Paper Belt on Fire: How Renegade Investors Sparked a Revolt Against the University (Part 2)

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Welcome back to Readers, everyone. Today we're back and continuing our series on Paper Belt on Fire by Michael Gibson. Michael, welcome back to the podcast, man. It's a pleasure to have you here, and I'm really looking forward to this part too.

The last discussion was a lot of fun. Great to continue it.

Yes, absolutely. You know, last episode we covered the origins, right? We talked about Michael's childhood, we talked about the father he barely knew, we talked about the unlikely path through philosophy into Peter Thiel's hedge fund, the launch of the Thiel Fellowship, and then how Danielle Strackman walked in and kind of gave the program its shape, right? Now this episode covers chapters 6 through 10, and it's the stretch where the whole project becomes like essentially a working machine, right? These chapters take on the hardest questions Michael and Danielle faced. How do you spot a great innovator before they've built anything, especially when the person in front of you is 19 years old, right? We'll talk about the character traits that they learned to look for, the strange kind of economics of the college diploma, the Vitalik Buterin story, and the worst financial decision of Michael's life. We'll talk about the founding of the 1517 Fund and the brutal education that they got from the established venture firms of Sand Hill Road. So without further ado, Michael, whenever you're ready, let's get into it.

All right. Yeah, let's do it.

Awesome. Now, chapter 6, right? This opens with one of the craziest kind of characters in this book, right? You talk about a hacker called Cypher. Now, you said this is one of the best you've ever met, right? He earned $2 million in his first year, but could never build a company because he couldn't work with anyone. He's essentially, at least to me, it seems like he's a cautionary tale that kind of frames the whole chapter, right? How do you spot a great founder before they've built anything? Now, but there's also another story in that chapter that also stuck with me, right? You talk about Louis Terman, spending decades tracking around 1,500 kids he'd identified as geniuses by IQ, but not one of them won a Nobel Prize. Meanwhile, 2 boys that he had excluded from the study, right, Alvarez and Shockley, they both did. Now, obviously, he was certain he had the right filter. He was wrong. You guys have created your own filters for kind of, you know, passing these students through, passing these kids through to create them into founders, to fund them, et cetera, right? Talk to me a little bit about the process of building your own filter, right? The traits, the pattern recognition, making sure you're not overlooking genius.

Yeah, so, So I think, you know, what is a genius? You know, it's one of these words that might cause people to laugh, but I still think it's helpful to think about. Most like the consensus now in our society seems to be the case that a genius is someone who scores very highly on their intelligence quotient test, the IQ test. And, you know, so people who join Mensa, the group that's dedicated, you know, community of geniuses. You know, they have some threshold of IQ below which no one is admitted. And I think in their case, it could be 130, 135. You know, you think of like really high IQ people, no matter what they've done, people tend to think that they're geniuses. But I don't think this is a proper characterization of genius. To me, genius is less about your ability to do well on a test and more about your ability to create exceptional achievements in your arena of ambition. So if you're a painter, you create masterpieces. If you're a poet, incredible poems that people quote for all time, playwrights, and even when it comes to startups and technology. And so in that chapter and in our work, what I've seen is like creativity is not IQ. I think our society right now is so geared towards IQ. What were your test scores to get into college? What was your GPA? And what university you went to? What was it ranked? And people are using these stats to try to make predictions about someone's future career and possibility of success. Now, I think these stats are all flawed. I think they're old-fashioned, antiquated, and in some cases even negative. And so in the chapter, what I wanted to talk about was this: we need to change our conception of what genius really refers to. It refers to artists who ship, artists who create, startup founders who build. You actually have to achieve something to be a genius. And when you look at that, when you start to study the people who have achieved things in history, something stands out, which is that divide between IQ and the ability to produce lasting works of greatness or of significance. Now, creativity could be defined as just like, yeah, what is that ability to produce something that is one novel or original, meaning it stands in no obvious relation to things that came before it. And 2, that's useful and valuable. So it's like, you can't just invent something original and useless. Like, that's not creative.

Yeah.

And so I, you know, you touched on some things there. So like, Cypher is a case study where, you know, the guy possessed incredible technical chops to this day. Yes, some of the best I've ever encountered when it comes to cybersecurity and low-level functional programming. And yet he was a very disagreeable person. He was very incapable of working with others. And it really did highlight for me that when we think about the traits that people have who are capable of starting great companies, it can't just be raw intelligence, raw technical ability, because there are so many other facets to the challenge of starting a company, raising money from investors, working with co-founders, hiring employees. working with customers, there's a social-emotional intelligence there and even a charisma, rizz, right? And so to see that, like, you know, genius, you know, if genius is defined as just an IQ, it's not enough.

Yeah.

You need more. And so that was a case study for me. And then the Terman study really highlights for me, what's kind of interesting is that came back into, you know, the public awareness in the last month or so, because I guess Malcolm Gladwell, the author, was digging into the numbers and wanted to claim that. So Terman does this study.

Yeah.

