Course lectures "Startup". Peter Thiel. Stanford 2012. Session 6

This spring, Peter Thiel, one of the founders of PayPal and the first Facebook investor, held a course in Stanford - “Startup”. Before starting, Thiel stated: "If I do my job correctly, this will be the last subject you will have to study."

One of the students of the lecture recorded and laid out a transcript . In this habratopic ntonio translates the sixth lesson. Formatting 9e9names . Astropilot Editor

Session 1: Future Challenge
Activity 2: Again, like in 1999?
Session 3: Value Systems
Lesson 4: The Last Turn Advantage
Session 5: Mafia Mechanics
Lesson 6: Thiel's Law
Lesson 7: Follow the Money
Session 8: Idea Presentation (Pitch)
Lesson 9: Everything is ready, but will they come?
Lesson 10: After Web 2.0
Session 11: Secrets
Session 12: War and Peace
Lesson 13: You are not a lottery ticket
Session 14: Ecology as a Worldview
Session 15: Back to the Future
Session 16: Understanding
Session 17: Deep Thoughts
Session 18: Founder — Sacrifice or God
Session 19: Stagnation or Singularity?

Lesson 6: Thiel's Law

I Foundations, rules, culture

All companies are different. But there are certain rules that you simply must follow when you start your business. The consequence of this is that some friends (somewhat pathetically) call Till's law: if something is confused in a startup from the very beginning, then this cannot be corrected.
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The starting point for any activity is very important. In each case, these points are qualitatively different. Consider, for example, the question of the origin of the universe. At that moment, various things happened that we did not experience in everyday life. Or, for example, turn to the process of formation of the state, which necessarily includes many elements that you will never encounter in the ordinary course of business. Here in the USA, the founding fathers have done a lot of the right things. With some things, they coped poorly enough. However, in most cases they are really impossible to fix. For example, in Alaska there are two senators. And in California too. And so Alaska, despite the fact that its population is 1/50 of the population of California, has with it an equal number of votes in the Senate. Some may say that this was intended, and this is no mistake. Whatever it is, the state of affairs is unlikely to change as long as the country exists.



The idea that the foundations are very important for any kind of activity is at the forefront of the Founders Fund (an investment company whose partner is Peter Thiel - comment of the translator ). The founders and starting points determine the further development of the business. If you focus all attention on building the foundation of activity and do not make major mistakes at this stage, then you will have a chance for development. If you do not do it - at best, you may be lucky, but hardly.

The importance of the fundamental decisions made during the founding of the company has already been laid in many of them. When controversy or controversy arises in Google, the final argument is the following: “The founders have a scientific rationale that statement x is true,” and the one who cites such an argument insists on x. If you think that the office should have special coffee pots with a strainer, because when people are satisfied, they work most productively, then say that Larry and Sergey have already solved this problem. The bottom line is that all the scientific justification has already been done at the very beginning when the company was founded, and no new introductory ones should change the fundamental principles.

However, all the basics have their own life span. But how long this term is - a difficult question. A typical story involves: the establishment of a company, hiring first employees, primary financing. However, it is believed that the foundation of the company is delayed for a much longer period. The transition from 0 to 1 - the creation of technology - occurs parallel to the foundation of the company. In contrast to this process, the transition from 1 to n in the framework of globalization, in turn, is fully implemented after the foundation of the company. It happens that the process of founding a company lasts as long as the development of technical innovations. It is unlikely that the founders of the company should be responsible for making decisions while the company is in the transition from 0 to 1. After the paradigm shift to “from 1 to n” occurs, the foundation process is completed. At this point, managers must fulfill their duties.

There is, of course, a limit to what you can do by the rules. Failures can not be avoided even if there are ideal "rules of the game." There is no way to initially set everything up so that later events unfold unhindered. But you should still lay the foundations of the company as correctly as possible.

Imagine a 2 x 2 matrix. On one axis you have good people who are trustworthy, and behind them there are people who should be trusted less. On the other axis, you first have an unregulated structure with a small number of rules, and then a perfectly adjusted structure, where the rules are set in sufficient quantity.
The work of good, trustworthy people in a poorly regulated structure leads mainly to anarchy. The nearest company to such an organization, which nevertheless achieved success, is Google approximately from 2000 to 2007. Talented people could work on all types of projects and in general, worked without a lot of restrictions.

Sometimes the opposite combination - unreliable people and a large number of rules - also works well. Basically, this system can be called totalitarian. Foxconn is a typical example. Many people work there. People are a kind of slave. The company even installs special nets on buildings for employees who jump from the roof in a suicide attempt. But this is a very productive company, and this approach seems to work.

