How The Best Companies Defend Against Mediocrity And Rot

The best way to make money is to create more value than your capture. Like to build something that people want out. 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? Today we have a very special guest, Eric Reese, 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 "Incorruptible" 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. Hey man, good to see you. Always fun to hang out. 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? You know all my books come from pain. I never asked anybody to do something in a book that I haven't done myself. And we've been around this a long time. How many companies have we seen built and created where the thing that made them special gets lost? How many founders lose control of our 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. Yeah. So I feel like The 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. So I'm sick of that. Going from zero to one, a lot of people spend a lot of time thinking about zero to one and I think The Lean Startup is one of the Bibles for being able to figure that out. Thank you for saying that. There isn't really a playbook that is written until now around how do you make it last for a hundred years? 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 comment but I've lived it now for quite a number of years. I've seen so many companies, you know, haven't happened to them. And the book I tell this story about like I was coaching a new founder, I call him the professor in the book to protect his privacy. He's a genius. There's just that story. He's an incredible person and building this really transformative technology, you know, on the cutting edge of AI plus bioscience. So super cool and huge upside, hella danger. Because you could easily use this technology for something really awful, bio weapons, pandemics, you know, 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? Yeah. But if an investor is want to do something evil on you, be like, well, I'll tell him no. Why will you be working there then if you're telling your investors, no, right? He didn't know that how to answer those questions. But when he would meet with investors, all these sees would just be like, oh, that's nice, honey. Oh, you're worried about that stuff. Like, 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 was flowing with a trap. Anyway, I happened to be on my way. I was talking to him to this event commemorating a founder who had a huge success, 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're doing this event to like celebrate him and people have flown in from all over the country. Employees, ex employees, like there was about 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 some explaining to the founder, listen to the professor. I can't talk right now because I got to go to this thing. I'm explaining about the founder of 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 were 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's at the company dying. 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. Yeah. 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. Life span of companies is dramatically down. Average tenure of executives is dramatically down. And then people say, now why is trust down? I don't trust anybody anymore. Well, because we've built an economy that this is how it runs. And I just think we have the final say that is 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 destroyed. Basically, there's Delaware bylaws. Is that right? Basically, you know, if you're a Delaware Seacorp, you have to relentlessly pursue profit. Otherwise, there's grounds to remove you. That specific principle is exactly how you know, the end of that founders reign of that particular company happened. 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 Delaware Seacorp, 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 what it'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.D. guy's talking about. This idea dates to the 1980s. When 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 had an incorporated Delaware C.Corp. I'm like, if I pull your charter right now, it says, you have to maximize your older 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 part. I would go to this thing. You call me back tomorrow and you tell me what he says. And he, 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 document. And then I have to sell if the most evil company in the world wants to buy this company. I have to sell it to them. My employees do that. They don't quit. Because we should probably fix it. I mean, this is the way we've always done it. It's sort of always done it. What people are going to tell you. 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 work with so many companies. I kept the 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. would sunset after seven years. And you're taking a company public seven years sounds like a long time. Yeah. 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 them, 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 text stocks we had was like, go to a stock like, it 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, okay, it's 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 that would really piss me off about the most is This 199 days so that's so he had run this company for seven years of 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 And he really earned so little grace To run this company like it does a fact that he had made all this money billions for his investors didn't as I count for nothing like What are we doing and what's strange to me in the book? I give obviously not just about 12. 