You know, he's the one who, who brought the IQ test to America after, you know, in the early 1900s. He was at Stanford. I don't know if it's still around, but in my youth, we had something called the Stanford-Binet test, the IQ test. And so, you know, he, he decided, he's like, okay, what if we, you know, do a longitudinal study We'll get as many of these high IQ, at the time, children into our— the group that we'll follow over time, and we'll just see what they do in their lives. So that study began in the 1920s and then continued on past Terman's death into the late 1950s. And so when you examine that group, and some of these people had, you know, these young people, they they had exceptional, extraordinary IQs, you know, in the 160, 170 range. It wasn't all just like 140, but there was a cutoff. I think it was like a 135 or so.

Okay.

Um, and, and so, you know, you follow this group over time. And so what were the results? Well, the thing about IQ, all right, there are a lot of IQ denialists out there because everyone's so worried about like the fixes in, I'm not smart enough, and the tests You know, is somehow going to pigeonhole me for life, or, you know, maybe there are social issues related to it people are concerned about. But nevertheless, the IQ test has a lot of predictive power. You know, you know someone's IQ, you can make a strong prediction about, you know, what their income will be, maybe how healthy they will be over life. There's some really robust findings in psychology and the study of IQ.

Yeah.

And so with, with term and study, that's indeed what you saw over time. These people became very accomplished. They earned lots of high income, mainly in professions like, you know, being a doctor or a lawyer. There were a lot of people in the academy and a lot of people. So there was a lot of books written, a lot of articles. But what stood out is that there was nothing of extraordinary achievement in that group.

Yeah.

No one wrote a great American novel. No one wrote the play of the year. No one, you know, no one. And then, and then what I highlight and what's kind of ironic is that 2 people who were excluded from the group because their IQs were deemed too low were, in fact, the ones who did go on to make incredible contributions to their field. One was William Shockley, who I'll talk about more about in a second. And the second person was Luis Alvarez, who, you know, made a fundamental contribution to physics and then went on to do other things too. Like, he and his son were the first to theorize that an asteroid had just killed the dinosaurs. So that stood out to me as just a telltale, you know, a warning that, you know, you become obsessed with the ability to take a test and it measures something. But when it comes to predicting what people are capable of, it's not a good number. And then the more you look into the psychology research, it's interesting. There seem to be threshold effects with creativity where like a little more IQ from like 100 to 120 is good at, you know, there's some correlation there with creative output. But anything higher than like 120, 130, all bets are off. And, you know, you can be 135 and derive— you know, Richard Feynman famously said he had a low IQ. People, some people don't believe him. I think I do. It's like, you know, because creativity, the ability to derive new ideas, is just very different from working within existing systems, you know, pleasing superiors, answering the questions that they pose. High IQ people are very good at those things, but they're not always great at— because, because look, we all know, you know, smart layabouts who don't do any work.

Yeah.

We know smart people who are, you know, unfriendly and not— can't work with others. You know, we know, we know brilliant conformists. And there's something always rebellious and a little punk about original new ideas. So that chapter, and we saw it with the Thiel Fellowship, where time and again, these stats that people would think would predict success, the SAT score, the school you went to, it just was not helpful. And so we had to develop our own set of traits. And to me, this is a moment where maybe the analogy is more like professional sports, and in particular, these the stats revolution first in baseball, where you had these old stats in baseball created in the late 1800s, early 1900s, that were supposed to tell us what was happening on the field, how good a player was, and then help us make decisions about in the game or do we sign this player for next year or trade them? And it turned out that these stats were very inefficient. Things like batting average, RBI. I mean, they're flawed in all sorts of ways.

Yeah.

And there were better methods for predicting how good any player was, how good a team was. And that could be defined as, you know, what they decided is like, how do you win baseball games? You need to score more runs than the other team. Well, what is— what, you know, are the factors that lead to more run scoring? Well, it turns out just getting on base is a lot, you know, including walks. And the big mistake with batting average is that it doesn't include that component. So something similar is at play here, where all of our institutions are geared towards finding smart conformists. And these stats are aligned with that. So we needed to develop our own stats when it came to evaluating talent. And that's what that chapter is about. I titled it Intelligence Reimagined, I think, or And the whole idea is like, yeah, we need to change our concept of genius. We need to move away from inputs like test scores and really focus on what matters, which is the creation of new valuable things.

Yeah.

And I think, you know, if you want new valuable things, you need— you can't focus on buying prestige. Prestige is just an imperfect way of trying to find new valuable things. Instead, you gotta fund creative genius. And to do that, you gotta fund it no matter where it is or what it looks like.

And so how does actually finding that creative genius come then, right? Obviously you reach all the way back to Homer and the word polytropon, right? Always finding a way. You lay out 8 character traits you and Danielle learned to spot, right? Several of which you actually had to invent names for because they weren't in any psychology literature, right? Which I thought was kind of cool. Edge control, right? Hyperfluency, I think egoless ambition, and the Friday night Dyson sphere, which I thought was cool.

Yeah.

Now, obviously 15 years, right? You've done thousands of evaluations. Which of these traits, like, what's hard to actually see in a 19-year-old? I'm sure all of them are, but what was the process of creating these? How do you— I don't want to say test for these because we've just talked about how testing is not the right method. How do you look for them in an interview, right? It's tough to spot.