A model with a low level of trust and a small number of rules is a merciless world. People whom you would not trust can do whatever they please. A good example of this is an investment bank. It is best to avoid this combination.

The ideal is a combination of people you can trust and a well-regulated structure. People trust each other and together create a good culture. And besides, it's all structured. People row in the same direction, and this is not an accident.

Equity is one of the key ways to think about regulating a startup. Various groups have shares in the capital of the company. A part, naturally, is received by the founders. First, they must figure out how to distribute shares among themselves. Business angels get their share. A certain number of shares are also received by the first employees and advisers of the company. Later, investors in round A will also buy shares. Then your option will appear in the form of shares. So you get some set of possibilities. With the development of this structure and the division of share capital, the key point is the organization of all shareholders in such a way that the company achieved success.

In this calculation, one of the factors prevails over the others. It is a question of whether the founders of the company are compatible with each other. This question is key from the point of view of both structure and corporate culture. If the founders work cohesively, you can go to the second part of the equation. But if this is not the case, the company will explode from the inside. Nothing will work. That is why investors should and indeed do pay so much attention to the founding teams of companies. Everything matters. It matters how well the founders know each other. It matters how they interact and work with each other. It matters whether they have complementary sets of competencies and personal qualities. All these questions are very important. Any cracks in the founding team will only increase in the future.

One of the first investments of Peter Thiel was an investment in a company that Luke Nosek founded in 1998. The investment did not bring such a good result. Luke met someone at an event, and they decided to start a joint business. The problem was that they had very different perspectives. Luke’s reflections were chaotic, but brilliant. The other guy was a “bookworm” - one of those guys who have everything on the shelves. The case was doomed to failure. In some respects, the choice of co-founders of the company is similar to marriage. Marriage sometimes makes sense, but to create a family with the first comer, who met at the slot machines in Vegas, right, it is not necessary. You can hit the jackpot, but more often than not it happens. Good relationships between the co-founders of a company tend to lead to success. Thus, the coherence of the founding team is the single most important issue when evaluating a startup at an early stage. It can be set in different forms. How do the co-founders share in the capital of the company? How well do they work together?

Ii. You must be a C-corporation in the state of Delaware (a corporation that is taxed separately from its founders - approx. Translator ).

A very important issue at the initial stage is how to register your company. This question is simple. You must register your company as a C-based corporation in Delaware. Here is the right answer. You unite to separate your own activities from the activities of the company. You need to create a structure in which you can include new people, sell stocks, etc. And registration will give you a lot more legal opportunities to do it. The business group "Larry Page and Comrades" could probably work today. But that would not have worked in 1997. Provide yourself with the basic structure you need.

There are different types of corporations. For startups, there is nothing better than C-corporations. S-corporations are good for companies with a small number of shareholders. In such a corporation there can be only one class of shareholders; there are no preferred shares along with ordinary shares. There are also no stock options (the right of employees to buy shares at a fixed price - approx. Translator ). There are restrictions on the number of shareholders. And you can't go IPO. Thus, S-corporations are good only for companies that will not scale beyond a certain limit. Limited liability companies ( LLC, Limited Liability Company, an analogue of our LLC - translator comment ) are more like C-corporations. But there can be problems with them if you want to issue preferred shares, give out options or go to IPO. In theory, you can arrange specially designed agreements to do all these things. In practice, this does not work as well as in theory.

A big disadvantage for a C-corporation is double taxation. You pay taxes on the income of the company, and then also pay your own income tax. Suppose your C-corporation earns $ 100. In the US, the corporate tax rate is 39.2%. Thus, $ 39.20 passes to the government immediately. You now have 60.80 dollars in net profit. But the maximum individual income tax rate is 35%. This is 21.28 dollars. So you end up with 39.52 dollars, if you are the sole owner of the company. Limited liability companies and certain other legal entities that are not C-corporations are taxed once. That is why consulting firms and law firms are not usually C-corporations.

The big advantage of C-corporations is that it is easier to get out of them. You can bring them to IPO. They are also easier to sell. Most likely, any company that acquires you will also be a C-corporation. This means that they are already accustomed to double taxation, and, regardless of their legal form, they evaluate your business as already functioning under double taxation conditions. That is, the legal form of LLC does not make you a more attractive target for the acquisition. You can also be a regular C-corporation.