12 is a fine company that you're doing right now It's not just them company after company for company. I give case studies going back 200 years Where we have this like urge or a founder makes a quote-unquote mistake they have to be fired. We have to have accountability founders True, we got to have a count of this important But oftentimes that's the end of the company right like when Edward Lan was fired from Polaroid now people like Polaroid was in that instant camera company No, man Polaroid used to be a R&D powerhouse at like 1500 research scientists on staff Steve Jobs I love that company admired them so much when when Edward Lan was fired He called it the dumbest thing he'd ever heard yeah, and like 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 had jumped to the conclusion that firing them bringing in some suit like doing the kind of standard breast 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 the mission can only be protected by the founder And then you get rid of the founder ever was 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 control companies There's a third way We can be building mission controlled companies where the mission itself has sovereignty and this company's gonna last a lot longer What does that really look like? I mean Patagonia sort of famously was one of the first to really do this But you're for someone who's watching they're like well, I know a Delaware C corp And then I know that they're super voting shares and I shouldn't let those expire. Yeah, yeah exactly People from the Jeff Lawson's I mean that would be better than at least tell it be better than the sunset for sure But no, there's a lot more to this and maybe tell me tell you story I tell you the legend of Saul price. Okay, let's get let's move away from tech for a second I think it's helpful to understand the precedence. They 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 FedBart Godmark 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'd been trained That you have a fiduciary duty to your client. I mean, 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 employee second shareholders third The great Peter Drucker said he got it wrong. It should have been employees first customer second shareholders last The famous Johnson and Johnson Alcrito is doctors patient that nurses first employee second Community third shareholders last you notice the pattern Not because shareholders are an 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 you 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 health of your customers Whatever everything becomes expendable on the altar of shareholder value and and no company can really endure with that structure Or they do and it 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 do 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 resumes to be like The gold star and now people are like why did you stay there? Yeah, I think there was a stat in your book that really jumped out at me It's like eight billion dollars in profit, but So 300 billion yeah in or 600 billion 600 billion yeah 300 billion dollars in direct healthcare costs Yeah, so when people say that Philip Morris is profitable You know order to call it profitable you have to take this incredibly narrow view of profit They have something like eight billion dollars a year in net income But there's been all these studies they create six hundred billion dollars a year in costs Just in the US that have to be born by others. I think it's 300 billion in direct healthcare costs and 300 billion dollars in loss productivity And obviously the mortality of people dying and if we're 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 six thousand dollars 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 salt price fed mart embody this principle of fiduciary to the customer You think about the way that Steve jobs would obsess about design See jobs used to get into fights with people about the 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 entrance would be like what do you care? No one's going to see it. We're going to see right like I this is my principle. This is not shareholder value If we stand for this principle good stuff's going to happen to us now how you do anything is how you do everything Now Steve jobs got fired because of this exact thing So spoiler alert so we'll solve 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. Oh wow right like he just he was like I don't care My job is to get you the lowest price. Yeah, don't care if it's for me people will come to you every single time because They're like hey, no if it's ever so cheaper so you imagine a modern retailer doing that like yeah other than DTC brands where I'm just like I got to Buy it on your pride like I 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 So it was a really stubborn SOB You know 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 gonna take the company private that was the whole plan And he thought the new board because they really understood retail it understood to him They like looked him in the eye and said I 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 saw comes into work and these guys have changed the locks on his door Oh my god. I can't even get into his office. Wow So it's just like just like Jeff lost in just like as 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 FedMarts investors got what they wanted to get saw out of the way They converted FedMarts to trap traditional business practices. It was bankrupt within seven years Oh wow they destroyed in seven years what he took 20 years to build Saw was a classic entrepreneur like so many people we know he took exactly two weeks off after this happened to him Delic is wounds and then he was back at work. He leased the office upstairs from FedMart Nice for his new company, which is like a few. 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 stockboy 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 make sense This is the deep cut backstory of how Costco came to be Costco today still embodies that Saul price fiduciary to the customer idea But it is protected by this thing. I call it governance fortress that protects it from outside attacks So that it's bored 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 well, we'll get into some of it But like overall 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 outside pressure. So that's kind of the short formula if you don't take much away from this ethos plus integrity Equals incredible. 