Patrick Lee, co-founder of Rotten Tomatoes, talks about how luck and timing affect startups, similar to a game of poker.
I first began my entrepreneurial pursuits 20 years ago during my sophomore year of college. Since that time I’ve co-founded a total of five companies spanning the Bay Area, China, and Hong Kong. My first company went under and my third, the movie review site Rotten Tomatoes, was a moderate success. The other three still exist in various states of operation, the last two in particular teaching me a lot of hard lessons. Below I attempt to condense all my experience and learning down to a form that many of you will understand: the card game known as poker.
A quick disclaimer before we begin: I am by no means a poker expert. I have not played, even for fun, in years. Even so, a number of poker concepts that I will be discussing are likely new to the majority of you. To make things easier to follow, I’ve put the first reference of any poker terms in CAPITALIZED ITALICS.
You can refer here for a full list of poker terms:
http://en.wikipedia.org/wiki/Glossary_of_poker_terms
So let’s begin!
Luck
One thing I have come to realize, especially over the past decade, is that luck and timing play a huge role in any startup. One wrong step and you could find your fortunes completely changed for the worse. The social networking space is littered with market leaders that no longer exist or are a shell of their former selves — 6degrees, Friendster, Bebo, Myspace. The same is true with the search engines — Alta Vista, Excite, Ask, and even Yahoo.
Yet even the current market leaders faced situations that would have drastically altered the course of their companies. Facebook had a handshake deal to sell to Yahoo for US$1 billion but then last minute Yahoo lowered their offer price to US$850 million and Zuckerberg refused [1]. How different would things have been had they sold? A US$1 billion exit would place them in the same ballpark as YouTube (which sold for US$1.65 billion in stock to Google [2]), a far cry from the US$60 billion plus market cap Facebook now possesses. Even more extreme, Google once tried to sell to Excite for under US$1 million and Excite refused [3]! If Excite accepted, how many of us would have heard of Google at all? Instead, no one under the age of 30 has ever heard of Excite and Google is worth well over US$200 billion.
Nowhere does luck play a greater role than during a startup’s inception, where ideas are essentially random. Much like movies, games, and film are hits-based businesses; often the startup entrepreneur has little to no clue if their idea will amount to anything until well after launch. Look at sites like HotorNot, Facebook, Yahoo, and YouTube. In many cases the creators make something as a test or for fun and for whatever reason it takes off. It’s literally a crapshoot as to what will find traction. Even the most seasoned entrepreneurs have trouble predicting what will work or not, regardless of funding, talent, or size of market.
Poker
An analogy can be made between starting a startup and the game of poker, as both depend heavily on the element of chance. For a startup,
1) launching your idea is the equivalent of being dealt your STARTING HAND;
2) the time and money spent getting to launch is your ANTE; and
3) the time you are willing to put in and the funds you have raised or invested is your CHIP STACK.
With this “startup as poker” framework, you can tie together many startup concepts as well as apply poker strategies toward running your startup.
You may be thinking to yourself, “So what is talent and experience good for if the ideas are so dependent on luck?” It is true that a beginner holding a PAIR OF ACES, the strongest starting hand in TEXAS HOLD’EM, will more often than not beat even the most skilled players holding a 2-7 OFFSUIT, the weakest starting hand and one most if not all veteran players would immediately FOLD. That being said, a new player may still end up losing with POCKET ACES due to incorrect play (think Friendster [4]); and even if they win they may not be maximizing their outcome (think Reddit [5]).
Even the best poker players can and will have huge swings if they are only playing 1-2 hours at a table. Let those same pros play at a table for 8+ hours and the randomness will even out. The longer a player plays, the greater the role skill and experience play and the less important luck becomes. Just like a good player will know how to play after the FLOP, a good entrepreneur will have an advantage iterating and improving on their idea past launch and maximizing both the chance of success and outcome.
