← Y Combinator Startup Podcast
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- [00:00]
A
The best way to make money is to create more value than you capture, right? To build something that people want. And yet we're all supposed to pretend these days that we think all kinds of making money is equally good. And there's so many ways of making money in our economy today where you can get rich without creating any value at all. And I just think, like, why don't we just stop pretending that we think that's good?
- [00:25]
B
Today we have a very special guest, Eric Rees, author of the Lean Startup, which was a New York Times bestseller and a crucial playbook for all founders. Eric has a new book coming out called why Good Companies Go Bad and How Great Companies Stay Great. And he's here to dive into some of those core themes with us. Welcome, Eric.
- [00:46]
A
Hey, man. Good to see you. Always fun to hang out.
- [00:47]
B
I mean, the Lean Startup taught our whole generation and the new generations how to build. Now you're back with a new book called Incorruptible. What made you decide to start it?
- [00:58]
A
You know, all my books come from pain. You know, I never ask anybody to do something in a book that I haven't done myself. And, man, we've been around this a long time. Like, how many companies have we seen built and created where the thing that made them special gets lost? How many founders lose control of their company, get kicked out? It doesn't become what they hoped it would be because they don't understand how to protect what they created. So I feel like Lean Startup, we created so many companies worth protecting, but we didn't give them the tools they needed to actually stay in control, to actually protect the trustworthiness of the thing that they made.
- [01:30]
B
So I'm sick of that going from zero to one. A lot of people spend a lot of time thinking about 0 to 1. And I think Lean Startup is one of the bibles for being able to figure that out.
- [01:38]
A
Thank you for saying that.
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B
There isn't really a playbook that is written until now around how do you make it last for 100 years.
- [01:47]
A
Absolutely. And unfortunately, the way we teach leadership and entrepreneurship today, we tell people that, like, don't worry, just be successful. Just get to product market fit. Success will protect you. So once you get successful, then you'll be powerful. That will give you freedom. And what we don't tell you, and what I wish no one told me, the more successful your organization, the more valuable it is as a target. Like, that's what makes it worth taking over. That's what makes it worth stealing from you, is the fact that it is successful. So I think there's like a missing ingredient here that I was a big blind spot for me, I didn't see this coming. But I've, you know, I've lived it now for quite a number of years. I've seen so many companies, you know, have it happen to them. In the book I tell this story about like I was coaching a new founder, Brad, I call him the professor in the book to protect his privacy. But like he's a genius. Those are the best stories. Always incred an incredible person and building this really transformative technology, you know, on the cutting edge of AI plus bioscience. So super cool, huge upside, hella danger because you could easily use this technology for something really awful. Bioweapons, pandemics, that kind of stuff. So he's trying to recruit talent. He's having to promise people that this is not going to be used for those things. And that's part of why he has this massive talent advantage is people trust him. People believe that this technology is going to be used in the right way. But then people are asking these tough questions like but aren't we a for profit company? But if an investor is want to do something evil? And he'd be like, well I'll tell him no. Why will you be working there then if you're telling your investors no? Right? He, he didn't know how to answer those questions. But when he would meet with investors, all these VCs would just be like, oh, that's nice honey. Oh, you're worried about that stuff. Like don't, don't worry about it. You know, if you're serious about business, this is not the kind of thing you should be worried about. So he like, he was feeling retrapped. Anyway, I happened to be on my way, I was talking to him to this event commemorating a founder who had huge success. So someone we both know well had made unbelievable amounts of money for his investors. And at their earliest opportunity they had betrayed him and kicked him out of his own company. And we were doing this event to like celebrate him. And people had flown in from all over the country, employees, ex employees. Like there must have been a thousand people there, including people he had laid off, who were like coming back at their own expense to come to this event to be there for him. So I'm explaining to the founder, listen to the professor, I can't talk right now. Cause I got to go to this thing. I'm explaining about the founder, the people coming in, he's like, wow, respect. That's the kind of company I want to build someday. And I was like, you are not listening to me. He doesn't work there anymore. This isn't a party. It's awake, right? And he's like, what, did he die? No, he's still alive. He's at the party. He said, did the company die? No, the company's still publicly traded company. He's like, what are you mourning? And this is the thing. I remember being at that party and being like, what are we mourning? What exactly is it? And I realized, like, we all had this sense like deep in our heart that like, this is not how it's supposed to be. Something's gone wrong here. We trusted this company. We trusted this guy. He was the mission guardian, the protector of this really important mission to us. And now that he's gone, I like the new CEO. He's a friend of mine too. But like, if he makes a promise investors don't like, then he'll be replaced. So what are his promises worth? So we're in this era now where we have temporary organizations being led by temporary managers on behalf of temporary investors. Average holding time of stocks is like dramatically down. Lifespan of companies is dramatically down. Average tenure of executives is dramatically down. Then people say, and why is trust down? How come trust? No one trusts anybody anymore. Well, because we've built an economy that this is how it runs. And I just think we have the final say. Founders either have to agree to or not this system. And so we actually are the ones propping it up. We're giving it the fresh meat it needs to survive because it's so value destroying.
- [05:13]
B
Basically there's Delaware bylaws, is that right? Basically, you know, if you're a Delaware C corp, you have to relentlessly pursue profit, otherwise there is grounds to remove you. That specific principle is exactly how you know the end of that founder's reign of that particular company happened.
