. Many of the most famous investors talk about how the best opportunities are the ones others have written off as impossible, or opportunities where something has failed in the past. There are countless examples, even as recently as AirBnB (Who thought Bed and Breakfasts were going to fundamentally alter the hotel industry?) of companies bucking trends to great success. Many ideas looked quite silly at first glance (even Facebook seemed ridiculous until it was massive), but, as Paul puts it:

“…If a good Idea were obviously good, someone else would already have done it.”

-Paul Graham

And yet, Silicon Valley doesn’t seem to understand, or even acknowledge the existence of startups solving hard problems. I work in Telecom, and investment in this sector has been at a standstill since 2001. Even a casual observer would tell you that outside of Switching, the amount of investment in Telco Infrastructure (a HUGE addressable market) has been essentially non-existent. I’ve been told by a number of investors that after 2001, they simply can’t invest in things that ring. Others have offered money but with bizarre terms that don’t align with business objectives.

This is the crux of the issue: The level of technical sophistication, across Venture Capitalism, has decreased over the years. The number of investors with the technical acumen to invest in heavy Engineering startups have dwindled to the point that companies are forced to seek investment from un-sophisticated investors, with all of the long-term ramifications that creates (imagine having a non-technical board member making technical decisions).

In short, the problem with startup investment now, is not success bias, but rather risk tolerance for fundamental shifts in the way we use technology. As Paul Graham said in a previous essay:

“The biggest startup ideas are terrifying. And not just because they’d be a lot of work. The biggest ideas seem to threaten your identity: you wonder if you’d have enough ambition to carry them through.”

-Paul Graham

Startups still dare to dream, sometimes they even dare to dream impossible dreams. Investors need to look deeper than user counts, back to a day when intrinsic value actually meant something. Startups embody the audacity of hope; that’s why we’re drawn to them like Moths to a flame. A better tomorrow starts not with investing in the next facebook, but by looking where no one else is looking, and, perhaps most importantly, thinking differently.

Dare to dream. Dare to change the world. That’s the power startups hold.