Startups and the expert opinion fallacy

Imagine 100 people in a stadium. Write down their heights, round it up and take the average. I don't know what your imaginary stadium looks like. Neither do I know who your imaginary 100 people are, but I can tell you for sure that the average you just wrote down is no more than 8 feet. Now, go back to the beginning and this time write down your contenders' wealth and take an average. This time, it would be impossible for me to give you a range of this average number. I can make a guess about the average height, because I know it to be impossible for a human being to be so tall to raise the height average of 100 people up by so much to take it over 8 feet. However it's completely possible to imagine only 1 of your 100 sample to take the average to $100M dollars or more from the global average of well below $10,000. By the way, how did you manage to get Bill Gates into a stadium?

If you are familiar with Nassim Nicholas Taleb's brilliant book, The Black Swan, you know that the above experiment is based on his book. Height, Taleb says belongs to Mediocristan where things live within normal ranges and events are more or less predictable with reasonably normal impacts. Wealth however belongs to Extremistan where there is no limit to attributes and highly improbable events have a huge impact. Now you can think of quite few attributes that belong to either of those universes: Weight, number of children or siblings and number of pages in a book belong to Mediocristan. Wealth, YouTube viewers and number of book copies sold on the other hand, belong to Extremistan.

The Black Swan, is about the impact of highly improbable. Until the 17th century people used to think swans are only white. It was simply not possible to think of a black swan. However, in 1697 the Dutch explorer Willem de Vlamingh discovered black swans in Australia. Following black swans, Mediocristan and Extremistan, Taleb tells us how predicting the future in Extremistan is impossible, futile and potentially a bad thing. He tells a convincing story of how self proclaimed "experts" fill up the airwaves and newspaper columns to tell us about the markets and other things from Extremistan where their opinions fare no better than a coin toss. In Thinking Fast and Slow, Daniel Kehneman, the Nobel prize laureate in economics, cites numerous experiments where not only the estimates of experts were worse than random guesses but actually worse than of the average population (who fared slightly better than random chance).

What about startups? Which world do they belong to? Repeating the same experiment with 100 startups this time, can you guess their average valuation? Would it be possible for a single startup in your randomly selected group to be as valuable as the rest put together? Common sense and our experience with Ubers, Dropboxes and thousands of failed startups suggests they certainly belong to Extremistan. This is confirmed if you believe how VCs think of their portfolios: most VCs think the Power Law applies to their portfolio where a single portfolio company can be responsible for the desired return of the entire cohort, hence their non-stop talk of the 10x return. Peter Thiel famously said of venture capital: We Don't Live In A Normal World; We Live Under A Power Law.

Now, don't get me wrong. I believe in mathematics as much as those VCs and cannot disagree with their logic of trying to find companies that will produce a 10x return for their funds to beat the market. My point is that, in a world so firmly grounded in Extremistan where events are unpredictable, improbable and have huge impacts, how do they pick the winner? More importantly, how do they, and the founders they pick predict the future, forecast it, plan for it and succeed?

Since predicting the future is not my specialty, let me rollback the clock and see how things turned out from no more than 15 years ago. It is 2003. You are an entrepreneur and founder of a new company that helps people connect with their friends online. You are sitting at a beautifully crafted walnut table in an amazingly designed conference room with a view of sycamore trees on Sandhill road, trying to convince a brilliant mind, reputable investor and Harvard MBA to invest in your company. To make your case, you produce charts, numbers and quotes in an attempt to show how the future is going to look like and how that future is going to make that man 10 times more money than he's investing in your company. This is 2003. Next year Google will be rolling out a social network called Orkut which for some reason will be very popular in a few random countries like Brazil and Iran but not in many other places. You've heard of a possible competitor called MySpace but not much more is known about them. Zuckerburg is still a spotty teenager living with his parents and Evan Williams has just sold Blogger to Google and it will be another 4 years for him to start Twitter. Snapchat founders are still asking their older brothers to buy them beer and What's App founders are in the queue of their local soup kitchen. Now, can you tell me how you predicted the way the world would turn out to be in the next 15 years, expressed your vision to the brilliant MBA in the room and avoided the people in white medical coats he consequently called in from the local mental asylum to take you there "to make you feel a bit better"?

