Startup - how it works

[Steve]

x-no-archive: yes

==========================

Debated about whether this was an appropriate post, but then
thought, sure, why not.  Incidentally, I might have access to some
venture capital, if there are startup types at SCN who might 
have something in mind...

===========================

Instant Company 

One new Internet idea, two enthusiastic venture capitalists, six
founders leaving behind millions at the jobs they quit, $8 million
raised before a line of code was written, 12 weeks.

Po Bronson
NY Times


What were you doing 12 weeks ago? 

Twelve weeks ago was Nirav Tolia's last day on a pretty enviable job.
He is 27, and in addition to managing the marketing of Yahoo!'s
E-commerce properties, he had represented the company on television
more than 100 times. Almost nobody leaves Yahoo!, but Nirav Tolia had
just heard a really interesting start-up idea from a friend, Naval
Ravikant, who had recently left @Home. It took Tolia about one day to
decide, and the following morning he resigned. 

Soon after Tolia's last day at Yahoo! he and Ravikant were joined by
one of the highest ranking engineers at Netscape, Ramanathan Guha,
who was cooking up an idea very similar to Ravikant's on the back
burner of his big brain. By the end of the week, they were five
strong. Eleven weeks ago, despite not having a single line of code
written or even a paper sketch of the Web site they wanted to build,
they got $8 million in seed financing from venture capitalists --
half from Benchmark Capital, which had financed Ebay, and half from
August Capital, where Naval Ravikant was camping out as entrepreneur
in residence. This gave the start-up what is believed to be one of
the highest seed-round valuations ever. 

Nine weeks ago, they brought on Lou Montulli and Aleksander Totic,
two of the original six founding engineers of Netscape. Eight weeks
ago, they moved into a second-floor gabled loft in Mountain View,
Calif., and began grinding out 15-hour days, seven days a week --
but of course these guys had done that before. 

In a spring when it had started to seem to some Silicon Valley
veterans that all the big original ideas were gone, theirs was a
lightning rod for talent. The new director of business development,
Dion Lim, began to cut deals with other Web sites to import their
data feeds. Seven weeks ago, they started hiring category managers.
Six weeks ago, it became clear to Guha that enough of the original
programming was already done, and he could switch hats from coder to
manager. Five weeks ago, their venture capitalist from Benchmark,
Bill Gurley, came by the office for his first look-see. He was blown
away: "This is, unequivocally, the fastest I have ever seen a
start-up move." 

Four weeks ago, they began to cut distribution deals; two weeks ago,
they settled on their marketing plan, and now, having reached a
critical mass of 31 people, they are set to launch their Web site. 

In 12 weeks, the amount of time it might take an average person to
decide what kind of hedge to plant in the backyard, they built a
company from scratch. An instant company, or what is being called in
Silicon Valley a "second-generation Web company." 

Not so long ago, it seemed incredible that a Web company could be
born in a mere two years. But rather than going back to normal, the
pace of creation in Silicon Valley now seems to be speeding up even
more. Any Web company that starts out today and takes two years to
get up and running is likely to be left in the dust. 

In first-generation Internet companies, the founder and a few college
buddies moved into a garage that they decorated with Nerf guns and
green army men. In second-generation Internet companies, the staff
coalesces not from friendships but from respect for mutually
complementary skill sets. They skip the garage phase, engage two
real-estate brokers and make simultaneous bids on three office
spaces, hoping one comes through. They move in over the weekend and
by Monday have it decorated with Nerf guns and green army men. 

In first-generation Internet companies, the staff resigned from
monolithic software corporations or took leave of business school or
jumped ship on brand-manager positions at Procter & Gamble. Nobody
had Internet experience; they learned by making mistakes, of which
there were many. The purpose of the Internet was unclear. Now,
companies are being formed by staff members who have years of
know-how. And they see the Internet, above all, as a place to buy
things. Some $301 billion was generated by the Internet economy in
1998, with an annual growth rate over the past four years of 174
percent. 

Because of the way high-tech employees are compensated, there are
likely to be a great number of second-generation start-ups in the
next year. The notorious stock options that add up to so much paper
wealth usually take four years to fully vest. For the early movers
on the Internet, the four years are coming up. And the golden
handcuffs are coming off. 

This particular second-generation Internet company has managed to
recruit top people who were still handcuffed -- what people in the
Valley call "the unhirables." Naval Ravikant walked away from what at
the time was $4 million worth of unvested @Home stock options.
Ramanathan Guha walked away from probably more than $4 million (a
figure he is contractually forbidden to confirm) at America Online,
which had acquired Netscape. Sabrina Berry's previous employer,
CommTouch Software, was planning to go public. Berry walked away
from all of her shares in that company. For Lou Montulli to join, he
resigned from a hot, well-financed start-up called Geocast Network
Systems. At the time Nirav Tolia left Yahoo!, the unvested options he
left on the table were worth $10 million. 