More than 50% of C-corporations are registered in the state of Delaware. There are many reasons for this. Delaware trade and industry law is clear and transparent. Office work in the state is fast and predictable. The judges are pretty good. And of course, it is in some sense famous; everything seems to be doing it, and most think it is right. Just believe, you should register your company as a C-corporation in the state of Delaware.

Iii. Ownership, ownership, control

As the founder of the company, you should always think about how and why processes can get out of control. Your task is to prevent such deviations from the desired course and correct them where they occur. One of the approaches that can help talk about such deviations, draws the line between ownership, possession and control / control. These are related things, but the difference between them is important. Ownership belongs to the one who actually owns the company: who has shares and in what quantities. Ownership belongs to those who manage the company. These are the ones who make decisions on a daily basis and work in the offices of the company. You can think about owning in relation to job titles. Finally, the control function is performed by those who formally control the company. The control function is performed by those people whom you invite to the board of directors; many of them do not know your business very well.

Consider the political equivalent of using this approach. Let's say you have to go to the DMV ( Department of Motor Vehicles, State Department of Transportation - approx. Translator ) to get a driver's license. In a sense, as a voter, you control the government, and the DMV is part of the government. Voters choose government employees. They, in turn, appoint other people to various positions. Probably, you somehow indirectly influenced who became the head of the bureaucratic structure of your DMV.

But you will not speak with him, after waiting for their turn. You will talk to the people who perform the function of ownership described above: the clerks in the window or the managers who actually set the DMV in motion. They are people with the ability to help you or not to help. You can tell them that they are freaks. You can remind them that, according to the theory of an elected government, you are their boss. But, most likely, it will not work. There is a bias between control and ownership. This imbalance is not a catastrophe, but it is very indicative. Distortions often occur when dealing with government officials, or, say, top executives in the business world.

In many countries, it is difficult to draw boundaries between ownership, ownership and control. This makes the creation of a viable business really challenging. If the controlling shareholder also exercises exclusive control, it is not profitable to be a minority shareholder, therefore there are no minority shareholders. As a result, we have companies that could be much more effective if people were able to share the above concepts.
That is, it is not to say that everything is simple when you can separate ownership from ownership or control. As shown by the example of obtaining rights, between these groups or even within them there can be a serious mismatch of actions. Everything can get confused quickly.

Suppose you start a company. You are the sole founder. You have 100% ownership, ownership and control. Taking into account the absence of other co-founders, everything is perfectly adjusted. But even adding another co-founder is a possible source of imbalance. There may be serious disagreements about how to properly perform these three functions. Since now there are only two of you, you are still quite compatible. But the more people are added, the more difficult it becomes. Employees will be more loaded with daily possession, have a small share of ownership with minimal control. Problems begin to appear if they are unhappy with the amount of their ownership or control shares. The intrigue becomes more interesting when you add investors to this pile.

Iv. Founders and employees

A. Capital Allocation

Your initial task will be to achieve consistency between the creators of the company, employees and the first investors. In technology start-ups, share capital is a classic tool for achieving consistency. It is very important, since this is exactly the common thing that everyone in the company has. Since all participants in the event benefit from a rising stock price, everyone is trying to increase this cost. It is difficult to overestimate the importance of equity in creating the most important long-term prospects of the company.

The flip side of the coin in this case is that bonuses and salaries can cause various imbalances. The "ceiling" of wages is very important. Based on its practice, the Founders Fund has created a categorical rule: no CEO should have a salary of more than 150 thousand dollars a year. Experience has shown that in the salaries of CEOs funded by venture capital, lies the tremendous power of prediction: the lower such a salary, the, as a rule, the company works better. If you could reduce all your activity to one question, you would have to ask what salary the CEO of the company you are potentially going to invest in gets paid. If the answer is "more than 150 thousand dollars", you should not invest in the company.

The issue of salary is important, because when CEOs get low salaries, they believe that the company's shares will be expensive and try to make it happen. This effect applies to the entire company, as the CEO salary cap means a salary cap for all employees. In this way, you create a culture focused on the value of stocks and equity. It's not like that when the CEO gets 300 thousand a year. - , . CEO , . CEO , . .

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As always, there are exceptions. Peter did not invest in YouTube in the summer of 2005, because all the guys worked on this project part-time. Then everything changed very quickly, and Sequoia benefited greatly by earning (or making, depending on the point of view) investments ( in detail ). But the basic rule remains. You need to think carefully, and then either get on the bus or not. And if you still get on the bus, you should get on the right bus.