- [05:34]
A
I still remember the professor being like. Because I was like, you're not listening to me, right? You're not getting it. He's like, wait, are you saying that's going to be me someday? I'm like, you're on a one way ticket to this exact outcome because you've adopted the so called best practices of corporate governance of how companies are supposed to be built and run and structured. One of them of course is what's called shareholder primacy, right? This idea that if you are a Delaware C corp, the thing you make is not a beautiful living thing that creates products and delights customers and is like a Good. No, it's just a financial instrument for investment returns. That's all it is. That's actually a very new idea. And I think one of the things that's a big misconception for founders is they assume that this is some kind of natural law or like a pillar of capitalism going back to Adam Smith or whatever. No, Adam Smith would have been like, what the f are you guys talking about? This idea dates to the 1980s. The professor was saying to me, he was just like, wait, so is it possible to build an incorruptible company? That's kind of how the book got its title. And I was like, well, it's a good news, bad news kind of thing. Everyone says this is impossible. That, like, this kind of corruption of the mission is natural. It's just as you get bigger, as you scale, as you whatever. But that's not true. There are actually choices we can make as founders, and especially choices we make early that can change the trajectory of the company so that, as you say, its longevity could be measured in decades and centuries, not quarters. But the bad news was, dude, you've already taken wrong steps in this direction. You're already. You had an incorporated Delaware C corp. I'm like, if I pull your charter right now, it says you have to maximize shareholder value. He's like, no, I doesn't. My guy would never have done that to me. I have a great lawyer. I was like, why don't you call him and call me back after this party? I'm going to go to this thing. You call me back tomorrow and you tell me what he says. And he. And I remember talking to him the next day. He was like, he felt so betrayed. He's like, my lawyer said he's doing me a favor by giving me the best practice documents and that I have to sell. If the most evil company in the world wants to buy this company, I have to sell it to them. If my employees do that, they'd all quit because, like, well, we should probably fix it.
- [07:32]
B
I mean, this is the way we've always done it, is sort of we've always done it. What people are going to tell you.
- [07:36]
A
I say in the book that one of the things every concept, every technique in this book has in common is that someone will try to talk you out of it. And so there's actually a whole section on, like, how to talk to your lawyer about it, how to talk to your investor about it. That's just for. Based on my having worked with so many companies, I kept a running log of all the BS objections, all the weird, like just asking questions, like passive aggressive comments that we got from anybody in the ecosystem. And I was like, look, here they are, here's exactly how to answer them. And here's the evidence. This is the part that really blew my mind. I've been working on this for a long time. I put the long term stock exchange, you know, you know all the stuff I've been doing, trying to like put my money where my mouth is, you know, like, look, we're going to change this ecosystem so we all make more money. We got to do it. The thing I didn't really understand is how much evidence we have that these so called best practices suck. They're like literally value destroying.
- [08:20]
B
I mean let's go into one, like the most astonishing one. You know, our friend Jeff Lawson at Twilio built that company from nothing to $4 billion in you know, actual revenue. Like stock up 390% since IPO. I mean by all accounts, you know, smash, rip roaring success. And then his super voting Shares expired after 199 days and he's out. And so less than half a percent of shareholders did that. You know, how did that happen? Like what, what's going on?
- [08:54]
A
It's like, it's honestly unbelievable to me. Well, here, let me make the case for why he needed to be fired and then you'll see if this makes sense to you. So what happened was so he took the company public. He agreed as part of the IPO prep process, as a lot of founders do, that he would have dual class control, founder control. He'd be the mission guardian. The protections would sunset after seven years. Man, you're taking a company public. Seven years sounds like a long time, but man, in the public market, seven years is just, that's barely a beginning. It's like a handful of quarters. Anyway, that was the deal. He made the deal. His advisors and everybody told him, don't worry about it, you can always extend it. It's always too early until it's too late. It's kind of the idea from the book, like, okay, whatever. So seven years come and go. Now it happens to be those seven years include the pandemic years. As you well remember, the run up in telecom and tech stocks we had, it was like polio stock was just up an insane amount. That bubble burst and the stock came way down. So at the time he was fired, the stock was down like 80% from the peak. And it's like, oh well, case closed. But if you measure from the IPO or even from the pandemic peak, revenue was up. That's like, did the business go down? Was revenue down? Was there some kind of problem? No. And yet that was enough for them to fire him. And what really pissed me off about it the Most is this.199 days. So he had run this company for seven years as a public company. Things expire. He didn't even last one year past the expiration of these protections. And even if you think he made mistakes, and even if you think there's something like, had he really earned so little grace to run this company, does the fact that he had made all this money, billions for his investors, does that count for nothing? What are we doing? And what's strange to me in the book I give, obviously it's not just about Twilio. Twilio is a fine company that they're doing great now. It's not just them, company after company after company. I give case studies going back 200 years where we have this like urge. When a founder makes a quote unquote mistake, they have to be fired. They have to have accountability for founders. True, you gotta have accountability. It's important. But oftentimes that's the end of the company. Right? Like when Edwin Land was fired from Polaroid. Now people are like, polaroid wasn't that instant camera company? No, man, Polaroid used to be an R and D powerhouse at like 1500 research scientists on staff. Steve Jobs loved that company, admired them so much. When Edwin Lamb was fired, he called it the dumbest thing he'd ever heard. And they never invented another thing ever again after they fired the founder. So I just think, even if you agree that the founders made a mistake, we jumped to the conclusion that firing them, bringing in some suit, like doing the kind of standard best practice thing is somehow going to lead to a positive outcome. And so often it doesn't. Because unfortunately we're teaching people that the mission can only be protected by the founder. And then you get rid of the founder. Everyone's like, well, I guess we have no mission anymore. We just become extractive. We just try to make money. What I really think is that we shouldn't be just building investor controlled companies or founder controlled companies. There's a third way.
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B
Interesting.
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A
We can be building mission controlled companies where the mission itself has sovereignty. And these companies can then last a lot longer.
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B
What does that really look like? I mean, Patagonia sort of famously was one of the first to really do this. But for someone who's watching, they're like, well, I know a Delaware C corp, and then I know that there are super voting shares and I shouldn't let those expire. That might save people from the Jeff Lawson.
