What is the 'Power Law' in startup investing?

The Power Law states that a single best investment will yield more returns than all other investments combined. This makes the magnitude of your biggest success critical, meaning you can afford a high failure rate (e.g., 95%) if one investment is incredibly successful.

How can early-stage investors add value to founders?

The most valued help includes assisting with hiring by sourcing and interviewing candidates. Investors can also provide tactical, moment-to-moment advice and be readily available during founder emergencies, which is often more impactful than broad strategic advice.

Is focusing on current market size a good strategy for startup investment?

No, focusing on current market size is a bad metric. The most successful companies often entered markets that didn't exist or were tiny a decade prior. You should focus on the potential market size in 10 years and prefer a small, rapidly growing market over a large, stagnant one.

What are the key traits of founders who build giant companies?

Key traits include obsession, focus, long-term vision (forgality), and love for what they do. In addition, founders need intelligence and creativity to generate new ideas constantly, strong communication skills, relentless execution speed, and a rapid rate of personal improvement.

How can investors identify a real trend versus a fake one?

A real trend has early users who engage with the platform a lot, use it daily, and spontaneously tell others about it. Conversely, a fake trend might involve much discussion but low actual daily usage or organic sharing, with products often sitting unused.

What is the best way to find promising startups to invest in?

The best way is through other founders, leveraging word-of-mouth referrals. Being open to unexpected introductions and helping founders for free can build a network that leads to future investment opportunities.

Key Moments

Sam Altman - Startup Investor School Day 1

Y Combinator

Science & Technology4 min read47 min video

Mar 6, 2018|82,704 views|1,793|45

YC Y Combinator Sam Altman Startup Investor School

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Key Moments

TL;DR

Sam Altman on startup investing: focus on homeruns, not singles; back great founders; invest in markets with future growth.

Key Insights

Startup investing follows a power law, where a few investments yield massive returns, making the magnitude of success critical.

Focus on founders with qualities like obsession, focus, audacity, and love; intelligence, communication, execution speed are key.

Invest in companies with the potential for massive future markets, not just current market size, and look for real trends.

Successful investing requires independent thought, identifying "good ideas that look like bad ideas" rather than popular trends.

A founder's rate of improvement, mission-driven motivation, and integrity are crucial indicators for long-term success.

Investor reputation matters immensely; be good to founders, especially during difficult times, as this influences future deal flow.

THE ENERGIZING NATURE OF STARTUP INVESTING

Sam Altman highlights that investing in startups is inherently energizing. It involves working with individuals who possess boundless energy, fresh ideas, and the courage of inexperience to attempt novel approaches. This environment fosters a sense of helping shape the future and offers leverage on time, with the potential for immense financial returns. Beyond financial gains, the gratification of assisting successful founders and being surrounded by optimistic, talented people contributes significantly to personal happiness.

UNDERSTANDING THE POWER LAW AND INVESTOR MISTAKES

A primary investor mistake is being overly influenced by other investors' opinions, leading to herd mentality. The most critical concept is the power law, where a small number of investments account for the vast majority of returns. This counters the intuitive approach of hitting many 'singles'; startup investing is about hitting 'homeruns.' Therefore, the focus should be on a company's potential to be massive if it succeeds, rather than its failure rate, adopting a mindset where 95% failure is acceptable if one investment yields a billion dollars.

FINDING FUTURE GENERATION-DEFINING COMPANIES

Identifying future major companies often involves looking beyond well-known individuals, as many are started by people outside traditional networks. The most effective method is through referrals from other founders, emphasizing the value of word-of-mouth and an open network. Y Combinator actively cultivates this by encouraging founders to refer others. Successful angel investors often start by helping founders for free, building relationships that lead to future investment opportunities through strong personal connections and a reputation for being helpful.

THE SHIFTING FOUNDER-FOUNDER DYNAMIC AND REPUTATION

In the current landscape, founders of good startups have significant leverage, as there are more investors than high-quality deals. An investor's reputation is paramount. Treating founders well, especially when a company struggles, is far more important than extracting marginal value from a failing venture. Founders conduct their own reference checks on investors, and a positive reputation for being fair and supportive is crucial for securing future deals and maintaining long-term success in the ecosystem.

INVESTING IN POTENTIAL AND FOUNDER TRAITS

Altman's investment thesis centers on believing a company could become a $10 billion enterprise, with no other strict criteria regarding stage or sector. He emphasizes that it's often easier to start a hard, ambitious company than an easy one that aims for moderate success. Key founder traits to look for include obsession, focus, audacity, and love, alongside intelligence, creativity, independent thought, strong communication skills, and relentless execution speed. The founder's rate of improvement over time is also a critical indicator.