C. Share capital allocation and time

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The founders of the company must also have a schedule for the distribution of share capital. It is not very good to immediately give the founders all the share capital. One of the co-founders of the company may decide to go out of business. If he fully owns a stake in the business from the very beginning, the second co-founder can, as a result, come to a dead end, working for two. In practice, everything is organized so that part of the share capital of the company passes to the founders instantly. They can go to 20-25% of the work they do before the first round of investment. But the rest of the capital should go to them already over time.

Consultants also receive money or part of the shares that go to them immediately. But you should never hire consultants. From the point of view of capital, this is not correct, since immediate payment does not stimulate work well. And the reason not related to capital is that consultants violate the “bus principle”. Everyone should be in the same boat and very hard to row in one direction.

V. Capital

There are several different types of company equity. There are, for example, common stock, which is simply a way to divide ownership of a company. This is usually expressed in the number of shares. But this number is meaningless in itself, it is just the numerator. You will also need to know the number of shares in circulation, it is in our case the denominator. Only a share of the share capital owned by a company matters. The ratio of 200 thousand to 100 million is the same as the ratio of 20 million to 1 billion. 2% is 2%.

A stock option is the right to buy a stake in the company at a fixed price at a certain point in the future. The price of its execution is the price of its purchase, set at the time when the option was given. Typically, the exercise price is set equal to or greater than the real market value of the share at the time this option is created, so as not to create a taxable event. If the real market value of the stock is $ 20, and you value the option at $ 10, then the remaining $ 10 in this case is taxable. Valuation of the option at real market value ensures that they will not cost anything on the first day.

Options also have an expiration date, after which they become invalid. The basic mechanics of the job are as follows: the value of the option increases if the value of the company increased between the date the option was issued and its expiration. If this happens, the option holder buys shares at the strike price, which brings him income in the amount of the real market value of the shares at the close of the option, minus the above exercise price. In theory, this contributes very well to consistency, since an option can be quite valuable if a company succeeds in a given period of time.

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The main conclusion of this story is that most equity metrics are inappropriate. The number of shares does not show a realistic picture, as does the price of a stock or the size of an option. Your share in relation to the share of other employees also, in theory, does not matter. What matters is your share in the company. 3- . . - . , , , . , , , 1 /1 , 1 /1.

In practice, equity shares are seriously reduced as soon as you invite new people to the company. The surest way to destroy a company is to send everyone a list indicating who has a stake in the company. In this case, the ability to be secretive can be very useful, as the coordination of actions in time really matters. Some of your employees will have very rare skills. Others will be less unique employees with interchangeable skills and abilities. But incentives are tied to when you joined a company, not just what you know how to do. Key employees who come to the company later will receive a share different from that which employees who perform less important functions, but who got to the company earlier, have. At eBay, secretaries could earn 100 times morethan their bosses who graduated from the Stanford MBA, and all this only because the secretaries came 3 years earlier. You can say that this is fair, as early employees are at greater risk. But employees hired later, who are often more valuable to the company, see this picture in a completely different light. Thus, in practice, it turns out that even if you have adjusted everything perfectly, something can go wrong. You can't make everyone happy.that even if you have adjusted everything perfectly, something can go wrong. You can't make everyone happy.that even if you have adjusted everything perfectly, something can go wrong. You can't make everyone happy.

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Suppose you have 2 founders, each of which has 1 million shares bought out at a price of $ 0.001 per share (each founder invested $ 1,000). The company has 2 million shares and it is estimated at $ 2,000.

A business angel can come and invest 200,000 dollars at 1 dollar per share. Thus, you are releasing 200,000 new shares for a business angel. Now you have 2.2 million shares outstanding.

Then, let's say you hire a few people. You hire 6 people, and, since you did not read above, 2 consultants. Each of these 8 people receives 100 thousand shares. Thus, you provide 800 thousand shares at a price of 10 cents per share.

You now have 3 million shares. The company's valuation is 3 million dollars, as the transaction price was 1 dollar per share. Angel owns 200 thousand shares, which is 6.7%. Consultants and employees own 3.33% each, or 26.7% together. Each of the founders of 1 million shares, or 1/3 of the company.

B. Why debt can be better.

As an alternative to this model, you can make a deal with convertible debt. There are two standard ways to structure such debt. First, you can fix the value of the company and issue a discount for the next round of investments. This means that the company's valuation will be limited to, say, 4 million dollars. The bill holder gets a discount of, say, 20% on the next round of investment. Secondly, you can not limit the valuation of the company and not make discounts, but simply accumulate bonds or options for each round.