I don't know the answer. If you are that person who's pitched a social network in 2003 to a VC, I'd love to hear your story. What I do know however is how things turned out to be, with the benefit of hindsight of course. I know Google abandoned Orkut for unknown reasons shortly after that. I know Facebook became popular with college students, until their parents showed up on the site so they had to leave Facebook for Instagram and Snapchat. I know everyone thought $1B is an insanely high price tag for Instagram until Facebook bought What's App for $19B and made Instagram founders look like losers. I know none of those who invested in What's App could give me a reason why they invested in it and more importantly none of those who didn't invest in What's App could tell me why they didn't. I know everyone thought Snapchat founders are rich, spoiled kids out of their minds for refusing a $3B acquisition offer until they went public. I know Twitter finally managed to be a business, more or less, or still is trying, this time in the public eye while Ev Williams started Medium to encourage long-reads, as if to resolve himself from his sins of making people's attention spans even shorter. I know once they realised they lost the social media game, Google tried to enter the market again with Google+ but didn't succeed and no one knows why they left the market they were in first and why they didn't succeed the second time with all their might.

I know all this because we all know it, and we all know it because it is 2018 now. We watched this crazy movie for 15 years and it's still not over. We don't know if the 2016 US elections is going to have a lasting impact on how social media advertisement is going to work and regulated. We don't know where the teenagers of tomorrow are going to hangout next year or if it involves disappearing pictures, enlarged eyeball video effects or cutified bunny ear face changers with voice modifiers that make you sound like a rat in a microwave.

We don't know these things because we haven't seen the rest of the movie yet but that's not the point. The point is there is nothing, absolutely nothing in the past events in this space that can be used as an indicator of what's coming next. In short, there is no value in history when you operate in Extremistan.

But now that the history has been played out, many "experts" have come out of the woodwork and tell us all about why Microsoft hasn't created it's own social media and why Google+ was a flop. If Facebook had sold to Yahoo! for $1B and turned into a social portal / media / advertisement entity with severe identity issues or had flopped and we were living in a Facebook-free world today, the same experts would have written hundreds of inches of OpEds on why and how accompanied by dozens of charts, numbers and quotes, trying to make sense of the highly improbable, high impact events and build their own personal brands and make a buck or two on the way.

The point is, startups are as extreme as Extremistan gets. As a founder, you can - and should - have a vision of the future. You can - and should - have faith in your ability to change the world (and reality) and execute your vision. Without the vision and borderline delusional faith, you won't be able to make it. You might even want to raise capital from some of those experts, known commonly as VCs to accelerate what's working for you. But don't confuse what's necessary for success with what makes you successful. More importantly, don't ever listen or believe the experts who weave stories about the past events to convince you they can use those events to predict the future.

Those experts, journalists, investors, MBAs, growth gurus or whatever, are like Turkeys thinking they've figured out life just because; today, they were fed great food for the 1000th day in a row just to learn today is this thing called the Thanksgiving! Those who survive, will be writing another story about what happened and how it can be avoided next time, until the next Black Swan event of their lives. Your job as founder is to avoid believing those who try to use the past events as a way to tell you how future would be in Extremistan.

On cancer and startups

Remembering that I’ll be dead soon is the most important tool I’ve ever encountered to help me make the big choices in life. Because almost everything—all external expectations, all pride, all fear of embarrassment or failure—these things just fall away in the face of death, leaving only what is truly important.

Around 6 months ago, I received an email from Laura, our financial controller. It was the monthly financial projection of our company, but it was different from the previous projection emails in one crucial way: it showed we are going to run out of money in 6 months. Suddenly we were going to die.

It was late at night and while the urge to pick up the phone and call Laura was almost unbearable, I managed to hold back and think. Reflecting on my emotions, I couldn’t help but to have the same feeling as when I had a cancer scare some years back. It was the same feeling: the feeling of facing imminent death.