But, he insisted, it didn't matter to him if it was $20 or $20
million -- he has a dream to pursue. 

"People are going to think I'm nuts," said Tolia, rolling his eyes. 

"Can we not talk about this anymore?" said Guha. "It's painful to
dwell on." 

Six weeks ago, the engineering team walked to In-N-Out Burger for
lunch. They crossed an overpass above Highway 101 and paused at the
rail. "This team has been responsible for many of the key features
of Netscape Navigator," Guha said. "These guys can point to any of
these cars passing underneath and say: 'That driver has almost
certainly used my code. And that driver. And that one.' We want to
build something that has that kind of influence. We want to build a
site that everyone will use." 

So what's the idea that is inspiring so many to jump? Until this
week, they've kept everything secret, operating under the code name
"Round One." In fact, not even people who come in to interview for a
position learn the idea their first day. Several hours of vague
conversation seem to be leading up to the grand presentation, but
alas, the applicant is sent home with a preliminary offer, setting
out salary and options and title -- and no clear sense of what the
company will do. If the candidate is sold on the team, then she or
he comes back for a second round. Only at the end of that next day
does she sit down in front of a whiteboard with Ravikant and Tolia
and hear something like this: 

As the Web becomes an infinite supply of goods and services, goes the
pitch, people crave guidance on what and where to buy. So far, the
great number of on-line shopping guides present quantitative,
machine-sorted and machine-generated data: comparisons of product
prices and specifications. But what consumers need (Ravikant and
Tolia contend) is a recommendation that gets beyond that: the advice
of someone they trust, someone just like them. 

Their solution is a Web site, Epinions.com, which they envision as a
sort of Zagat-for-everything, a site consisting entirely of consumer
opinions or reviews of anything you can buy. Epinions.com itself
will sell nothing at all -- it has no warehouse, no trucks on the
back end. The money would come from deals Epinions.com cuts with
companies that do sell things: every time an "E-pinion" prompts a
reader to click "Buy," the company will earn a tiny commission on the
resulting sale. 

At the start, the E-pinions on Epinions.com will be culled from
existing sources, guiding users through aggregations of expertise
from the four corners of the Web. But the key to the whole idea is
to make Epinions.com participatory, taking advantage of what I call
the Tom Sawyer model. Write and post a short review of any product on
Epinions.com, and you can earn a few pennies every time the review is
read by another user. By letting readers rate the usefulness of the
E-pinions, the most trusted ones will float to the top of every
category. As Ebay is a marketplace for products, Epinions.com seeks
to be a marketplace for ideas. If it catches on, like Ebay, then
everything snowballs, and these hobbyist-reviewers function as
sliver-time virtual employees who do all the work for you.
"Everybody is an expert at something," they kept repeating around the
Epinions.com office; they hope their site will be the place where
everyone shares their expertise. 

Similar logic has been welling up in the collective unconscious of
Silicon Valley, and most E-commerce sites are already adding some
form of E-pinion to their Web pages. Productopia, Deja.com, Cnet,
Amazon.com -- everyone's hiring editors and bringing back the
old-fashioned, well-trusted written word. Of course, sites that both
sell goods and review them are subject to criticisms of bias.
Epinions.com.com would be the first company to start up doing
E-pinions and only E-pinions, hoping to be as Jell-o is to flavored
gelatin.

And that's it. Then again, what was Yahoo! at the start but just a
Yellow Pages to the Web? The point is that job recruits with
demonstrable talent are buying in to give it a go. And they know
that in the short and unpredictable history of Internet businesses,
success has often come down to getting the details right, fast. 

"We don't need any more strategists," says Mike Speiser, a McKinsey
consulting alumnus who learned to curtail his own inclination to
heady analysis. This was 10 weeks ago. 

"We need closers," agrees Nirav Tolia. "We need bulldogs." 

"We need engineers who are execution machines," says Guha. "This is
not a strategy play. This is an execution play." 

First-generation start-ups raise small seed rounds to develop a
"proof-of-concept version," at which point the start-up has to go
back to dog-and-pony shows, negotiating for more money. Again the
second generation is different, faster. Prototypes, demos, alphas --
the language of the hustle -- those words aren't even in the
Epinions.com vocabulary. Every minute spent dancing for investors is
a minute stolen from the finished product. Ravikant and Tolia's
business plan (which consisted of 16 sparse slides) had no financial
projections and no budget. They negotiated for $8 million, enough
that they wouldn't have to go back for more until well after launch.
They had no idea what it would cost to pull together the E-pinions
they would need to stock the site, but they budgeted $5 million,
just to be safe. 