Right, exactly. There's not like a Turing test where you, through a list of simple questions, you can get reliable answers.

Yeah.

And then judge whether or not the person on the other side of the door has these attributes, which is why I decided, and as a fund, we still operate this way. It's always better to try to get to know someone early and then we know them over time. If we have more data points over time, character is revealed in action. That term edge control is like some combination of imaginative daring and spend. the ability to execute on a very thin balance line where you're spending money to run experiments, but you're not spending too much where you bankrupt the company, and you're not just hoarding money and not spending enough to grow. There's a fine line there that people have to learn how to navigate. And there's some element of courage there and practical wisdom when it comes to practical reasoning. And so courage, let's just take courage as an attribute. It's like, how do you test for courage? It's just got to be something that we see in someone's life. Maybe it can come out in stories. People talk about things they've done, maybe debates they've had where it's 1 against 20, a thesis they wrote, some Orthodoxy that they tried to overthrow, or maybe there's some other part of their life where they demonstrated that. But it is something that is necessary for success. It doesn't guarantee success. Remember that we're always just talking about what increases the probability that you're the type of person who can go on to create a billion-dollar company. So it's like you can have all these traits and do all the right things and still have a bad luck outcome, sadly enough.

Yeah.

Yeah. So, so yeah, so when it comes to courage, it's like, yeah, if we, if over time, like, we just get to see, we do something, we'll give out a $1K grant, you know, someone just builds a prototype and they start like collecting resources on their own and, and, and meeting potential customers. Maybe they make a sale of the thing they, they happen to build. It's like you start to see things moving where people are action and deeds and not all talk. And that's great. So then they come to pitch us and they're like, hey, we're raising— what about if we raise $500K now? And I just feel way more comfortable in my judgment that this person has a sort of default aggressive mode of executing, especially with few resources. So yeah, it's challenging. Like, the weak point of our model when it comes to assessing character traits is that they're vague. There's a fuzziness to to them and there's no direct test. Like, why can't we just test for these things?

Yeah.

So like that creativity question, what's interesting is there is no equivalent, like the IQ test that we can give people to make predictions about how creative they will be. There are some tests like divergent thinking tests where they tell you, you know, you'll have some time limit to think of how many different ways you can use a brick. And, you know, people, there are, you know, yeah, people, some are better than others at that. But unfortunately, it's like, we don't know, like, if you're good on that test, that doesn't mean you're capable of writing an emotionally involving novel.

Sure.

So yeah, there's no test for that. There's no test for courage. You know, something we look for in people is curiosity. So we're always gonna, like, you know, that's why I think polymaths are interesting. It's not because they— it's not only because they study many different subjects. that can be helpful, but it's also just an expression of their innate curiosity. They just want to dive into something and never give up on trying to figure it out.

Yeah.

Maybe that could be like puzzles and riddles, you know, that uninhibited, you know, another piece of that is like their identity is not wrapped up in getting the right answer, which happens in, you know, university life or high school where it's like, you know, people feel a lot of stress taking tests 'Cause they know it's gonna be this tattoo that labels them forever. We meet creative people who are just curious and they have this uninhibited riddle play where if they don't get the right answer, it's no big deal. Another one is like they just like reverse engineer things. They see TVs and computers, they take 'em apart, they figure out how they work, they put 'em back together. And they're doing these things without any kind of, it's not to impress a committee. that's giving out an award or admitting someone to college.

Yeah.

So yeah, these traits are hard to look for in the sense of we're just making judgments like, okay, that fits the pattern, that fits the pattern. But the problem is we can't assign a score to it. So there's no one single score we can award to a founder saying, okay, this guy scores high on all 5 tools here and is gonna is going to be. But nevertheless, it is a composite picture, a construct, if you will.

Let me ask you this. Is there, is there any one single question that you would say, I ask this to every single founder I interview or I talk to? Like, is there one question? If there's any founders out there listening, any creators, builders, whoever that may be, you know, what's the question you ask every single one?

In the, in the old days, it was the old Teal question. What do you believe is true that the rest of the world thinks is false? And it was great originally because people would have to give spontaneous and authentic answers.

Yeah.

But I feel now that question's so well known that, you know, people might rehearse for it and think up answers. You know, we try to tease this out through backstory. People will tell us about their company, but I want to know, you know, tell me about how you arrived here. Um, you know, to get to this point. And then maybe in the course of that person telling me more about their background, we'll start asking some personal questions or, you know, questions about previous hard problems that they've faced, how they solved them. Um, yeah, it's, it's, it's, it's sort of loose form. I don't, I don't have a single question, but—

Yeah.

But I am trying to get at, like, you know, we're trying to see how ambitious, you know, we'll ask someone We got to gauge how ambitious they are.

That's fair.

Sometimes it is about like, or the commitment. Yeah, I mean, all these things are occurring to me. There are always things we're asking.

There's so much to think about.

Yeah, it's like, you know, it's like, you know, the commitment, like, why are you doing this? That's really important. And we have something we believe in called the sustaining motivation, which is, you know, because building a startup is, there are going to be so many ups and downs.

Yes.