- [12:02]
A
I mean, that would be better than. At least be better than the sunset for sure. But no, there's a lot more to this. And maybe tell you a story. I'll tell you the legend of Saul Price. Okay, let's move away from tech for a second. I think it's helpful to understand the precedents that got us into the situation we're in. Saul is widely considered to be the father of modern retail. If you want to know why he's like, people say that about him to give a sense of how influential he was. When a guy named Sam Walton was thinking about starting a retailer in Arkansas, he called it Walmart as an intentional tribute to the company Saul created, which was called fedmart. Fedmart's the original modern retail company. Started in my hometown in San Diego in the 1950s. Saul was a lawyer before he became an entrepreneur. And when he was a lawyer, he had this idea. He had been trained that you have a fiduciary duty to your client. That means you put your client's interest before yours. So when he became a retailer, he asked himself the simple question, who's my client? And so many companies get this wrong. He was just like, this is very simple. I am a fiduciary to my customer. Customer is the client. So he had this clear fiduciary hierarchy. Customers first, employees second, shareholders third. The great Peter Drucker said he got it wrong. It should have been employees first, customers second, shareholders last. The famous Johnson and Johnson Al credo is doctors, patient, and nurses first, employees second, communities third, shareholders last. You notice the pattern, not because shareholders aren't important, but because everyone who's ever studied this and looked at it seriously understands that shareholder value is like the exhaust that comes out of the engine. When you take the exhaust pipe and put it in the intake and make that your explicit goal now you don't stand for anything anymore. Now product quality suffers. Now whatever, you know, whatever thing you think is important, the thing that's going to make you money, design, quality, health of your customers, whatever, everything becomes expendable on the altar of shareholder value. And no company can really endure with
- [13:55]
B
that structure, or they do, and it
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A
looks like Philip Morris, or you wind up being the kind of company that your grandkids are embarrassed to be related to you because that's what you did. And we know a lot of current tech companies are on that trajectory right now. And it's sad. I don't want to name names, but, like, think about companies where having that on your resume used to be like the gold star, and now people are like, why did you stay there?
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B
Yeah. I think there was a stat in your book that really jumped out at me. It's like $8 billion in profit. But was it 300 billion?
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A
Yeah.
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B
In. Or 600 billion?
- [14:23]
A
600 billion? Yeah. $300 billion in direct health care costs. Yeah. So when people say that Philip Morris is profitable, in order to call it profitable, you have to take this incredibly narrow view of profit. They have something like $8 billion a year in net income. But there's been all these studies. They create $600 billion a year in costs just in the US that have to be borne by others. I think it's 300 billion in direct healthcare costs and $300 billion in lost productivity and obviously the mortality of people dying and therefore not being able to work. It's like, it's grim. And there's a zillion different studies. I think someone calculated recently that the tobacco industry makes $6,000 from every customer that dies. Do you want that to be your future? Like, if you don't get the governance of your startup right, no other decision you make in the long term is going to matter because you're not going to be there to be the one making it. So someone's like, I have an idea. Let's turn this company into Philip Morris. What are you going to do? Back to Sol Price Fed Martin, embody this principle of fiduciary to the customer. You think about the way that Steve Jobs would obsess about design. Steve Jobs used to get into fights with people about the visual design layout of the cables inside computers where he didn't even want customers to be allowed to open the case. And his engineers would be like, what do you care? No one's going to see it. But he was like, we're going to see it. Right? Like, this is my principle. This is not shareholder value. If we stand for this principle, good stuff's going to happen to us.
- [15:38]
B
Now, how you do anything is how you do everything.
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A
Now, Steve Jobs got fired because of this exact thing. So spoiler alert. So we'll Saul in a second. So he built this company. Fiduciary to the customer meant if you try to undercut him on price, he would literally put up signs inside his own store being like, don't buy this product from me. You can get it cheaper at a competitor. And he'd have, like, instructions on where to go.
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B
Oh, wow.
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A
Right? Like, he just. He was like, I don't care. My job is to get you the lowest price. Yeah, I don't care if it's for me.
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B
People will come to you every single time because they're like, hey, no, if
- [16:06]
A
it's ever so cheap or something. Can you imagine a modern retailer doing that? Like these DTC brands where I'm just like, I gotta buy it on your pride. I gotta go check over here. It's like, no, why don't you. Why don't you be my ally and then I'll trust you. So he understood trust is an asset. So customers would drive, like, miles out of their way to shop at fedmart. It was a huge success. Huge private company success. He took the company public. Everyone made a lot of money from this ipo. And as a public company, you know what happened? Investors kept being on him. He felt this, like, gravitational pull. He wanted low prices and high wages. Investors seemed to want high prices and low wages. So he just was always battling investors, battling investors. Now Saul was a really stubborn sob. In order to try to get out of this situation, he brought in a new controlling shareholder to buy out public market investors to give him this protection. He got a new board and the whole thing is going to take the company private. That was the whole plan. And he thought the new board, because they really understood retail, they understood him. They looked him in the eye and said, I see. See you, man. You're the. They'll surely back him up. But no, the new board didn't solve anything because they were still into this gravitational hypnotic power of these best practices. So they wanted higher prices and lower wages and faster growth. And they didn't care about the collateral damage to employees, customers or anything else. They just wanted to see the number go up. So one day in 1975, Saul comes into work and these guys have changed the locks on his door.
- [17:26]
B
Oh, my God.
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A
Can't even get into his office. He doesn't work there anymore. Wow. So it's just like. Just like Jeff Lawson. Just like so many people lose control. So what happened? This is like a natural, a B test experiment in business history. You don't get this that often in branch A. Fedmart's investors got what they wanted. They got Saul out of the way. They converted Fedmart to traditional business practices. It was bankrupt within seven years. Oh, wow. They destroyed in seven years what he took 20 years to build. Saul was a classic entrepreneur. Like so many people we know, he took exactly two weeks off after this happened to him. To lick his wounds. Yeah. And then he was back at work. He leased the office upstairs from fedmart for his new company. It was just like, f you, I'm doing it again. He created a new company called Price Club. And when I was a kid, Price Club was like a major retailer. My family shop there all the time. But most people today don't know Price Club because of what happened next. One of the fedmart employees, a guy who had worked his way up from stock boy to executive, he quit fedmart in protest when Saul was fired, and he created his own company because he understood, as Saul understood the engine. Later, the two companies merged to form a company they called Price Costco, but we just call it Costco.
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B
Makes sense.