Playing Styles
Once you are dealt your starting hand, you finally see what cards you have. At that time you must decide whether to continue putting in time and money to develop your idea further or fold the hand.
How players play their starting hand and approach the game in general can be broken into four main playing styles. To understand these four styles, we must first look at two play concepts:
- LOOSE versus TIGHT play – A loose player plays most hands whereas a tight player folds often while waiting for a strong hand to play.
- PASSIVE versus AGGRESSIVE play – A passive player tends to CHECK or CALL. An aggressive player likes to BET and RAISE.
We can cross these two pairs into four distinct playing styles: LOOSE PASSIVE, TIGHT PASSIVE, LOOSE AGGRESSIVE, and TIGHT AGGRESSIVE. Let’s delve deeper into first three:
1) LOOSE PASSIVE – As the name describes, this type of player tends to play most hands and play those hands passively. Because they are not picky about the hands they play, most of the time their hands are weak and they win few POTS. When they do manage to win, the pots tend to be smaller due to the player’s passive play. This is by far the weakest poker playing style, and most beginner poker players fall into this category. Similarly, most entrepreneurs also run their startups in a “loose passive” style. They tend to spend too much time and money building to launch, don’t track metrics and do not know if things are really working or not, fall in love with their idea and are unwilling or extremely slow to pivot, and passively put in more time and money trying to SEE THE RIVER and hoping for the perfect card to bail them out. And like the loose passive poker players, even when these entrepreneurs exit, the exits tend to be small.
2) TIGHT PASSIVE – Tight passive players tend to be very patient in their play, waiting for the strongest hands before committing to play. Their Achilles heel comes from playing their hand too passively once they’ve joined in on the action. By not aggressively betting and raising they are unable to knock out other players, decrease the odds of winning the hand, and fail to maximize the size of the pot when they do win. Tight passive entrepreneurs are those that happen upon a great idea and find traction, but then fail to raise money or raise too little, continue to bootstrap when they should be spending to increase growth, allow more aggressive competitors to overtake them, and often sell too early and let someone else capitalize on their idea (think Rotten Tomatoes and the sale to IGN Entertainment [6]; or Reddit’s sale to Conde Nast). Given that finding an idea with traction is essentially random luck, selling too early and not maximizing your outcome is a huge mistake; you could end up starting another 50 companies and never hit on an idea even a tenth as big. Imagine if Mark Zuckerberg sold Facebook to focus on Wirehog [7].
3) LOOSE AGGRESSIVE – Loose aggressive players play lots of hands and bet and raise aggressively, often BLUFFING or overestimating the strength of their hand. These players tend to see the most swings in their chip stack as they will win big and lose big. If they manage to win a big hand early, they will use their big stack to BULLY other players, often with better hands, into folding. In the real world, the loose aggressive entrepreneurs tend to be veteran entrepreneurs or senior executives that manage to raise a lot of venture funding early and attempt to “go big or go home” on an untested idea in a big market. And just like the loose aggressive poker players, sometimes they win big (think LinkedIn [8]) and sometimes they lose big (think Color [9]).
The Optimal Style: Tight Aggressive
That brings us to the fourth and final playing style: the tight aggressive player. The tight aggressive player folds often and waits for a strong hand to play. When they do play, they aggressively bet and raise to knock out other players and increase the size of the pot. By folding quickly and often on bad hands, the tight aggressive player is able to preserve their chip stack to allow them to be aggressive when they finally land a strong hand. This is considered the best play style for the majority of players (although for extremely skilled and experienced players the loose aggressive style may be best).