And, and you're going to face so many challenges. And you'll eventually come to a dark night of the soul. And the only way through that is to have that sustaining motivation. Can't be money, can't be fame, it's going to be something deeper. And so we want— we will— I'll try to tease that out in an interview.

I'm like, so tempted to just go deeper into this right now. But we'll stay, we'll stay on track a little bit. I want to switch gears here a little bit, right? Chapter 7, The Clock Tower. Now this is where you kind of lay out the signaling theory of college, right? You get banned from MIT, you meet Ari Weinstein paying $60,000 a year to learn things he taught himself as a teenager, and you kind of arrive at the sheepskin effect, right? Finishing senior year pays out double what the first 3 years combined are worth.

Yeah.

Now your conclusion is essentially that a diploma kind of just signals the willingness to keep a 4-year commitment or promise, right? Not actual knowledge. Now, that was the argument that was made in 2022, right? Since then, obviously a lot has moved. Employers have dropped degree requirements. There's a real kind of almost cultural wave of, you know, quote unquote, college isn't worth it for a lot of people. Now, AI is also doing a lot of the entry-level kind of grinding that a degree used to gate. So I want to ask, right, has the signaling value of the diploma actually started to crack the way you predicted? Or has it turned out to be maybe more durable than you expected?

A little of both. You know, it's interesting, it's like one of the things I didn't foresee was just how polarized politics have become. And with that, you know, on campus, with the just sort of real intensification or, you know, the levels of extremism, of far-left extremism on campus, you know, has, has sort of negated the signaling value of some of the highest, most prestigious degrees out there where, you know, some employers now don't want to have to deal with, you know, an activist, young new employee because they've been radicalized by their, their school, which is kind of interesting. So that's like one segment. Another is like the, And the dynamics behind it are interesting, but just like the grade inflation. So it's like in Harvard's Enron style of accounting, everyone gets an A. Well, what is that? So therefore, what does an A signal about a Harvard degree? Not as much as it used to. So then there's that. And then, yeah, I think in the meantime, I mean, it was evident then, and Ari was a great example of that, was that You know, if you have demonstrable skills that can be validated in other ways, you know, you can have a successful career. So a strong GitHub account with lots of, you know, contributions that are highly ranked, that'll get you a job at a top tech company way before your resume with your whatever college you went to. So these alternative ways of, you know—

Hmm.

separating yourself out in the labor market have really become powerful. But nevertheless, I think there is a big chunk of the economy. If you think of just labor economics, these firms need to make hires, and they've got to find a quick and cheap way to try to narrow the job applicants down. And to this day, it's like some HR gatekeeper You know, it's just going through resumes and they'll just like dump the college grads in one and, you know, the elite college grads, you know, the winner went down and then they'll pick from there. Yeah. So it's still, it still has like, you know, some powerful signaling. But I do think it's attenuated somewhat from, from 2022.

Sure.

You know, it is one of these things where I guess because it is, it's like some people think that the Like that the college degree signals intelligence. And again, it like might do that, but there's more to having a good employee than just a high IQ. It's all the same things I was talking about before. Like you don't want some disagreeable contrarian person. You just want someone who gets the job done, you know, takes some orders and will sit in a seat for hours and finish the job in a very professional way.

Yeah.

I think, you know, the college degree is a great filter for that. So, you know, as long as those types of knowledge workers are still needed and there's no cheaper way for people to send that signal, I think we're going to still have this issue. And then there are other things too, right? There's always just going to be exclusivity and snobbery. And, you know, people are searching for community and meaning and they find it in going to an exclusive university where they get to wear the mascot and go to the football games and, and all that stuff. I think, you know, people will do that. And then maybe even, you know, you could think of, you could think of another way to think of college and retirement. It's like, we don't have guaranteed universal basic income today. We don't have AI luxury communism, but maybe we have it incrementally on these edges where, you know, for, you know, as, as societies become wealthier, people extend their childhood longer and longer, and they don't work. And then maybe they retire earlier and earlier. And so it's like the window of people working will shrink. So it's like maybe college will still exist just because it's like, you know, wealthy families want their kids to be busy doing something.

It's really interesting. Yeah. I want to talk a little bit about, you know, one of the people who's obviously had a big contribution to the world today, who you guys back pretty early. I would assume that's definitely a huge success for you guys, but also, you know, a later part of that, a big regret for you, right? Chapter 8 brings us to Vitalik Buterin. He'd applied to the fellowship a year earlier, right, pitching an education idea. You said you rejected him. Then a fellow mentioned his old high school friend was off doing, you know, Bitcoin work, and you met this 19-year-old in Llama Corn t-shirts, right, who taught himself Mandarin, and he'd sketched out Ethereum. over lunch. Yeah, you backed him, right? And then you made what you call the worst financial decision of your life— marketing the Ether sale to everyone and buying none of it yourself. Talk to me about that, right? This sounds like a crazy ride— the rejection, then believing in the second idea but not buying any of it, but marketing. Like, there's a lot going on there.