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 yeah the first step and the hardest step by far is to be willing to say that you are not in 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. - Yeah, you gotta agree that you're gonna be punk rock. - Yeah, so if you're willing, you gotta just be like, this is not for me. Because like, I tell the 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 have this natural experiment where Costco has been incredibly successful since this moment, 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. There's just 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 shade on Kroger. But you could be one of the greatest performing stocks all the time where 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 gonna make a quick buck from it. Even if they're investors who are gonna profit from you, you wanna 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. You're not taking investment from that individual person. You're taking investment from a company than 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 gonna be a good long-term partner. And they're so easily bamboozled by people who are like, I'm founder friendly. We don't need to worry about this stuff. We're aligned, it's gonna be good. But I also do need to be the ability to fire you at will, whenever I want. It's like, that 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. Why see 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. What about on the dock side? Let's say you get into YC, you've got a safe, 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 for 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 people to start out? I think PBC 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 door is going to have it done for you tomorrow. And especially if you only have safes, if you don't have any equity investors, it's turning you into a PBC tomorrow. You just don't even need anyone to agree, you just do it. What's interesting to me about the PBC, and most people get confused, 'cause I think it's like the same as the little B in a circle, you see at the farmers market, which is something totally different. That's covered in the book too, but that's not what we're talking about. 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. So literally a mission or a public benefit. It 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. Interesting. - Charizard, yeah. - It would say like we've created this thing to create a railroad 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 shareholder primacy, we like forgot this really important lesson. - So who did this? - Who did this to us? It's actually super well. We'll do a history lesson, you okay? - I love to. - Okay, yeah. - This is incredible to me. So there's this story in the book about this 19th century situation that like if you know Elon's taken over of Twitter or whatever, you're like, I know how this is gonna go. One of the richest men in the world tries to buy, take over this company that was the eerie 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 gonna 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. So 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. Like literally those stories where like, they were both bribing the same state legislatures, legislators and people were 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 it naturally, and it makes perfect sense. And like I said, if he lost in the end, they fought him off, using what's called a poison pill tactic, which now today, you could just ask your lawyer to put this in your juxtaposed and you could just have it if you want. If you don't have it, why not? That's another tactic. So many of these things, you could just have it. You don't have to 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 Mekha Canal to maximize shareholder value, that would have been considered a crime. And the courts would have voided the company's charter. It 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 chargers, you had to get your state legislature to give you one. Imagine if you had to go a lot of 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 with 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 as an 1899. So like not 1299. This is a 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, no, read it. You're gonna read it and you're gonna 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 madlib and someone has crawled in any legal act or activity. That means anything. So it's all good, wrong, so wrong we're gonna to win. 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, Artley 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-Cort people, they're like, well, we have regular corporations and we're gonna have e-corp's, extractive companies. And there's, this is the, 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 wanna be part of it. And if you read the legal papers, I'll give you one last funny bit, just blew my mind reading these papers. There's only 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 as hilarious. So we like, the shareholder primacy is a legal obligation, not a legal duty. They're like, oh, settle. That really clear us 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 courts to enforce it like a law. Remember, you'll be fired if you violate this law. It's very, it is the law. It's okay because-- - And it is sued about it. - Yeah, you will lose that lawsuit. - 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 food sharing duty. We have to do it. So different than-- - For the shareholders. - For the shareholders. And if they hadn't done it, they would have been sued and the 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 like, take it 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 ever met, it's 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 loud. And if it's a controversy, it can't be a consensus now, can it? So luckily we have the PBC tools. We have a bunch of tools in our arsenal where we can declare this formally, legally for our company. So we don't have to have, you know, social movement per se, but we could, but we could be fun. But we could and also like, in the book I call this the Builders Intuition, that the best way to make money is to create more value than you capture, or to build something that people want. Yeah. Timor Riley, PG, all the legends of our industry, all agree on this, they talk about this all the time. 