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A
This is the deep cut backstory of how Costco came to be. Costco today still embodies that Sol Price fiduciary to the customer idea, but it is protected by this thing I call a governance fortress that protects it from outside attacks so that its board understands its job very differently than most companies boards. Instead of saying, my job is just to maximize returns for shareholders, the board understands our job is to protect the mission. And so when we talk about being mission controlled, this is what we're aiming for. Now, the book is loaded with techniques like, I promise it's not just a manifesto. There's a lot of detail to it. You're not going to learn it from some guy on a podcast. Obviously, like, we'll. We'll get into some of it. But like, overall, if you zoom way out, the pattern is this. We read an ethos like Saul Price had some kind of higher principle that we're committed to that we understand we're going to make money by maximizing human flourishing by doing this thing. And then we need the structural integrity, the ability to protect that precious thing that we've created from any kind of temptation or outside pressure. So that's kind of the short formula. If you don't take much away from this. Ethos plus integrity equals incorruptible.
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B
How do you find the right board members for something like that? I mean, there's sort of like the docs, which, you know, founders. When you're starting out, you do have control over that. All the best docs in the world, without the right people, like you still can't keep it going.
- [19:53]
A
Yeah. The first step, and the hardest step by far, is to be willing to say that you are not in line with these best practices. They are what's called a normative consensus. Everyone agrees that. Everyone agrees that this is the right way.
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B
You gotta agree that you're gonna be punk rock.
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A
Yeah. So you got. So if you're willing, yeah, you gotta just be like, this is not for me. Because like I tell a story in the book about Costco versus Kroger. The grocery store Costco came under attack in the early 2000s for having these non standard governance practices. In fact, Costco routinely gets the worst possible governance rating from governance rating people. And Kroger decided to go all in on best practices. So we had this like natural experiment where like Costco has been like incredibly successful since this moment being having bad governance. And Kroger has not had the same level of success. In fact, one analyst called Kroger's performance like Costco in reverse. So I always tell people the next time someone says to you, I want you to adopt some best practice, you just, in your mind, you don't have to say anything out loud, just says best practice equals Kroger practice. This is someone who wants to be more like Kroger and less like Costco. Why would you want that? Again, no, no shade on Kroger. But you could be one of the greatest performing stocks of all time or you could be this thing. We have to master these techniques. And the most important thing is to create selection bias. So you want investors and board members who are choosing to be with you because they believe in this mission, not just because they think they're going to make a quick buck from it. Even if they're investors who are they are going to profit from you. You want to make sure their interests are truly aligned with you. I just was talking to a founder today that ran into this common problem where you put some awesome person on your board who you just think this person walks on water. And you forget that you take a venture investment from a venture firm, not taking investment from that individual person, you're taking investment from a company, then that person leaves and now you're stuck with some new person. And you've given all these veto rights, all these control rights to someone. You don't even know who they are. You don't know if they're aligned with you. You've never read the LPA of these funds like you don't really know what their incentives are. So I think founders are generally much too naive and much too credulous about who's going to be a good long term partner. And they're so easily bamboozled by people like, I'm founder friendly. We don't need to worry about this stuff. We're aligned, it's going to be good. But I also do need to be the ability to fire you at will whenever I want. It's like I thought you said you were a believer in my vision. It's like, well, as long as I like what's going on. That's not actually what belief means. YC Startup school is back. We're hand selecting the most promising builders in the world and flying them out to San Francisco for July 25th and 26th to discuss the cutting edge of tech and startups. Apply now for your spot.
- [22:26]
B
What about on the doc side? Let's say you get into yc, you've got a safe, you know, maybe you haven't converted equity yet. The normal path, which is like pure founder shares is like, all right, let me see if I can get super voting or let's write it in from day one. I guess the Delaware C Corp thing is actually a pretty big thing. A lot of AI companies have chosen to be PBCs or public benefit corporations on day one. What sort of best practice for starting out?
- [22:52]
A
Yeah, I think, I think PPC is an absolute must do and kind of like an utter no brainer. Of all the things in the book, it's by far the easiest thing. If you want to pick one thing to do, it's the easiest thing to do. It's a two page legal filing in Delaware. Your lawyers can have it done for you tomorrow. And especially if you only have safes, if you don't have any like equity
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B
investors and you turn into a PPC
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A
tomorrow, you just, just, you know, you don't even need anyone to agree. You just, you just do it. What's interesting to me about the PPC and most people get confused because they think it's like the same as the little B in a circle you see at the farmer's market, which is something totally different. That's covered in the book too. But that's not what we're talking about right now. All it does is restore what's called purposeful incorporation, which for the vast majority of the centuries that we have had joint stock corporations on this planet, everybody understood and thought it was totally obvious that companies should be incorporated to do a specific thing.
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B
So literally a mission or a benefit,
- [23:42]
A
it have should have a public benefit. If you look at the 19th century, like companies that were created and you read their charter, none of them say maximize shareholder value. That would have been considered a crime.
- [23:51]
B
Interesting.
- [23:52]
A
I think it would say like we've created this thing to create a railroad road, to build a canal from place to place, to do something specific. And the board's responsibility, the fiduciary duty, their first highest priority, was to defend and protect that purpose. When we shifted to Charlotte of Primacy, we forgot this really important lesson.
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B
So who did this? Who did this to us?
- [24:13]
A
Who did this to us? It's actually super wild. Okay, we'll do a history lesson. You okay? I'd love to.
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B
Yeah.
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A
This is incredible to me. So, like, there's this story in the book about this 19th century situation that, like, if you know, Elon's taking over of Twitter or whatever, you're like, I know how this is going to go. One of the richest men in the world tries to buy, take over this. This company that was the Erie Canal Company that built and operated this canal. And he has unlimited money. So he's just like, no matter what it takes, I'm going to buy this company and convert it to what I want it to do. And the board directors, unlike modern boards who are told, when that happens, you have to become an auctioneer and sell. No. They were just like, we will fight you by whatever means necessary. And both sides went crazy. It was like a crazy fight. And there were no corporate governance or even ethical standards like we have now, literally. There's stories where, like, they were both bribing the same state legislature legislators, and people would, like, take bribes from both sides and then vote with one of them. You know, like, it was an epic fight. But what's interesting, if you read the commentary about it, people were scandalized because they did a bunch of bad and legal stuff, but nobody was like, it's wrong that the board tried to fight this. They were all like, of course they tried to fight. Naturally, that makes perfect sense. And like I said, if he lost, in the end, they fought him off using what's called the poison pill tactic, which now, today, you could just ask your lawyer to put this in your jocks, and you can just have it if you want. If you don't have it, why not?