Yeah, I wasn't able to find the application from 2012, but apparently Vitalik applied on an edtech idea You know, some other people remembered it, Danielle. And, and so I don't recall. I've always just been negative on edtech because, I mean, there are lots of problems with it. Mainly, it just does not improve outcomes yet. But maybe that's changing. Different conversation. Maybe that's changing. But at any rate, you know, his application didn't make it through. One of the interesting things about that story in the book is the friend who was a fellow who recommended Vitalik was Chris Aula from— I believe they went to the same high school in Canada. Now, Chris Aula is famous because he's one of the co-founders of Anthropic. And just a couple of weeks ago, met the Pope in a much-covered media event, which is pretty crazy.

Wow.

So yeah, Chris Aula had been talking to Vitalik. Chris was not interested in crypto. I had been following the development of Bitcoin. Mainly for philosophical reasons. But so I knew something of the blockchain, but it was great to be reintroduced to Vitalik. The old Teal offices were in the Presidio in San Francisco, which is like the northernmost tip of that peninsula right near the Golden Gate Bridge. And we were part of this office complex where Lucasfilms was. And so therefore, Lucasfilms had a beautiful cafeteria. I just remember we had this awesome lunch with Vitalik, and I can still see the beautiful architecture outside.

Yeah.

But yeah, he basically at that lunch pitched us some of the fundamental concepts of Ethereum, digital assets, smart contracts. These were new concepts to me. But since I had been following the development of Bitcoin, interested me. And, and so, yeah, we, we pressed on. It was, uh, encouraged him to apply to the program. In that time, you know, he, he had been writing a lot, so he, he was gaining some, some attention in crypto circles. Um, so, but we decided, you know, it was just so exciting. We, we awarded him a fellowship. Uh, he had published, you know, I found out that we, it was like re— re— uh, re— or I should say researching this, I discovered that You know, he published the white paper for Ethereum, I think, you know, only a few days after we had launched that day. So pretty wild.

Yeah.

And so, yeah, we award him a fellowship. Okay, great. I was, you know, we always ask, we always have one person running point with any given fellow, meaning that's like, you know, you catch up every 2 to 3 months with the person, check in, see how they're doing, see where you can be helpful, make connections they need. And I did that for Vitalik for just about all his fellowship, I guess. And so in the lead-up to the release of Ethereum or Ether, yeah, I'm out there pitching this thing on social media, telling people to buy it. Okay, we were a nonprofit. Nonprofits are not supposed to make their donors or their executive staff money. We see this now in the controversy with OpenAI and its origins. It started as a nonprofit and then the for-profit thing causing problems. Well, we were in a similar situation where, okay, it was starting to be clear that we have this nonprofit generating these— here was one where it's like, oh, geez. So, I was a little apprehensive to buy some Ether in that initial offering. And quite frankly, I didn't have a lot of money.

Yeah.

So, I didn't. So, yeah, I have some friends who did. That's how I know, you know, what a bad financial decision that was because it was like, you know, some guys spending tens of thousands of bucks made millions. And Danielle always jokes, she's always asking, did he buy you a beer? Because they owe you. So yeah, I forewent millions of dollars, sadly. But it was incredible to see and to be a part of. I mean, Vitalik is an extraordinary person. He has that— he has a high IQ, that cannot be denied. But he is possessed by a curiosity, the like of which I haven't seen in many people. He's constantly teaching himself new things. Yeah, he told me— I saw him chatting in Mandarin on his phone with developers in Asia. And I asked him about that. And he just told me he was teaching himself Mandarin in order to work with these people.

That's so cool.

It's crazy. There was a recent story I heard about him that just reminded me of his mind, where there's this town in Texas that's starting south of Austin. It's called Proto Town, cool startup city thing. Right now it's like a bunch of different startups, a few houses, there's a nuclear reactor that's being built, pretty crazy. But Vitalik, because he's interested in startup cities, Charter cities. And so he went to visit, and there's this guy there who owns a plane. So he asked Vitalik if he wanted to go up, and they did. He took him up in the plane, and then he asked Vitalik, oh, have you ever flown? And he's like, no. So he let Vitalik take the controls.

Oh, wow.

And the pilot starts telling Vitalik, like, okay, here's where we got to go. We're going this many nautical miles. at this speed. And then Vitalik in real time was translating it into metric units. So it's like the guy was telling me, he's like, okay, we're going 400 nautical miles per hour. And then Vitalik would say, okay, that's immediately in metric terms what that meant. And then he'd say, okay, we have to descend 2,000 feet over this many minutes. And then Vitalik would tell him immediately, the conversion rate into the metric units. This is so metallic.

I guess he is like— that's interesting that he has kind of that combination of obviously a very high IQ, but also, like you mentioned, right, is possessed by a level of creativity that just causes—

Yeah, look at— I recommend look at his website. I think he posts his essays there still, or maybe he's on Substack. You know, he— his writing is out there, and the range of the topics is extraordinary. And the care, the level of detail, what he writes about is impressive. His acknowledgments of holes in his argument, and then his counterarguments to those holes. I mean, he's such a comprehensive thinker. It's just extraordinary.

Yeah.

I wouldn't be surprised. Maybe it all depends on the future of Ethereum. But if there's ever a Nobel Prize awarded to crypto people, I wouldn't be surprised if he's included in it. And I think—

Sounds incredible. I'll definitely check this out. Looks interesting.

Yeah.