The group's biggest fear was the wrath of prominent venture
capitalists who did not get an opportunity for a cut of the deal. A
slightly rattled Tolia played me several phone messages left on his
answering machine by furious V.C.'s. One of the advantages of
combining August Capital and Benchmark is that they occupy the same
two-story building. When the terms of the valuation were set with
August, Ravikant and Tolia walked upstairs to Bill Gurley's office
at Benchmark. Gurley had joined Benchmark only a month before, and
Epinions.com would be one of his first big plays for his new
employer. 

"I need to know if you're in," Tolia said. 

Gurley was calm. He recounted some of the internal discussion among
the Benchmark partners. One partner, Gurley offered, had scored the
idea a 6.5 and the team a 9.5 on a scale of 1 to 10. But he wouldn't
tell them details of how the final vote was scored. 

"So where does that leave us?" Tolia asked. 

"Don't worry, it's done," said Gurley. 

"Should I contact your lawyer or something? Draw up term sheets?" 

"We don't do term sheets here," Gurley responded, offering his palm.
"We do handshakes." 

In those first crucial weeks, the Benchmark investment was like
having a Hertz Club Gold pass. Every service provider is overbooked
in Silicon Valley -- realtors, phone-system installers, furniture
suppliers, headhunters. Dropping the Benchmark name was the way to
impress vendors without sharing the idea. Everyone wants to do
business with what may become the next Ebay, dreaming they'll be
rewarded with friends-and-family shares when the time comes. 

Of course, they can't do everything. There was that first weekend in
their new digs, when the parts for their desks arrived from Home
Depot -- 25 solid wood doors, 100 4-by-4 legs and 400 metal braces.
Despite this formidable team of engineering talent, in eight hours of
off-and-on tinkering they couldn't correctly assemble any desks.
Finally they called a carpenter who had done this before, and he
started building two desks an hour. 

Fortunately, what they don't know about desks, they do know about
code. Hiring staff with seasoned Internet experience has allowed
Epinions.com to delegate like crazy. "We need to be told what to do
but not how to do it," said Luke Knowland, who had done it before at
Wired Digital. 

"It would take four very bright first-generation engineers a full
year to program this site," Guha estimated. "But because we've done
it before, we can write most of the code in six weeks." 

Everything is faster. Zero drag is optimal. For a while, new
applicants would jokingly be asked about their "drag coefficient."
Since the office is a full hour's commute from San Francisco, an
apartment in the city was a full unit of drag. A spouse? Drag
coefficient of one. Kids? A half point per. Then they recognized that
such talk, even in jest, could be taken as discriminatory in a hiring
situation. 

On the business-development side, "I no longer have to waste months
evangelizing," says Dion Lim, who has been cutting deals to
aggregate opinion material from existing Web sites. A couple of years
ago, the process would have been slow and painful. "Now, I just call,
and they have a syndication rate scale and a preferred data-feed
format," he says. 

Meanwhile, Epinions.com has kept up constant reconnaissance on the
competitors it will be jockeying with this fall, despite those
competitors' best efforts to keep their strategies secret. The Valley
has what it calls the "whisper circuit," which is not so much wild
gossip as the ability to call in old favors and threaten to pull
people's teeth. A lot of whisper-circuit surveillance leaks out the
back door of companies through their engineers, who often refuse to
lie on principle or are very bad at it when they try. 

Through the whisper circuit the company learned that one potential
competitor was trying to wiggle out of a partnership so that it
could overhaul its product toward something like Epinions.com. The
team learned that a top job applicant, on the verge of accepting its
offer, had been grilled so hard by another venture capitalist that he
cracked and spilled the Epinions.com idea. (The offer was retracted.)
Another V.C. was trying to discredit Epinions.com by telling people
he'd turned down its deal, which he'd never seen. 

And it was on the whisper circuit that the Epinions.com team learned
that Amazon.com had started flying writers and editors to Seattle and
offering them positions as category editors to cover a wide range of
products -- food, video games and so on. The whispering was specific
-- that Amazon.com was offering a $65,000 salary, a 10-percent
signing bonus and options that could be worth $1 million in four
years. (Amazon declines to confirm or deny those details.) The
entrance of Amazon.com onto the scene seemed like bad news for
Epinions.com. Everyone lost sleep that night. 

