
Black Swan Seed Rounds - BIackSwan
http://blog.samaltman.com/black-swan-seed-rounds
======
cwal37
I don't think black swan is an appropriate title. This investing is more like
when a small group of people split a large powerball jackpot; statistically
unlikely, but not really fitting the definition of a black swan (at least as
proposed by Taleb).

His rules:

1\. The disproportionate role of high-profile, hard-to-predict, and rare
events that are beyond the realm of normal expectations in history, science,
finance, and technology.

2\. The non-computability of the probability of the consequential rare events
using scientific methods (owing to the very nature of small probabilities).

3\. The psychological biases that make people individually and collectively
blind to uncertainty and unaware of the massive role of the rare event in
historical affairs.

[http://en.wikipedia.org/wiki/Black_swan_theory](http://en.wikipedia.org/wiki/Black_swan_theory)

On a related note, Antifragile is a fun read. Taleb is extremely sure of
himself, and extremely passionate. His books and ideas (culminating in
Antifragile) can be pretty seductive in the moment.

~~~
graeme
I think there's a difference from a Powerball jackpot. There, the upper limit
is defined. Whereas there's no upper limits on Sam's investments.

They're perhaps not black swans in the sense that Sam is aware they may
increase in value, but other than that they seem to match the criteria in a
way that Powerball doesn't. Taleb has spoken specifically about how black
swans are not lottery tickets because of this calculability.

~~~
cwal37
The limit doesn't matter so much as striking it in the first place.
Realistically, all of the mentioned investments are within the realm of
reasonable thought. The presumption of a black swan is that it is completely
outside the ability for one to rationally assess a system then predict it with
decent success. 5/40 would be a phenomenally high success rate.

Lottery is totally not black swan, which is exactly what I was trying to say.
Despite having prior knowledge of the company's situation (unlike a completely
random lottery), it seems to me that these investments are closer to the
lottery than black swan.

You don't place bets on a specific black swan, but you could place a
different, outside bet on a disrupting event (kind of the idea of antifragile,
benefiting from disorder). I think under Taleb's comments in Antifragile,
living life as an artist as opposed to someone who is inherently reliant on
the stability of say, an office job, is placing that bet every day.

~~~
pdenya
I also misunderstood this

    
    
        It's more like when a small group of people split a large powerball jackpot
    

as

    
    
        [A Black Swan is] more like when a small group of people split a large powerball jackpot

~~~
stillsut
Why is it even unusual for multiple people to split a _large_ powerball? By
definition: a large powerball means there's more tickets and thus more
possible matches for the random draw.

Another minor point: there's gotta be dozens of people playing the Lost
numbers, the Miami heat starting lineup, etc... every time, so there are
natural clusters of group splitting jackpots for lotto winners .

~~~
cwal37
I just said group because presumably he wasn't the only investor in those
companies, so a group of people stand to profit. If he was the only investor I
would have said individual. It's also meant to highlight the fact that
multiple people are in on this, whereas an actual black swan event is
something that tends to be much more difficult to predict or be a part of.

I would be amazed if someone could go 5/40 in predicting black swan events
under their original definition.

------
bthomas
There's no evidence here that successful seed companies are more likely to
look like bad ideas than unsuccessful seed companies. If 4/5 black swans look
like bad ideas when they start, but 4000/5000 of this year's startups also
look like bad ideas, then there's no effect to explain. The only lesson is
that seed investing is just throwing darts.

~~~
foobarqux
And being wealthy and well connected.

------
imjk
Sam, could you (or any other Angel investor) talk frankly about the money your
put in and what your exact returns have been. How much have you had to
reinvest in later rounds too. I can't find any really experienced angel to
talk frankly about this with me.

~~~
sama
in 5 years, when the numbers should be real, i will shared all my aggregate
data.

the normal warning i give people: seed investing has always been hard, and
likely to continue to get harder. valuations are up on average maybe 3x since
i started, and it's not clear the companies are 3x more valuable.

~~~
ChuckMcM

       > valuations are up on average maybe 3x since i started,
       > and it's not clear the companies are 3x more valuable.
    

This is something I've been thinking about as well. Are companies creating
less value? Or is the value being going elsewhere?

In a constrained supply there might be an argument that things that wouldn't
have been funded before, now are, and those represent less value creating
ideas. But it seems YC is always oversubscribed, would that keep the quality
high?

Is the vision of the investors getting cloudy, or more specifically are there
still companies that are 3x as valuable but they are being funded elsewhere?

Or is just the capital availability pushing down the yield price on seed
rounds?

I don't have any answers, but its interesting to think about.

~~~
crapshoot101
> Or is just the capital availability pushing down the yield price on seed
> rounds?

This is almost certainly the case - I recall valuations in 2009 / 2010 vs now,
and the gap is absolutely crazy. A lot of that has to do with the deluge of
angel money floating around partially as an offshoot of the big-name IPO's
like Facebook, but more broadly, we are in a financial world that is
desperately chasing yield anyway it can get it - and a seed round is the
lowest level commitment of it (that and the high end rounds). The rub, as it
lies, is the middle tier.

------
sama
to be clear: i don't think seed investing is random. far from it. i just think
it's really important to think independently and take the time to really get
to know founders and understand businesses instead of just following other
investors.