Naturally I went through all of our available options: raising more capital, taking pay cuts, or letting people go. None of those were good or feasible options. It was like driving at 100 mph and suddenly seeing a concrete wall on the road 50 meters away. Being paralyzed from the neck down on a life support machine might be the best outcome you can hope for.

A cocktail of fear and anxiety about the future, guilt and embarrassment for not seeing this coming, and confusion and hopelessness about the next steps had such strong paralyzing effect that I couldn’t think straight for a couple of hours. Gradually I managed to calm down and think through the options we had. But before firing off any emails, I wanted to talk to Laura and go through the numbers again.

The next day, first thing in the morning, we sat down and reviewed the numbers. It turned out a misunderstanding on some cashflow realization and rent payment caused the “runway” to drop to 6 months. We were not about to die after all! We made the changes in the spreadsheet and the concrete wall in the middle of the road was gone.

That episode, while triggered by a false alarm, made me think about life of startups and how they are similar to our own lives. The prospect of death brings focus and attention to the most important things in life. This is no different in startups. When faced with imminent death, I didn’t think “maybe we should build a new feature to get out of this” or “perhaps it would help to release our product as open source and get out of this by increasing the number of retweets we are going to have on the story”.

One option however looks deceiving: raising capital. On the surface raising capital might look like a reasonable way to get out of a running-out-of-money situation. I believe that’s not the case. I would go further and say raising external capital has become an overgrown part of the startup life. It’s not the cure; it’s the cancer itself.

Your time is limited, so don’t waste it living someone else’s life. Don’t be trapped by dogma—which is living with the results of other people’s thinking. Don’t let the noise of others’ opinions drown out your own inner voice.

No matter what the latest article on HackerNews or your favorite VC’s blog post tells you, your aim should be to build a profitable and purposeful business. All the land-grab, moonshot, “reach for the Mars,” “you are the next Elon Musk,” “build the next unicorn” hoo-ha is self serving for the VCs who want you to raise loads of money and burn it fast so they can get a 10x return or stop wasting their time with you and turn over to the next entrepreneur.

The question we should be asking ourselves is, did we escape the dogma of “living the corporate life” so we can live the dogma of “raise tons of money, go big or go bust”?

It seems to me that we might have overestimated the role of external capital in building a business. Our industry’s over-reliance on VCs is absurd, unhealthy, and downright dangerous.

Let me be clear here, I am not against raising money to grow an existing successful model. I also acknowledge that some businesses can only be built at scale which requires external capital. But those are exceptions, not rules.

To be fair to VCs, I also need to clarify something: my issue is not with external capital coming from the VCs. It is with having too much cash in the bank. In most startups, this is either by raising money from a VC or by the virtue of having a rich founder. No matter where your money comes from, if it is not from your customers, you are harming your business by having it. Those zeros next to your bank balance take the focus away from what’s most important in your startup’s life. They will fool you into thinking you should be spending your day in upgrading your infrastructure or building your next awesome feature. Would you be doing that if you only had 6 months to live?

I find it ironic that while many might look for external capital as a way of getting out of deathbed, it is the cancer-like growth of venture capital in the startup business that’s causing a lot of those businesses be on deathbed in the first place. This constant demand for building more, capturing more, and grabbing market faster without solid foundations of a business, serves investors very well and that’s why they propagate it in the startup market so readily, but most of us started a business to live our own lives and not someone else’s. It feels to me that many of us are now in danger of living a VC’s life instead.

It is true that “If you live each day as if it was your last, someday you’ll most certainly be right.” It certainly applies to us mortals and while it doesn’t have to be true for businesses we build, living by it is the best thing we can do to stay hungry and focused, both for ourselves and our startups.

Quotes in this article are from the Commencement speech given by Steve Jobs at Stanford University in 2005. For many, Steve Jobs is the guy who brought smartphones to the world but for thousands of entrepreneurs around the world, he is the inspiration to take on the daunting challenges of building a business and creating something new from nothing.

I read this speech every year or two to remind myself why I do what I do and I know many others who do the same. I invite you to listen to his talk if you haven’t done so already.

This post was first published here