I want to move a little bit to obviously one of my favorite parts of, you know, this book and definitely this episode, right? Chapter 9, right? The founding of the fund. 1517, this is the fund you run now. Obviously, you guys are doing some really, really cool stuff. You've backed some really interesting companies. You take us back all the way kind of to the beginning, right, that you test the name at a UCLA hackathon. You say it was BS then and it's BS now. And the whole thing rests on the Luther analogy, right?

Yeah.

In 1517, the church sold indulgences, expensive paper to save your soul. And now universities sell diplomas, also expensive paper to save your soul. Now, that analogy was really interesting because Luther's Reformation didn't just crack the church's monopoly, right? It splintered Christianity. essentially into like a lot of sects. It helped touch off what, I mean, almost a century of religious war. I'm curious, right? If you really are lighting that kind of fire under the credentialing system, have you ever thought about maybe the messy, destructive downside of the Reformation you're calling for, right? What would replace, I don't know, you know, the university's authority? Does that part worry you at all?

Hmm. Yeah, maybe just to rehearse for the audience a little bit is that Luther, you know, there had been other dissenters in the church, but they all, you know, gave their speeches or produced writings prior to the invention of the printing press. And so Luther, you can think of as like one of the first people to have an article go viral, a listicle, basically the 95 Theses. And what Luther was upset about was the church was selling a piece of paper and telling people that it would save their souls, or at least give them less time in purgatory. And they made a lot of money doing that. They financed the construction of St. Peter's Basilica. But Luther was pretty upset because who are these people to say they're going to sell a piece of paper?

Yeah.

So yeah, he nailed his theses to the door. And because of the printing press, had diffused throughout Europe, the tech enabled that. So yeah, it really was a tumultuous time where, you know, in the old church, the Bibles were in Latin. Priests were trained to read the Bible and interpret it. It was very, you know, the literacy rates were quite low, but people couldn't even read Latin anyway. So. You had to depend on the priest to interpret things for you. And what the Reformation wrought was sort of this disintermediation of that relationship. So it's like now the Bibles could be written in the vernacular and they could be produced in great number. And you as an individual, without needing this authority to tell you what it means, you could decide for yourself. So, just that resonated a lot with me that you have a technological change introducing a challenge to authority and really empowering individuals. And I was hoping and still hope to this day that technology, the internet, the decentralization of knowledge now with this new AI wave is like all these authorities are being challenged and disintermediated. And so I thought that would echo in our name, that that's why we do it, not because we're Protestant, but because, you know, that the style of that revolution appealed to us. Now, as you point out, it led to some bloody conflicts in Europe and quite catastrophic at times. It's crazy to, you know, you see Protestants and Catholics in Ireland still distrustful of each other, and not too long ago, still killing each other. But from the outside, if you were an alien, you'd be like, what are the differences between these people? That's how deep those animosities run.

Yeah.

So, you know, I don't know. You know, I'm hopeful that, you know, I think institutions today are under a lot of pressure. They're buckling because they're not performing to their stated purposes. And I think we are in due of some revolutions, hopefully not bloody revolutions. But I do think there's going to be a period of time in the next, call it 15, 20 years, where, you know, they're going to be— there's going to be reform, there's going to be failure, and we're going to see the emergence of new things. I think the polarization in our country right now is is driven by the old and the new, the people who want to believe in those old institutions versus the creator of these new things that are scaring people. So, yeah, I don't have an answer other than to say this is— I think you put your finger on the pulse. The forces unleashed by this decentralization of knowledge and capabilities is still working itself out.

Yeah. I want to talk a little bit about kind of, again, going back to the starting of this fund, How you guys were even able to scale, gain people's trust. Obviously, it's a competitive market. It's hard to make it, right? When you and Danielle went out to raise the fund, you lay out just how stacked the odds were, right? You say, obviously, most VC funds fail. Returns are massively skewed to kind of these established names on Sand Hill Road, right? Founders want the firm that backed Google, not kind of the upstart with no track record. And at the beginning, obviously, neither of you looked or sounded like a venture capitalist, right? A philosopher and a former school principal. I mean, you're only investing in people without degrees. There's a parallel book— there's a parallel there that, you know, I don't know if the book says quite out loud, but I thought it was interesting, right? You were asking investors to take a bet on 2 unproven outsiders with a strange thesis, which is exactly the leap of faith you asked the whole world to take on Dropouts, right?

Yes.

But I'm wondering, right, what made someone other than you know, Peter believe you? How did you guys grow? What was that process like? Obviously, there's other VC firms out there. How did you guys become and get to where you kind of are now?