- [25:32]
B
That's another tactic.
- [25:33]
A
So many of these things, you could just. You just have it. You don't have to, like, wait for someone to give you permission. You just do it. So anyway, if he had prevailed and he had actually managed to convert the legal purpose of this company from make a canal to maximize shareholder value, that would have been considered a crime. And the courts would have voided the company's charter, would have given them the corporate death penalty, because that would have been Considered beyond the scope of what was authorized to be in the public benefit. So this was the rule all up in the US all up through the end of the 19th century. The problem was, in order to get one of these charters, you had to get your state legislature to give you one. Imagine if, like you had to go lobby your local state senate for permission to form a company. It was like, very cumbersome. That part of the system was bad. So there was a big fight over the whole 19th century to create what was called general incorporation, which was a simple idea that anybody who wanted to should be able to form a company for any reason, which we were very grateful that it had to be fought. It was literally a battle, state house by state house, everywhere over the course of 19th century, every state eventually came into compliance. The key date for our purposes is Delaware adopted this in 1899. So, like, not 1299. This is relatively recent history. 1899. But even in 1899, if you read the Delaware rule, it said that you can have a company for any purpose, but it still assumed you would have a purpose, a mission that was considered completely obvious. And yet, over the course of the 20th century, companies more and more and more were being advised by lawyers to, instead of writing in your specific purpose, just put a general purpose in there. So most founders have never read their corporate charter. I have no idea what it says. Shame on you. Go read it. You're going to read it. You're going to say, eric, what are you talking about? It says here the Acme AI company is incorporated to pursue. And there's like a blank space, like a mad lib. And someone has scrawled in any legal act or activity that means anything. So it's all good. Wrong. So wrong. We're going to get to why. In the 60s and 70s, a bunch of academics and judges and like legal scholars, like a very small group, decided that any lawful actor activity actually means shareholder primacy. Unlike general incorporation that they were replacing, they never put this to any kind of vote. In the history of the world, shareholder primacy has never been subject to any referendum, any legislative action, nothing. So it's weird. If you learned in school how a bill becomes a law, there's no law. Yeah, for shareholder primacy. Yet if you ask any director on any board in America, what is your first duty, they'll say, to maximize returns for shareholders. So how can it be the law and not a law? Well, the courts just decided there were guys like Milton Friedman and they would write these op eds where they write very Famously, things like the social purpose of a corporation is to increase its profits. Notice they never said they weren't like the B Corp people, where they're like, well, we have regular corporations and we're going to have E Corps extractive companies. And there's. This is the best. No, they said the purpose of a company is. The trick was they convinced everybody that this is how it's always been. And we've all learned that. We were taught, well, this is just how it is. Well, it turns out we don't even need to get the law changed. We just have to start saying, no. We don't actually think this makes sense, and we don't want to be part of it. If you read the legal papers, I'll give you one last funny bit. This blew my mind reading these papers. There's all these legal scholars who've had to write papers about why is this the law if it's not the law? And they write this stuff. That's hilarious. They'll be like, shareholder primacy is a legal obligation, not a legal duty. They're like, oh, subtle. That really settles it up for me. Like, what are you talking about? What? And so they're like, look, look, look. At the end of the day, even though this is not technically a law, it is the law, and it's okay for the court to enforce it like a law. Remember, you'll be fired if you violate this law. It's very. It is the law.
- [29:13]
B
It's okay because sued about it.
- [29:16]
A
Yeah. You will lose that lawsuit. Yeah. The board of Twitter was forced to sue Elon to complete that transaction, even though they weren't that happy about it, because they felt like we have this fiduciary duty. We have to do it so differently for the shareholders. For the shareholders. And if they hadn't done it, they would have been sued, and this lawsuit would definitely have worked. So they weren't wrong about their requirement. But why would we build companies like this? Who wants to be taken over at the barrel of a gun? So they basically conclude, if you read these papers, they said, look, at this point, shareholder primacy is what's called a normative consensus, meaning everyone agrees that everyone agrees that this is how companies should act. So I work with a lot of founders. I love to ask them, hey, are you part of this normative consensus? Does it seem right to you? Every founder I've ever met is like, oh, I'm not. Certainly not. I'm like, great. Have you ever told even one other human being that you're not Part of this normative consensus, until just now when you told me everybody I talked to is like, oh no, you can't say stuff like that out loud. You can, you can say it out
- [30:17]
B
loud and just say it.
- [30:18]
A
If it's a controversy, it can't be a consensus now can it? So luckily we have the PPC tools. We have a bunch of tools in our arsenal where we can declare this formally, legally for our company so we
- [30:28]
B
don't have to have social movement per se. But we could, because it'd be fun. But we could.
- [30:33]
A
And also, like in the book, I call this the builder's intuition that the best way to make money is to create more value than you capture. Right? To build something that people want. Tim O'Reilly PG all the Legends of our industry all agree on this. They talk about this all the time. And yet we're all supposed to pretend these days that we think all kinds of making money is equally good. And there's so many ways of making money in our economy today that where you can get rich without creating any value at all. And I just think like, why don't we just stop pretending that we think that's good. None of us think it's good. We think it's all bs. So we should start, I think, as builders reclaim that sense of identity to say, you know what? Yeah, we're not part of this normative consensus. We don't want to do this anymore. We would like to have a different solution now. I think if we just say, well, because investor control is not working, we should have founder control. Founder control is not that great either because I know a lot of people who are like basically trapped. They can never quit their company because they're like the one. They're like literally the human shield blocking every, that's too much. And of course people die. Then what? So if you want to build a truly long term solution, we got to look for structural solutions that do not depend on the goodwill of any individual one person. But we start to think about almost like building a government, like checks and balances, about how do we balance faction against faction. And luckily, like, there are good precedents for this.