~~~
edanm
Curious thought- you mention the (unsurprising) thought that people who are
good at fundraising aren't necessarily good at running a company.

But, all other things being equal, I'd expect someone who's good at "winning"
at the game called "raising money" to be the type of person who is better at
winning at other games, e.g. running a good company. In other words, while
being good at raising money doesn't necessarily mean they're good at running a
company, I'd still take them over the "average person".

You seem to imply the opposite in your post - is that really right? Maybe
people who are good at fundraising have spent too much time/energy on that vs.
getting good at building a company? That sounds specious to me.

~~~
nostrademons
If the skillsets needed to found a company are largely independent and time
spent learning them is a limiting factor - both of which are true in my
startup experience - then time spent learning the fundraising skillset cuts
into time spent learning customer development, or the particulars of your
market, or engineering, or hiring, or management. You'd expect skill at
fundraising to be anti-correlated with some other important skill, then,
because you don't have time to get good at some other skill you need.

I've never seen a startup where the founders knew everything they needed to at
company formation. Usually it's one giant, steep learning curve.

~~~
edanm
That makes sense.

But let's say you have some underlying quality, say intelligence or ambition
or determination or "grit". This quality will probably correlate with success
at both fundraising and building/running a company.

Now I don't have anywhere near the experience of YC or even you, but I wold
imagine that at least intelligence and determination are positively correlated
with both. So I'd expect someone who is good at fundraising to also be good at
the rest.

There could be a few reasons why this might not be the case. It could be that
we're looking at a small subset who have already passed an
intelligence/determination threshold, above which these 2 traits matter less,
and time spent developing the proper skills matters more. It could be that
there are other factors in raising money or building/running companies which
matter more, which would be an interesting conclusion to me.

Or it could be that I've made an error in reasoning somewhere :)

~~~
nostrademons
Let's say that having high intelligence makes you 5% more effective per
standard deviation at everything you do, but deliberate practice makes you 10%
more effective per week at whatever you practice.

Now take two founders, one of whom is twice as effective at fundraising as the
other. There are a couple possibilities: maybe he spent 7 weeks more time
practicing fundraising than the other, or maybe he spent 6 weeks more and is 2
standard deviations more intelligent. If he spent 7 weeks more time
practicing, then the other founder who devoted that to, say, customer
development will know the market twice as well. But even if he spent 6 weeks
practicing and gets a boost from his higher intelligence (equivalent to 1 week
of practice), the other person is still 60% more effective at the other stuff.

This model is very much simplified, but illustrates a big point that I took a
long time to learn: small broad-based improvements take much longer to pay off
than targeted, high-% improvements in narrow areas. So yes, being intelligent
is nice, it helps slant every skill you learn in your favor. But it is no
substitute for actually practicing hard and removing errors.

There are similar counterintuitive principles at work in many other areas.
I've found that engineering tools or frameworks that promise a few percent
improvement in productivity are rarely worth learning and almost never worth
developing unless they have a huge userbase, because it may take you 2 months
to develop them but if they save you 5% in development time it'll take 40
months to break even, by which time they're probably not applicable anymore.
Similarly, you are almost always better off hiring the person with little
experience who is really passionate about your company, rather than the guy
who is seemingly a genius at everything he does but really doesn't care about
you or what you do. It's probably also behind the YC advice to be "narrow and
deep" when building for customers; you can improve the product much more
quickly when directly targeting a small userbase than when trying to please a
large one.

------
tormeh
A recent blog post [0] from the Economist stated that buying random stocks on
the stock market actually performs better than valuation-weighted investment
and conscious investment. I wonder if the optimal strategy is to just invest
randomly?

[0]:
[http://www.economist.com/blogs/freeexchange/2014/06/financia...](http://www.economist.com/blogs/freeexchange/2014/06/financial-
knowledge-and-investment-performance)

~~~
chimeracoder
That's really an argument for buying index funds, since the costs and fees of
buying and selling random stocks would eat away any profits very quickly.