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C. Series A

After your meeting with an investor who wants to invest in your company, you have compiled a list of investment conditions. After about a month of comprehensive examination, under which the venture capitalist carefully examines the team, as well as the financial and technical perspectives of the company, the transaction closes and you receive money.

You must set up an option pool for future employees. 5% is a small pool. 15% is big. Larger pools of options weaken shareholders, but in a sense, this approach may be more honest. You may need to part with a tangible share in the share capital to attract good employees later in the process of working for the company. The size of the pool of options is a classic compromise between fear and greed. If you are too greedy, you will leave more to yourself, but this may cost nothing as a result. If you are too afraid, you can give away too much. You need to find the right balance. Investors prefer an option pool to be created before a round of financing, so as not to suffer from an immediate blurring of shares. You also want to create a pool of options after a round of financing. This is a matter of your negotiations with the investor.

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You need the benefits of payout conditions in case of liquidation, as they help coordinate the motivation of the participants. Without writing benefits for payments, you can simply take the investment, cover up the shop and distribute the money among the team members. This is obviously not the best result for investors. They need guarantees that you will not take the money and not escape. Using such an investment mechanism, when a company closes, they get back all the money invested before you receive anything, and you are interested in growing a business so that everyone earns money.

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Conditions preventing the dilution of capital are also an important form of investor protection. In fact, they retroactively revalue investments made earlier, when and if additional issue of shares is carried out. The basic mathematics is simple: the new number of shares equals the initial amount of investment divided by the new conversion price.

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If there is one definitive rule, you should never, ever, allow an additional issue of shares. With rare exceptions, this is a disaster. If there are tough conditions that prevent the dilution of capital, the additional issue will ruin the founders and employees. They also make the company less attractive to other investors. The fact is that additional emission makes everyone just go crazy. Owners may blame the controlling persons, who, in turn, may blame the employees. Everyone blames everyone. Essentially, on the day when the company has an additional share issue, the company is destroyed.



If you have to go through an additional issue, it’s probably better to be truly catastrophic. Thus, a lot of inadequacies will leave the company and will not cause even more problems when you begin the hard work of rebuilding the company. But, I repeat, you should NEVER allow an additional issue of shares.

If you have created a company and in each round of investment you are playing for a raise, you will at least make money. But if you have to issue additional shares at least once, you probably will not earn anything.

Viii. Even greater investor protection.

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There are also joint sale agreements, dividends on preferred shares, agreements on refusal to search for co-investors, repayment terms and conditions for the exchange of shares. All this may be important. All this is worth learning, understanding and, if possible, discussing. But they, as a rule, are not the most important terms of a financial agreement.

Ix. The board

Your board of directors is responsible for corporate governance. Another way to say what exactly the board of directors is responsible for. Holders of preferred shares usually have the right to vote, which allows them to approve certain actions, refuse to use protective mechanisms, etc. But the importance of the board of directors can not be overstated.

Every person on your board matters. Each of them must be a really good person. A typical board of directors is two investors, one “independent” director, and two company founders. Five people - already a fairly large board of directors. More than five people on the board of directors are no longer the optimal solution. The council should meet only when absolutely necessary. In matters of the board of directors, “less” often means “more.” Ideal advice probably consists of three people: one investor and two founders. It is much easier to reach agreement between members of the board of directors if they are all great people, and if there are few of them.

X. Planning for the future

Creating a company with value is a long way to go. The key question that you, as a founder, will need to watch out for is a blur. The founders of Google owned 15.6% of the company’s IPO. Steve Jobs owned 13.5% of Apple when it went public in the early 80s. Mark Pincus owned 16% of Zynga's IPO. If you have more than 10% left after many rounds of funding, this is generally a very good result. Blur share - a merciless process.

There is an alternative when you do not attract investors. Briefly on this approach. It is worth remembering that many successful companies were created that way. Craigslist would cost about $ 5 billion if it developed, more like a company than a commune. GoDaddy never accepted third-party financing. Trilogy had no outside investors in the late 1990s. Microsoft almost joined this club, the corporation took one small venture capital investment, right before the IPO. When Microsoft went public, Bill Gates still owned an impressive 49.2% of the company.

So the question of whether to think about attracting investors is not so different from the question of attracting the co-founders of a company or its employees. What are the best people? Who do you want to see next to you, who do you need on board your ship?

From the translator:
I ask translation errors and spelling in lichku. I also remind you that this text is a translation, its content is copyright, and the author’s opinion may not coincide with mine.

I repeat once again that translated ntonio . Formatting 9e9names . Astropilot Editor. All thanks to them.