- [31:52]
B
Interesting. So if you become a PBC and you have a specific mission, does that you know you are no longer subject to being removed? If you work against or make choices that are not maximizing shareholder value, does that also mean that you can be removed if you are not working towards the mission?
- [32:10]
A
Well, unfortunately not.
- [32:12]
B
Interesting.
- [32:12]
A
Does not. It doesn't work both ways. The problem is directors, especially under Delaware law have extremely wide latitude to basically do whatever they want as long as they can justify it as being, you know, in line with what it says in the charter. It's helpful in this case if your directors are under pressure from investors to fire you because you're not being shareholder. Maximizing the PBC can be a shield that they can use to protect themselves from these.
- [32:37]
B
We're working this mission.
- [32:39]
A
Unfortunately, if they decide to fire you anyway, it still doesn't help you. You can't sue them to be like, what the f. Yeah, they still get to make their own judgments. So a huge part of the problem is we are being taught today that the best practice is to have a combination of investor directors and independent directors and say good governance is the more independent directors.
- [32:57]
B
Why is that?
- [32:57]
A
Well, the theory, reasonable theory that because independent directors are independent. What does it mean to be independent? For those that don't know, it means they literally have no stake in the outcome. They don't have, like, they're not aligned to you at all. They don't have equity in the company. The idea is they're random people. They're basically like, you want random, eminent, eminent people. The problem is they have no financial incentive for the mission to endure. But they do have a financial incentive to be seen as pro investor. Because how do you get independent director jobs? You get recommended by investors, okay, Founders, you gotta do a better job at this. Most founders never recommend anybody for a director job. Investors do a great job of it. So if you have a board, like classic Silicon Valley board would be two VCs, two founders and an independent. That's supposed to be fair because it's 2 and 2 balance. That is basically just investors control your company already. Don't kid yourself. The research, by the way, this is one of many. There's a whole chart in chapter nine of this book that just is called Best Practices destroy shareholder value. This is one of these best practices. We have the evidence. Independent directors do not accomplish the goal that they're supposed to have because they have this actual conflict of interest despite their nominal independence. So the solution is just like investor directors are doubly accountable. Like if you put a GP of a venture fund on your board, they have a double duty. They have a duty to the company, but also a duty to their LPs. That doesn't bother anybody. We understand investors are smart enough to be able to handle that. Not a big deal. But independent directors don't have that because they're not really accountable to anybody. They're just accountable to themselves. But there is a solution. We can actually create a second entity like a two branch government where we have outside trustees who have the responsibility of appointing directors. Sometimes just the independent directors, sometimes all the directors. So that structure has been proven to be more stable than the so called best practice of a single entity. Just run as a Delaware C Corp. I tell you story. Yeah, this is one of my favorite stories because here I'm going to tell you. I'm going to tell you the premise of the story. You're not going to believe me and then I'll try to prove it to you. That's true. Premise of the story is this story about a time when the non profit directors of a company created more than $500 billion of shareholder value. In the 1920s. There's a woman named Marie Krogh, she was living in Denmark and she gets a fatal diagnosis of an illness that has no known cure at that time called diabetes. Today Marie is mostly famous because of her husband August. He just won the Nobel Prize. So he's a pretty smart guy. He asks her if she would, despite her fatal illness, would she accompany him on a lecture tour of North America. She says, sure. So they go to North America, they're meeting scientists, you know, and doing these lectures and whatever. At dinner one night, one of the scientists tells them that in Canada someone has figured out how to isolate insulin for the first time, potential cure. So they're excited and so it was obvious to them that they should go see. You know, it could have easily just been like, can you send us some doses? We don't care. But no, they wanted to go see it for themselves. So they meet the Canadians, they see this possibility and they say, look, we would like to commercialize this technology in Denmark. Can we license it for you? And they, and the Canadians have this worry, decades ahead of Martin Shkreli. Okay? They were like, wait a minute. If we have a for profit company that is selling a life saving medicine, like let's say you sell a medicine to me that I need to live, I want you to charge me a fair price, right? I want you to stay in business. I want you to have every incentive to keep producing the medicine. That's great, but I would live in fear that one day you would wake up like Martin Shkreli did and be like, wait a second, if Eric owes his life to this medicine, can I charge him anything I want? He's basically my slave. So they were, they foresaw this in the 1920s. So when they went home to Denmark, they Made their agreement with the Canadians. What they would do is they would build this thing. They called it the Nordisk Insulin Laboratorium as a for profit subsidiary of a nonprofit foundation. So they built two entities instead of one. And the nonprofit had trustees and the for profit had directors. That structure, really, it's a great MVP story, by the way. They had the first insulin. I think they produced it within like three months of getting back to Denmark. They got to work. They really, like this was an urgent problem for them because they wanted Marie to live, but also they wanted to save a lot of lives. Anyway, if the Nordisk Insulin Laboratorium sounds familiar, it should. This is the predecessor company to what we now call Novo Nordisk. This company's been going for more than 100 years with its scientific integrity intact. And people hear that story, they're like, well, maybe they were just lucky. Maybe the Danes are more friendly or whatever. Like people have all these dumb theories about why. No, every crazy thing. The same force that came for Jeff Lawson, same force that came for Saul Price, same force that has destroyed so many tech companies, of course it came for Novo Nordisk. They're a huge company. Of course it did. So in the early 2000s, it was a big wave of new best practices for pharmaceutical companies that they all needed to combine and do M and A to get bigger. So the for profit board and all of its independent directors and everybody of Novo Dortisk are like, oh, I guess we have to merge. So they go around trying to find a merger to sell the company. They find this company, they have a signed merger agreement. They're going to get a huge premium on the stock price. Now at this point, Novo is a publicly traded company. They get this agreement. The last like due diligence checklist item they have to do is go to the foundation and get their permission to do the merger. The trustees are like, well, what is the purpose of this transaction? And they're like, our job is to look after the mission of Novo Nordisk. We're only allowed to approve a merger if it's necessary for the survival of the company. And my, the favorite detail about this story is they had to have two meetings because they were like, we're going to get back to you. We're going to get the bankers. They re huddle with the bankers, they bring the bankers back and they're like, ah, since you said it's but necessary for the survival of the company, this is the new best practice in pharma. It's eat or be eaten. If we don't merge, we're going to die, whatever. And the nonprofit trustees are like, okay, that's interesting, but what problem are we solving exactly? Because Novo Nordisk has been profitable for 10 years in a row, growing like 20% a year.