(Even just buying and holding truly random stocks is still less likely to be a
better investment strategy than index funds after taxes and fees are taken
into account, let alone the volatility).

~~~
tormeh
Sorry, I think I wrote hedge fund when I meant index fund. To clarify I've
just replaced it with "valuation-weighed investment".

------
chatmasta
A few more reasons raising a quiet/controversial seed round might be a good
signal:

1\. Publicly raising a large seed round creates a lot of hype when the product
might not be ready yet, or even before there's any product/market fit. As a
founder, that creates a lot of pressure to satisfy the hype, and also might
cause you to attempt building a product that satisfies the opinions of the
blogosphere, rather than your customers. In contrast, when you raise a quiet
round, you can build your product and achieve product/market fit without
worrying about the outside world, instead focusing purely on your customers.

2\. If no investors are questioning the model, you should be alarmed. Almost
by definition, no company seeking a seed round has proven revenue model.
Knowing this risk, you should expect some fraction of investors to be
questioning it. If none are, then it's likely a signal that they've been
swayed by smooth-talking founders who are very good at raising investment,
but, as you mention, not necessarily fit or ready to build the business
they're hyping.

So if we assume quiet seed rounds help with success, this leads to some
questions about YC, which is essentially a loud seed round. Namely: should you
announce your YC acceptance before you have product/market fit? Should you go
through YC in stealth mode until ready to capitalize on hype?

It seems your observations can tell us a lot about the value, or anti-value,
of product hype. The lesson seems to be, in the words of Denzel
Washington/American Gangster, "the loudest person in the room is probably the
weakest."

------
razvanr
I suspect there's also an inverse correlation between the amount of money
raised at an early stage and founder focus going forward.

It's easy to interpret a large seed round as early success and become side-
tracked or overestimate what your company's impact really is at that stage.
Which can impact focus and lead to disaster.

~~~
ameister14
While there might be a point where an effect like this would take place, I
think you'd have to raise an extremely substantial seed round for that. I
don't think it would be a truly inverse correlation, at least not a normally
distributed one. It would probably be one sided as well, because getting no
funding shouldn't increase focus.

------
snowwrestler
"Make your own decisions" is good advice, but I think the main question is
whether there exists any reliable means of distinguishing the good contrarian
vs. bad contrarian investments--or whether it's just luck. The title seems to
imply that the answer might be just luck.

------
zmitri
What's an approximate range of $ raised/valuation that makes for a Black Swan
seed round in your opinion? It's hard for me to understand what the
implications are of this besides "don't believe the hype" without having some
relative sense of that.

------
tmuir
Isn't basing the multiplier on valuations at the latest investment round
disingenuous? After all, its just a number the owners and investors hope
someone will eventually pay for the company. It's the asking price set by
people hoping for large returns.

~~~
rgbrgb
Well it's a number that some people (the investors in that round) DID pay for
a chunk of the company. If those investors have any sway on the board then
it's well below the asking price for the entire company.

~~~
tmuir
A valuation based on an investment round is the valuation of the complete
company, not just the amount invested. So if I invest $1M for 10% of a
company, that "values" the company at $10M.

------
hharrisbrown
In the case of competitive seed rounds (like mentioned Optimizely), would be
interesting to hear why someone like Sam's money was accepted over others --
any thoughts?

------
EGreg
Does Sam Altman continue to do angel investing or now that he's running YC
he's stopped as part of their policy?

------
silverlake
So investing at the seed stage is random. I'm surprised that VCs don't help
new companies more in the early stage to mitigate some of the common failure
patterns, for example the list PG had in 2006. Perhaps couples counseling for
YC founders? Every little bit reduces investor risk even a little.

[http://www.paulgraham.com/startupmistakes.html](http://www.paulgraham.com/startupmistakes.html)

~~~
prostoalex
"Engineered random". Sam still gets a better deal flow than most of angel
investors are out there, so even "meh" companies with high risk have passed
some initial filter.

Any angel investor without the name or brand recognition gets much worse deal
flow _plus_ the companies subject to negative selection bias, as they've been
rejected by sama, SV Angel, YC, etc.

------
panabee
he lists four: teespring, zenefits, stripe, and optimizely. anyone know the
fifth?

------
wunderlust
This essay might be remotely insightful if Sam explained why great companies
"often look like bad ideas at the beginning" and "look really risky at the
seed stage".

------
recalibrator
Teespring and Zenefits I've never even heard of until today. Are they rolling
in the bank and disrupting their respective industries?

And Stripe, there was huge pent-up demand for a PayPal alternative before they
came on the scene. How could anyone say that was a "black swan" bet? It
doesn't make sense.

~~~
bellerocky
When Stripe came out it did not compete with Paypal, it competed with
companies like Braintree. Stripe was never just a traditional payment gateway.
It created an API for payments and a dashboard for managing invoices and
recurring customers.

Pent-up demand for a PayPal alternative are from sellers who have a customer
facing PayPal payment mechanism. Customers know they're paying with Paypal and
customers usually have a PayPal account they use to pay you with. PayPal can
hold on to customer funds like a bank.

With Stripe, a customer doesn't know you're using Stripe and if they had a
Stripe account they wouldn't be able to see all the purchases they made at
various sites that used Stripe, they're just not the same thing.

PayPal now owns Braintree, so they now do compete with Stripe.

~~~
recalibrator
I recall Stripe was being positioned as a PayPal alternative to collecting
international funds, but that wasn't the point.

My point is there is no black swan here. Far from it. It makes no sense in
this context.

~~~
bellerocky
The argument that Stripe was a black swan comes because getting into
established industries with significant regulation used to be considered dead
on arrival, now it's hip.

~~~
recalibrator
That's the heroic narrative used by investors like Sam, but I don't believe
it.

~~~
randall
Keep in mind Stripe's original name was /dev/payments. If you do some research
you'll see they were in a pretty bad spot right until they opened publicly as
Stripe.