But their exuberance returned with dawn. "Amazon is supersmart,"
said Naval, marching out of Benchmark Capital's Sand Hill Road
offices with his teammates in tow. "But we're a start-up. We've got
focus. Nobody will be able to move as fast as us. I pity the fools!" 

Other than that first night with Amazon, I haven't lost a single
hour's sleep over our competition," Nirav Tolia said four weeks ago,
when he was only rationing himself four hours a night anyway. "All
the sleep I've lost has been over our internal conflicts." 

Indeed. By hiring so many bulldogs and execution machines who were
all used to being No. 1, Tolia feared the competition between
employees would tear the company apart. For the first month, without
a product to obsess about, they focused on their responsibilities,
and the closest proxy for their responsibilities was their title.
That they had given up so much money to be here made them a little
testy -- they wanted constant assurance that their career decision
wasn't a mistake. 

Everyone kept demanding an org chart, preferably with his or her
name in a box near the top. In first-generation Web companies, the
premise was that no task was beneath you: you did whatever it took to
succeed. This wisdom seems not to have been passed down. "How do we
go from a team of champions to a championship team?" Tolia kept
asking. 

Bill Gurley had turned Naval Ravikant on to complexity theory.
"Truly alive systems exist only at what is called 'the edge of
chaos,"' Ravikant said in one meeting. So though it was causing him
to lose hair, he was running the company on the edge of chaos,
rallying people to risk making mistakes. "I don't want to be a
company that plays it safe." He gave his employees an org chart, and
then another one every week. Their titles became vague, more
fungible. 

Going through the start-up experience usually bonds a team together.
There are those occasional "Breakfast Club"-like days when workers'
inner lives get revealed to each other. This bedrock of goodwill
gets the team through hard times later. Going through it at
second-generation speed only allows brief bonding moments. Mike
Speiser covered Internet companies as an investment-banking research
analyst, but he hadn't worked at one before Epinions.com. A few weeks
ago he said: "You know what I miss? I miss those good old days, when
we had the run of the place at August Capital, hanging out and
brainstorming." Those halcyon days, six weeks earlier. 

Nirav Tolia came up with what he thought would be a solution to
distract the champions from their fiefdoms. At the all-hands meeting
five weeks ago, Tolia announced that he would shave his head if the
company met its offical launch date. This is a guy whose E-mail was
"the-face at yahoo.com" for a good reason -- a hair is never out of
place on his head. "When you're wondering why you're here at 2 in the
morning, think about my cue ball," he said. 

Everybody howled with laughter. Then Aleksander Totic went over to
his computer and pulled up an ancient Web page, from way back in
1994. Digital photographs were posted from the period when the
original Netscape engineers shipped Navigator 1.0. There at the top
of the page was a picture of Lou Montulli -- who is even more of a
sharp dresser than Tolia -- with his head completely shaved. Then
everyone really laughed. 

"If we're going to be a second-generation Web company, Nirav's going
to have to come up with something better," Totic chuckled. 

Watching an instant company get built has been slightly disorienting.
Silicon Valley is sustained by the myth that you can come here from
anywhere with sheer smarts and a firm handshake and make good.
Second-generation Internet companies seem to seriously tip the favor
to those already here. Four weeks ago on the whisper circuit, Tolia
learned that an entrepreneur from Arizona was in town to shop a
business plan for a company, called Publicopinion.com, with some of
the same basic concepts, like rating reviews. Tolia took the
challenge seriously -- Publicopinion.com already had a prototype on
line and needed financing to take the next step. But the truth is
that if the guy from Arizona is only now trying to get an audience
with venture capitalists, he probably doesn't have a chance to catch
up. 

After Ravikant left @Home, he would still see old colleagues at
parties. The comment he heard from them time and time again was:
"It's amazing you walked away from all that money. I wish I was brave
enough to take the chance." 

So why did they walk away from all that money? Take it as a given
that they all believe in the commercial viability of the idea, but
beyond that, their comments are all over the map. One guy talked
blatantly about wanting "plane money," and how you weren't even a
player in the Valley with less than $100 million. A few plead that
they just want to live the start-up experience, and the money they've
earned has bought them the unconditional freedom to pursue that
dream. 

Now they are at the takeoff point, and their first-generation
experience can't help them. The next 12 weeks will be an even greater
challenge: the goal now is to turn a brand-new site into a hive, one
that has 80 percent of all E-commerce categories covered well in
advance of the crucial Christmas buying season. They are blindly
gambling that they have the right incentives and the right filtering
mechanisms in place. Ready. Fire. Aim. 

Copyright 1999 The New York Times Company 


                                                                      
                          







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