- [38:29]
B
It doesn't have to do anything.
- [38:31]
A
Why do we have to do. Why can't we just be a great business doing our thing? Anyway, long story short, the trustees say no, merger over. Yeah. People are so pissed at them because this is going to be like a $20 billion merger. It was going to make a lot of money for a lot of people. Bankers are. Everyone's pissed now. It's rare in business that you have these moments, like with fedmart, where you actually get to see the counterfactual. So we know for sure that if they had not done this, all of the major R and D programs of Novo Nordisk would have been canceled. We know, because the company they were going to merge with two years later was bought by Merck. And that's what happened.
- [39:04]
B
Oh, my God.
- [39:05]
A
One of those research programs was in year, I think, 11 of 13 of inventing GLP1. So because the trustees interfered here, the research program was allowed to come to fruition. You have to understand, this was. GLP1 was such a difficult drug to produce that even 10 years in, they had no evidence whatsoever that it was going to work. And everyone was like, why are we funding this thing? It seems like it's never going to work. But they kept the faith. If you fast forward 20 years, this intervention caused Novo Nordisk to have, for a time, a value cap, a market valuation greater than the GDP of Denmark. And if you freeze frame right that moment, you will have now noticed the delta between what they would have sold for and what they actually are worth
- [39:47]
B
more than short term versus long term, which is a theme over and over
- [39:50]
A
again, over and over again. They became, I think, their valuation crested at $600 billion. I think, though, that builders have to take some responsibility here. I mentioned before that most founders have never read their corporate governing documents worth doing. Everyone's just like, well, my lawyer will take care of it. It's like governance. I hate even using the word governance, because as soon as I hear that people are just like, boring, who cares? I mean, I remember with Lean Start, Lean Startup is a book about management. And I remember telling people, like, it's going to talk about management. They'd be like, management so boring. Like, yeah. So because we delegate this to lawyers and bankers and whoever else we like, when it comes back to bite us in the butt. We're like totally unprepared. I think builders have to get a lot more savvy about this. This first of all make sure they understand what they're signing. But then also to, yeah, to put on the T shirt with the fist to be like, I don't want this to happen to me. Like, this is not the kind of company I want to build. And I think we are not that far from being able to have an economy that is about building again. I really think we are close to that. The younger generations are super pissed off. This idea of shareholder primacy has had its 40, 50 year run now. People who've grown up only under that system have seen its failure. Like we live in a time of institutional collapse and institutional weakness. And this is the thing, like when companies collapse, when they go through these ethical moral collapses, it's also an economic collapse. Like that's what's so interesting to me is it's value destroying. So we don't need to make a moral argument necessarily. We can just make an economic argument. And the book is loaded with the evidence. For example, the Novo Nordisk style of company where you have this two tiered foundation that's called an industrial foundation structure in academic literature. Companies with that structure, there's a lot of them. The German optics company Zeiss had this structure in 1885. So it's not even that new. There's enough of these companies that we have a data set to see how they perform. Companies with this structure are six times more likely to live to year 50.
- [41:40]
B
Amazing.
- [41:41]
A
10% versus 60% probability. So we as founders, when we're choosing our corporate form, we're being told that there's this business monoculture, all you can do as a Delaware C corp, everything standard. Best practice. Best practice. Man, we've been deprived of our birthright. There's way more options out there than we're being told. And I just, I always tell founders, why are you having to hear about it from me? Yeah, why didn't your investors tell you? Why didn't your lawyers tell you? Like, how come you, if you don't know this story, why not? Why wasn't in your MBA class? Why isn't this not in the curriculum?
- [42:08]
B
Well, we need VC funds to not be 10 year funds.
- [42:11]
A
Well, that's a huge problem.
- [42:12]
B
Just for the people, the audience. I mean, Basically the standard LP agreement for a venture capital fund is 10 years. Which also means that at the end of those 10 years, the money that was put out is expected to come back so 10 years is, it's just
- [42:27]
A
not that long anymore especially, I mean it made sense. Most of these practices come from a time when companies would go public like three years after being founded. Amazon went public, I think that way raised like $20 million. Like it just the scale of an IPO was much less of a big deal back then.
- [42:40]
B
It used to be the three year overnight success, now it's the 20 year overnight success.
- [42:44]
A
Absolutely. And of course we have companies like Stripe that are like stubbornly just refusing to go public because why should they? And I think people wring their hands about this, but it's like, what do you expect, man? If you create a system that puts this gravitational pressure on companies, you have to expect people to fight back and resist. I don't think the tools we've used in our resistance are very good. I think we've like been desperately grabbing for whatever we can grab because we
- [43:05]
B
feel like founder control, which is, I mean honestly what we advocate for, it's better than nothing.
- [43:10]
A
I mean it's certainly better than investor control, which really is self defeating. Founder control has all these problems and what's interesting to me is people who do founder control have no bridge. They're stuck. So like for example, one of the things I advocate for is that if you're going to do founder control, just write into the docs that if the founder control is ever defeated for any reason, there's an alternative thing that springs up in its place. You can just write this in your docs right now. You can have this at the seed stage. It's not that hard. Just say, yes, I'm going to have the Novo Nordisk Industrial foundation structure or I'm going to have one. There's a bunch of structures that I explain in the book. What's cool about that is founders think that having dual class shares makes you invincible, but it really doesn't. Dual class is defeated all the time. I give a bunch of examples in the book, like, you know, stock price drops, everyone panics, founders forced out anyway, because at the end of the day like having the votes is not the only thing that matters. There's a bunch of things that matter, including like investors being like, well, we won't give you any more money unless you turn this protection off. So I think the perception of being invincible and like being emperor for life, not only is it not true those people still get betrayed, but you also, it has a psychological effect that's not healthy. It's called hubris syndrome in the psychological literature. It makes you less generous Less compassionate. It makes you more selfish. It makes you more afraid conversely of losing your power. So if you notice some of these emperor for life billionaire types out on social media, like having a mental breakdown in front of us all, part of what's going on is that this is a mental illness. This is not actually a good structure because we have these better structures. There's really no reason to do it, or at least do it as a backup for after your dual class shares get, get defeated, which, you know, generally speaking, they eventually do get defeated, including by the death of the founder. So what then? Like, I think if you want to build a 50 or 100 year company, you got to last longer.