This is also, in my opinion, the best strategy for entrepreneurs: wait for an idea that finds traction FIRST and THEN (and only then) go aggressive. If it’s a weak hand, fold immediately – as in, pivot or start something new. Bootstrap, launch with a minimum viable product (MVP), A/B test, and keep development times as short and costs as low as possible. The goal is to see as many hands as quickly and cheaply as you can in order to find a strong hand – as in, test as many ideas as you can until you find traction. At the same time, you need to preserve your cash so that you can spend aggressively once you have found traction; and have enough runway to raise additional funding without losing your leverage (if you overspend too early and have nothing in the bank when you try to raise more money, you will have no leverage when negotiating terms). This is why having tech founders is critical; they allow you to launch, test, and pivot quickly and cheaply. An all-sales-and-marketing founding team will inevitably have to hire or contract out the development of their product, leading to increased costs and development cycles. Steve Jobs would have had no computer to sell without Steve Wozniak.
For a consumer-facing tech startup, traction generally focuses around distribution (ie. traffic, downloads, installs, etc.) and engagement (ie. how often a user returns to your website, launches your app, and so on). When your idea reaches a high level of distribution and engagement and positive rates of growth in each, you know your hand is strong. Be prepared to move quickly and aggressively – drop everything that’s unrelated to the idea (see Twitter with Odeo [10]), increase spending to speed up product development and growth, and raise venture capital.
One good recent example of a tight aggressive company is Rovio Entertainment, which subsisted on contract work and a seed investment from family for eight years and over 50 games before hitting on Angry Birds [11]. Since then they have raised US$42 million, aggressively grown the Angry Birds franchise, and are now valued in the billions. Similarly, Mark Zuckerberg built and tested a number of apps and sites before Facebook [12], Max Levchin had four failed companies before Paypal [13], and the list goes on.
WHAT THIS MEANS TO YOU
My old saying was “You only fail when you give up.” While there is certainly value in persevering, I was saying that in the context of not folding a hand. What I realize now is that was the wrong play. And believe me when I tell you that I learned this the hard way (think nine years, two companies, and two thirds of all my savings – an expensive lesson!)
More appropriate is a quote from Max Levchin [14]:
“Being an entrepreneur is not about being in love with an idea, it’s about being in love with running a company.”
To paraphrase in poker terms, it’s basically saying that if you want to win at poker, you need to learn to fold. It’s not just that it’s okay to fail, it’s actually the correct strategy (tight play). If you’re not folding, either you were lucky and got dealt a strong hand as soon as you sat down or more likely, you’re doing something wrong. When things aren’t working, don’t be afraid to pivot or if necessary, fold the company, return what you can back to your investors to minimize their losses, and try something new. Whatever you decide, do it as quickly and cheaply as possible rather than drag things out and waste more time and money.
Another useful saying is a quote from Kenny Rogers’ classic song, The Gambler [15]:
“You got to know when to hold ‘em, know when to fold ‘em”.
A good poker player can play a wider range of hands than beginners, and can quickly tell if their hand is playable after seeing the flop. Similarly, you should track key metrics and stats, use analytics, and set targets to help figure out if you should hold or fold your hand. Without this, it can often be difficult to see or feel the progress as there can be a lot of variance over short intervals of time.
Another takeaway is the importance of fundraising. Fundraising gives you a bigger stack to play with. Which means you can see more hands and play more aggressively when you are dealt a strong hand. In poker, you never want to be SHORT STACKED. When that situation occurs, it becomes much harder to make another player fold, you lose the ability to bluff, and cannot maximize your winnings. As an entrepreneur, for much the same reasons, you never want to be in a situation where you don’t have enough funding to be aggressive after you have found traction for your idea. Having a short stack or insufficient funding forces you to play passively.
How Investors Play Poker
Venture capitalists have the luxury of waiting to invest in players that are already holding strong hands – as in, companies that have already found traction – which massively reduces their risk. This is true even with the early stage VC’s at the Series A level.
Angels and VC’s participating at the seed stage don’t have it so easy, as the chance for an idea to find traction is essentially random. At this stage, it’s better to bet on the player as opposed to the idea. Specifically, they should invest in players with a tight aggressive playing style. Tight meaning entrepreneurs that are good at bootstrapping, have a strong engineering background, are not afraid to pivot, and actively use metrics to track and measure their progress (see the “Lean Startup” link in the Further Reading section for more on this). Aggressive meaning entrepreneurs that are experienced, ambitious, and know how to quickly grow and scale a company after their idea has found traction.