Yeah, there's no way we would get jobs at another VC. We just couldn't get hired. We didn't have the background. So the only way we could work in this industry, certainly by starting our own fund. So yeah, we did have Peter's support, which was a strong first signal. We had, through the fellowship, made a number of contacts with successful people in Silicon Valley, entrepreneurs, former entrepreneurs, now investors. And that's where we started our list. The pitch was, it was early days. I mean, the fellowship was nowhere nearly as successful now as it is in hindsight, but still there were some green shoots. You had companies like Figma, doing quite well. You had Oyo Rooms. There was a company called Hired that was in the HR space doing well. And so we made this hypothetical portfolio that said, if we had invested $250K at these companies' seed round, what would it be worth today? And we thought that showed, okay, it'd be worth something like $30, $35 million. on like, I don't know, $10 million invested, we were thinking, I don't know, something like that. I can't remember. But anyway, it was like, hey, here are the returns of that hypothetical track record. We developed this pattern recognition skill for identifying the traits that are conducive or increase the likelihood of success for a startup. And then we started knocking on those doors and You know, some people were on board right away because I think they had seen the success or worked with Thiel Fellows. So one of our first commitments was from Jan Talan, former founder of Skype. But it was only when we transitioned from those types, we started getting intros to— so in the world of investors who invest in investors who then invest in companies, the people up here, you know, there are individuals who are wealthy.

Yeah.

But then there are families that are wealthy. So it's like, it was a kind of interesting education in 20th century capitalism, because we'd meet these families like the Coors family, inventor of the beer more than 100 years ago. It's like, that's a substantial fortune. And those families find ways to maintain their wealth and grow it. They'll allocate their money to all sorts of things, of course, public stocks and bonds, But they'll allocate some to high-risk, interesting things like venture. And so we started meeting some of these families and they would have, you know, some of them would just like, you know, reject us in total disbelief.

Yeah.

Because they didn't believe in us and, you know, for whatever, you know, despite everything we showed them, they didn't find it plausible. And then, yeah, we found we started to convince some people. Families in the oil business, families in alcohol beverages that our founders can't drink. And so, we were able to cobble together $20 million, which took about, I can't remember, something like 9 months. So, it's like when you raise a fund, you put together a first close, could be like half the fund, in this case, $10 million, and then you have about a year to fill it out. And so, we got to $20. And we set to work doing what we do.

Yeah.

And that was only possible because I guess, yeah, we had developed those connections. We never made— I don't think we gained a single investor from a cold outreach, email, phone call. We tried it. No one returned our emails. The only people who talked to us were based on warm intros, referrals. So, it started with that initial base in Silicon Valley and then sort of made our way out into the world. And now we're on our 4th fund and we have international funds because they want access to US markets. But in that world of investors who invest in investors, when you look at like the Murderer's Row of Silicon Valley, Sand Hill Road, those funds, they're operating at such a scale. We're such a tiny little thing compared to— they're raising billion dollars.

Yeah.

And they're raising that money from pensions, from sovereign wealth funds, from university endowments. And we've just always been a small fund, too small for those types of entities. So we do primarily raise money from families. But now that we have a track record, now that the Thiel Fellowship is obviously successful, it's crazy. It's still interesting. We still have people telling us, oh, you just got lucky.

Yeah.

I don't believe this is true. So, you know, we're still out here doing the Lord's work, trying to do it. So it is a, you know, just in the same way that raising money for a startup itself can be grueling, the same is true of a fund. There are going to be easier years than others or harder years sometimes, but it is a challenge.

Yeah, I think to a lot of people who may not really know, obviously, how hard running a fund works or Even just how the finances of all that may work or what it looks like after you've raised and gotten some money and stuff like that. $20 million sounds like a lot, right? But the reality is, you know, that just puts more pressure on you right after, right? I think through this final, you know, stretch of what we're going to talk about here today, you talk about the cram down, right? It's the most painful stretch of the book. You're the first money in the loom, right? This is what you talk about.

Mm-hmm.

You help them get off the ground. ground, you've got contractual prorata rights, and then round after round after round, right, these big funds that you were talking about come in, right? General Catalyst, Kleiner, finally Sequoia, and they squeeze you out of those rights anyway, right? You quote Thucydides, right? The strong do what they can and the weak suffer what they must. And I was kind of wondering while reading this part, right, your whole identity is essentially fighting these entrenched Essentially incumbent power, right? And then the incumbents of your own industry just took what they wanted from you repeatedly, and there was essentially nothing you could do about it at the time, right? My question to you is—

That's a great way— that was a good summary.

I mean, you know, my question to you is, how did getting crammed down change the way 1517 operates, right? Would you say surviving it forced you to become a little bit more like the sharks that you initially set out to Yeah, it's a great question.

And our investors ask it. It's funny, people read our book, they're like, all right, so what have you done? Yeah, it's, you know, competition in the venture industry. You mentioned in the last question that, yeah, it's very fierce. I think it's something like, you know, 5% of the funds generate 90% of the profits in the industry. There are these bandwagon effects that help these funds. But then in this instance, we started to learn about some of the tactics they use. in order to maintain their advantage. And what they do is, we're the first money in, the belief capital, when there's probably not even a product yet sometimes. And so we help them get started. These companies start to find some success, they raise their next round, and if they become the hottest thing in Silicon Valley, they get the attention of these top-tier funds. And then those funds can use their muscle to sort of, you know, squeeze these earlier investors out. When we make an investment, the idea is like, okay, that first check is going to return a lot of money if the company does well. But we also want to retain the right to invest in subsequent rounds, not a lot, but just like something in order to bolster the business model because, you know, most of the investments we make will fail. So for the ones that succeed, we got to try to drive as much returns as possible. So when we started, you know, basically it was a handshake agreement. And then we learned, okay, we got to have these rights baked into contracts. With Loom, we had the contract, but these tier 1 funds would tell the company or work with the company to say, hey, look, you know, in this next round, we don't want these people on the cap table. And because it can help a startup so much to work for those funds. You get the positive signal. They do have incredible network staff who can help you. You know, it's called value-added services. They'll do what they can to help you succeed. The media and potential employees look to these funds as being kingmakers. So it's like it makes hiring easier if you've been backed by one.