- [44:54]
B
One of the more profound reasons to start a company is actually wanting to create something that outlives you.
- [45:00]
A
I think so. I think that's actually part of why entrepreneurship is so awesome, like as a career.
- [45:04]
B
The first time I ever heard of a PBC actually was from my friend Scott Phoenix. He started a AI lab called Vicarious and he very explicitly said, I'm going to do it as a pbc. We're going to try to create AGI. And if we create AGI, we don't want to be, you know, sort of forced into a paperclip maximization world.
- [45:26]
A
No kidding.
- [45:27]
B
You have AGI and it's self improving. And then anyone, any shareholder could come and say, actually we're not maximizing enough. And then you helped design the long term benefit trust for Anthropic.
- [45:41]
A
Yeah.
- [45:42]
B
So I'm curious, I mean, what was that like?
- [45:44]
A
Oh, it was wild.
- [45:45]
B
Yeah.
- [45:46]
A
Yeah. Listen, I do not take credit for Anthropic's success. Okay. Just for the record, like I played only a bit part and all credit to Dario and Daniela and the whole team. They're on such a run. Love them. But if you talk to people about why is Anthropic so successful, they'll often say something like, well, their inference costs are lower.
- [46:02]
B
Oh, that's definitely not true right now.
- [46:03]
A
Yeah. Or whatever, you know, whatever it is. Right. They have, they have better superior focus.
- [46:07]
B
The models are fantastic.
- [46:08]
A
The models are better. But like, if you ask why, you'll be like, well, they have better technical architecture. But why? Well, because they're better at doing this thing and that thing. But why? Well, not about its people. Yeah, it's like because they have the best talent. Why is that? Well, because the best people want to work there. But why? Because they think they're the good guys. That's like a huge recruiting talent advantage. It's unbelievable. So Many incredible people want to work there because they are. You ask for the focus. Why are they so aligned? Because everyone's on mission because the mission is primary. But why has an anthropic been able to be bullied from the outside? People certainly have tried. I think part of the reason is they have that magic formula, ethos plus integrity. They have this ethos of AI safety. Whether you agree with it or not, they really believe it. I remember I met them. Now they're world beaters. I know. But I remember meeting them when they had just left OpenAI. Their team was very aligned. The people that were leaving, people who were leaving a really lucrative job behind to do this. So people really were there for the mission. They had what they thought were really aligned investors, including Sam Bankman Fried. So actually turned out not so much to be. But they thought that's what they thought at the time.
- [47:09]
B
It would have made that whole situation whole.
- [47:10]
A
Apparently the stake that the bankruptcy has of those shares is worth more than the whole, than all of the entire fraud by a lot. And it's going to be worth even more when. When the time comes. Yeah, it's like one of the most bizarre situations in history.
- [47:22]
B
It's pretty wild.
- [47:23]
A
And in spite of having so carefully curated their cap table, like one of the most tightly curated cap tables I've ever seen for a company like this, a huge chunk of the company wound up being sold at auction in a bankruptcy auction. Like, how crazy is that? So anyway, people always think if I just curate, if I just choose the right people. Well, they thought they had, but they were also really worried about this paperclip maximizer thing. Like, what happens if we're sold to the highest bidder? What happens? Well, they understood this technology is going to be worth trillions. If it works, the incentive to take it over is going to be unbelievable. So we need a structure strong enough. And so we talk just like we're talking now. We had the same conversation then that we're having now again, credit to them for actually doing the work. But I remember working with them on their charter and they had to defend this idea for two years because they kept writing it into the term sheets that they would do it, would do it, would do it. But it took time to, like, figure out what they wanted to do. I think it was the Series C when they finally established this thing called the Long Term Benefit Trust, which is not a nonprofit foundation. It's actually what's called a Perpetual Purpose Trust, which is a different legal category, but the same idea outside Trustees who have the power to appoint directors to the for profit board. People very frequently ask me, why is Anthropic the most courageous of the AI Labs? And I think this is part of the reason why. They have this structural strength to stand up for what they believe. And if you notice when companies stand up and do the right thing, we live in such a polarized time, it's like, what do you mean, the right thing? Are you saying they're absolutely right? They're the morally perfect? Not. You want me to criticize Anthropic? I can think of lots of things when I say they did the right thing. They acted consistent with their own values. Those values are consistent with human flourishing, and they have the strength to defend them. So I know a lot of people, even in San Francisco, like San Francisco, I'm a lot of turmoil right now. Tech companies are not the most popular here right now. AI companies maybe even less so. When Anthropic turned down that $200 million contract, someone sent me a video. The sidewalks around their headquarters had been chalked up with people saying, thank you.
- [49:15]
B
Oh, wow. Yeah, man.
- [49:16]
A
When I tell you that a San Francisco tech company had its sidewalk chalked up, thank you is not what you're. Not the kind of language you're expecting. So, like, because they have the strength, they get all these counterintuitive benefits. Claude went to number one when they did that. They couldn't have known that was going to happen. They couldn't. Like they. And who knows what's going to happen next? Obviously, long way to go with Anthropic and with the question of AGI, but I think the early returns are very promising. That just taking a little bit of extra time to set this structure up in a thoughtful way has been incredibly valuable to their success.
- [49:45]
B
Eric, thank you so much for joining us. This is truly epic.
- [49:49]
A
It's an honor. I really think this is a message that YC founders need to hear and pay attention to. So I'm really excited to see this finally get out in the world.