ASSESSING MARKET POTENTIAL AND TRENDS

A crucial insight is that investors should focus on the potential market size in ten years, not the current market size. A small, rapidly growing market is preferable to a large, stagnant one. Differentiating between real and fake trends is vital. Real trends are characterized by users who engage heavily and spontaneously recommend the product, even if adoption numbers are initially small. Skepticism towards hyped trends is healthy, and assessing active, enthusiastic user engagement is a key indicator of a genuine trend.

IDENTIFYING GOOD IDEAS THAT LOOK LIKE BAD IDEAS

The most successful investments are often 'good ideas that look like bad ideas'—initially counterintuitive or underestimated by the market. Conversely, many investors chase 'bad ideas that look like good ideas,' frequently by replicating past successes or investing in crowded markets. Altman stresses the importance of independent thought and developing a thesis about future, rapidly growing markets. The best companies, he notes, possess a great product that people spontaneously recommend, indicating organic traction and potential for exponential growth.

THE MISSION-DRIVEN FOUNDER AND LONG-TERM VISION

Startup endeavors are long-term commitments requiring deep conviction. Founders driven by a mission, rather than just the desire for quick wealth or a resume item, are more likely to persevere through inevitable hardships. Altman advises investing in founders who possess exceptional qualities and a clear vision, indicating that even a mediocre product can sometimes be scaled with strong execution, but ultimate success hinges on a truly great product. He also highlights the importance of understanding what unique insights an investor brings to a deal.

INVESTORS AS VALUE-ADD PARTNERS

Investors can add significant value by assisting founders with crucial tasks like hiring, fundraising, and providing strategic advice. Being available for tactical support, even for urgent, small matters, is highly valued. Founders look for integrity, a willingness to learn and improve, and a clear mission. Experienced investors look for founders who exhibit rapid improvement, even if they start with flaws, as long as core integrity is present. The decision to invest should ideally stem from a strong belief in the founder and business, compelling the investor to dedicate significant time and resources.

Mentioned in This Episode

●Products

●Companies

●Organizations

●Concepts

●People Referenced

Startup Investor Mistakes & Corrections

Data extracted from this episode

Mistake Category	Common Error	Correction/Advice
Decision Making External Influence	Caring too much about what other investors think; 80% outsourcing decisions	Free yourself from external opinions; focus on your own analysis.
Understanding Investment Returns	Not investing according to the power law; focusing on singles instead of home runs.	Prioritize identifying potential home runs; focus on the magnitude of the biggest success, not the failure rate.
Early Stage Idea Evaluation	Chasing bad ideas that look like good ideas (e.g., trends from 2 years ago).	Look for good ideas that sound like bad ideas; be skeptical of common pitches and differentiations.
Market Sizing	Focusing on the current market size rather than the future potential.	Care about the market size in 10 years; prefer a small, fast-growing market over a large, stagnant one.
Product Focus	Over-emphasis on growth hacking and sales over product quality.	Ensure the company has or can develop a great product; word-of-mouth is a key indicator.

Common Questions

Investors are motivated by the energy of working with optimistic founders, shaping the future, the potential for high returns (100x-1000x), being around talented people with endless optimism, and the humbling lessons learned from being wrong often, which improves other areas of life.

Topics

Startup Investing Angel Investing Market Trends Business & Entrepreneurship Economics & Markets Venture Capital Founder Evaluation Investment Strategy

Mentioned in this video

Concepts

Power Law

The principle that a single best investment will be worth more than all other investments combined, a core concept in startup investing.

Products

iPhone

Cited as an example of a real trend where early adopters found it life-changing and highly engaging.

Software & Apps

Virtual reality

Used as a contrasting example to the iPhone, illustrating a trend that has not yet become a real platform with high daily usage.

People

Sam Altman

President of Y Combinator and speaker providing insights on startup investing.

Brian Chesky

Airbnb CEO, used as a benchmark for the ideal founder's growth trajectory, emphasizing the importance of a founder's rate of improvement.

Companies

Y Combinator

Accelerator that focuses on funding promising startups and provides guidance.

Dropbox

Cited as an example of a company that seemed like a good idea but faced skepticism due to the assumption that big companies would crush it.

Presented as a prime example of a 'good idea that seemed like a bad idea' during its early days, which Altman himself experienced.

Facebook

Mentioned as an example of a company whose market size was negligible when it started, highlighting the importance of future market size.

Uber

Used as an example to illustrate how shifts in consumer behavior can create new, large markets, and also mentioned for initial market size skepticism.