Yeah.

So those funds bring a lot of advantages. And so, you know, it makes sense that you'd want them on the cap table and these founders want to please them and be nice. So it's like, okay, we found ourselves getting squeezed out round after round with this company. And that was unfortunate. So what did we do? Okay, so we, for one thing, it's like having that conversation with the company when they are the hot blonde at the party is much more difficult. than having it earlier when they're getting started. So now that we know this happens, it's like upfront talking to companies like, hey, we know down the road, should you find, you know, incredible success, these conversations are gonna happen. We have these rights, we're willing to waive them, but at least let's like have the conversation.

Yeah.

And we can do what we can too to build a stronger relationship with those founders. I mean, obviously helping them out, as much as we can, but also just like on a personal level, just staying closer. So that's number one. We have like, God, is this interesting? There are all these little moves where this problem kept creeping up. So it's like, okay, we have, and this gets esoteric into these legal documents, people raise money on something called a SAFE. A SAFE is not a way to purchase equity. It stands for a standard agreement for future equity. It's like a loan.

Yeah.

So if we invest on a SAFE, sometimes those pro rata rights, as they're called, would not kick in until the first priced round. But there might be another round of fundraising in between that SAFE that we invested in and the priced round. And so we found ourselves not getting to participate in that. So we had to change the SAFE, we had to change the contract. So it said, okay, we get these rights even if the round is raised on one of these contracts. So there are all these little tactical things that we did. It still comes up. It's gonna be a perennial tension, I think, between each round a company raises and the previous investors. The last couple ones, I mean, look, there's always gonna be dilution. So with each round that a company raises, like the Federal Reserve, they'll print new shares that dilutes the pot. Those shares are typically for employees to make hires. But investors who invest in those subsequent rounds, they've started to do more things where it's like, oh, we'll dilute the early investors, we'll give these founders, let them take some off the table. So it's like the founders get to cash out a few million. It's like, I don't think this is good for the company. And then in really bad cases, not when the company's doing well, but there are just like crazy instances where, you know, the company's struggling and they find an investor who's willing to put money in, but they— the investor demands that you basically zero out the earlier investors. So there are these pay-to-play clauses, they're called, which say if you don't invest in this next round, all your previous equity that you invested to obtain in previous rounds will be worthless. And that is a really nasty situation.

Sure.

So, these are the moments where the interests, you know, normally the investors in the company are on the same page, but it's only in these gap moments where there can be a conflict. And I wanted to take people behind the scenes of that. There aren't books out there that talk about the nuts and bolts of the venture industry. And so in this case, it was a story I wanted to tell because as a fund, yeah, it's like not only are you competing on all those factors that are out of your control, like previous success, but there are all these tactics these big funds can use to try to limit your success.

Yeah, I love it. I mean, I always definitely appreciate how much transparency this book has, not just obviously about you, your own journey, your life, but also about the reality of just the venture industry in general, right?

Yeah.

So I think I've definitely enjoyed kind of learning about that.

I think it's better. And this is June 8th or 9th.

9th.

I think last week there was like a round of people on X talking about bad experiences with VCs. That was kind of interesting. So I think it's good for the industry. You know, it helps people behave better if their reputations are at stake.

100%, 100%. But, you know, with that, we'll wrap it up.

This was kind of another great session. Feel like we covered a lot.

Yeah, absolutely. Absolutely. You know, this was really the stretch where the whole thesis became a working machine, like we said, right? I mean, yeah, we've got the character traits, we talked about the signaling theory of the diploma, Vitalik, the birth of Ethereum, obviously the founding of 1517, and, you know, kind of close that out with the, the tough lessons of, of Sand Hill Road, right?

Yeah.

You know, to everyone listening, I think to me at least, one of the most interesting parts of these chapters was, you know, that the people who are actually building the future are rarely the ones that, you know, quote unquote, the system would pick, right? They're working on these strange, weird things in hacker houses, in their garages. They almost never look the part, right? And I guess that just means that they're valuing following their own curiosity more than kind of trying to get to, as Michael says, the innermost room of the temple. But, you know, again, Michael, Been an absolute pleasure.

I've really enjoyed it. Yeah, thanks for having me.

Absolutely. And I'm looking forward to part 3, right? Next episode, we'll close it out. We'll talk about Austin Russell. We'll talk about the Luminar IPO, Michael's obituary for Silicon Valley, you know, the journey to Switzerland to investigate his father's bank account. And, you know, finally, the vision he calls the Invisible College, which personally I'm really excited for. Okay. So, you know, to everyone listening, thanks for tuning in to Readers. I'll see you in part 3, and until then, keep on learning, keep on changing, and keep on growing.