A special note needs to be made about the startup accelerator YCombinator, which seems designed to play the “startups as poker” game. They look for and encourage tight play from their teams. That is why they strongly prefer engineering-heavy teams, do not worry about what your initial idea is, do not mind when you pivot, give you just enough money that you are forced to bootstrap, and have a fixed deadline of three months before you are forced to demo your product. They also encourage aggressive play through their Demo Day to help their startups raise a lot of money fairly early on. Best of all, they are able to place a Rovio’s worth of US$11-20,000 antes every six months in the hopes of landing another Airbnb or Dropbox. In poker terms, they’re like a poker bot with perfect memory and near-perfect play playing 50 machines’ worth of hands at once. It’s almost cheating.
About the author
Patrick Lee co-founded and served as CEO of Rotten Tomatoes (rottentomatoes.com), a leading entertainment website focused on movie reviews and news and one of the top 800 most trafficked sites in the world (according to Alexa). Mr. Lee also co-founded and served as CEO for Design Reactor (designreactor.com), a leading Internet marketing firm focused on the entertainment industry. Design Reactor’s portfolio of clients under Patrick’s tenure included Disney, ABC, Warner Bros., and Artisan Entertainment, among others. Patrick holds a BA in Cognitive Science from the University of California at Berkeley.
Further Reading
1. Article with more detail on the four poker playing styles referenced above:
http://www.suntzupoker.com/poker-playing-styles.aspx
2. Another article that ties poker strategy to startups:
http://venturebeat.com/2010/04/01/8-poker-tactics-that-apply-to-startups/
3. An old but good blog post from David Cowan of Bessemer Venture Partners that pushes a “tight aggressive” strategy:
http://whohastimeforthis.blogspot.hk/2005/09/best-startup-advice-i-have.html
4. A business methodology for applying the “tight” playing style to find a strong hand to play:
http://en.wikipedia.org/wiki/Lean_Startup
5. A great article by YCombinator founder Paul Graham on coming up with startup ideas:
http://paulgraham.com/startupideas.html
6. A link to a talk I gave on the history of Rotten Tomatoes from the inception of the company all the way to present day:
http://www.youtube.com/watch?v=w2xWEbB6y6g
Notes
[1] http://mashable.com/2012/05/18/rosenwig-facebook/
[2] http://techcrunch.com/2006/10/09/google-has-acquired-youtube/
[3] http://techcrunch.com/2010/09/29/google-excite/
[4] http://en.wikipedia.org/wiki/Friendster
[5] http://www.forbes.com/sites/georgeanders/2012/10/31/what-is-reddit-worth/
[6] http://www.startup-review.com/blog/rotten-tomatoes-case-study-seo-drives-traffic-growth.php
[7] http://www.zdnet.com/blog/facebook/mark-zuckerberg-was-planning-to-sell-facebook-in-july-2004/8277
[8] http://en.wikipedia.org/wiki/LinkedIn
[9] http://techcrunch.com/2011/06/25/fly-or-die-color-ishtar/
[10] http://www.fastcompany.com/1837848/insiders-history-how-podcasting-startup-pivoted-become-twitter
[11] http://www.forbes.com/forbes/2011/0718/technology-vesterbacka-rovio-mobile-angry-birds-audacious-birds.html
[12] http://en.wikipedia.org/wiki/Mark_Zuckerberg
[13] http://blog.score.org/2013/bryan-janeczko/giving-up-so-soon-the-most-successful-entrepreneurs-try-try-and-try-again/
[14] http://www.forbes.com/sites/quora/2011/10/12/among-max-levchins-lessons-learned-as-a-young-entrepreneur-which-are-the-greatest/
[15] http://en.wikipedia.org/wiki/The_Gambler_%28song%29
Image Credits: SodaHead
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