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. Now, and I just think like, why don't we just stop pretending that we think that's good? No one, 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 wanna 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 found a control. Found a control is not that great either, because I know a lot of people who are like basically tracked, they can never quit their company because they're like the one, they're literally the human shield blocking every, that's too much. And of course, people die. Then what? So if you wanna build a truly long-term solution, we gotta look for structural solutions that do not depend on the goodwill of any individual one person, what we start to think about, almost like building a government, like checks and balances about how we balance faction against faction, and luckily, they're our good precedents for this. Interesting. So if you become a PBC and you have a specific mission, does that, you're no longer subject to being removed if you work against or make choices that are not maximizing shareholder value? - Correct. - Does that also mean that you can be removed if you're not working towards the mission? - Well, unfortunately not. Interesting. - It does not 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, 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 a shareholder, maximizing the PBC can be a shield that they can use to protect themselves from being glued. - We're working towards this mission. - 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, they still get to make their own judgment. So a huge part of the problem is, we are being taught today that the best practices that have a combination of investor directors and independent directors. And could they good governance is the more independent directors? - Yeah, why is that? - Well, the theory, the reasonable theory, that because independent directors are independent, what does it mean to be independent for those who don't know? It means they literally have no stake in the outcome. They're not aligned to you at all. They don't have equity in the company. The idea is they're going to be-- - So random people. They're basically like, you want-- - Yeah, both of you. - Yeah, both of you. - 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 got to 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, a classic Silicon Valley board would be two VCs, two founders, and an independent. That's supposed to be fair, 'cause it's two and two balance. That is basically just investors control your company. All right, don't kid yourself. The research, by the way, this is one of men. It's a whole chart in chapter nine of this book that just is called Best Practices Destroyed Shareholder Value. This is one of these best practices that 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, 'cause they're not really accountable to anybody. They're just accountable to themselves. Well, 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-Core. I tell you a story. - Yeah. - Is it one of my favorite stories? Because, yeah, I'm gonna tell you a story. I'm gonna tell you the premise of the story. You're not gonna 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 nonprofit directors of a company created more than $500 billion of shareholder value. In the 1920s, there's a woman named Marie Crow. 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 Bruce Markeye. 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. What dinner one night? One of the scientists tells them that in Canada, someone has figured out how to isolate insulin for the first time. - Oh, yeah. - potential cure. So they're excited. And so it was obvious to them that they should go see. You know, they could have easily just been like, can you set us some doses? We don't care about it. No, they wanted to go see it for themselves. They meet the Canadians. They see this possibility and they say, look, we would like to commercialize this technology in Denmark. It can be licensed for you. And they and the Canadians have this worry. Decades ahead of Martin Screlie, okay? They were like, wait a minute. If we're 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 Screlie did and be like, wait a second. If Eric owes his life to this medicine, can I charge him anything I want? That's basically my slave. So they were worth, 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 Laboratory 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 was a great MVP story. By the way, they had the first insulating, they produced it within like three months of getting back to Denmark. They got to work. They really, this was an urge problem for them because they wanted Marie to live, but also they wanted to save a lot of lives. Anyway, if the Nordisk Insulin Laboratory on Sound's familiar issue, this is the predecessor company to what we now call Nova Nordisk. This company's been going for more than 100 years with its scientific integrity intact. And people hear that story and they're like, well, maybe they were just lucky. Maybe the Danes are more friendly or whatever. Like people have all these dumb stories, theories about why? No. Every crazy thing, the same force that came for Jeff Lawson, the same force that came for a Saul price, the same force that has destroyed so many tech companies. Of course, it came for Nova 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&A to get bigger. So the for profit board and all of its independent directors and everybody of Nova Nordisk 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, Nova is a publicly traded company. They give 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 Nova Nordisk. We're only allowed to approve a merger if it's necessary for the survival of the company. And my favorite detail about the story is they had to have two meetings. 'Cause they were like, we're gonna get back to you. We're gonna get the bankers. They re-hutdle with the bankers. They bring the bankers back and they're like, ah, since you said it's 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 gonna die whatever. And the nonprofit trustees are like, okay, that's interesting, but what problem will we solve exactly? Because Nova Nordisk has been profitable for 10 years in a row, growing like 20% a year. It doesn't have to do anything. 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. 'Cause this is gonna be like a $20 billion merger. It's gonna make a lot of money for a lot of people. Bankers are pissed. Now, it's rare in business that you have these moments like with FedMAR, 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&D programs of Nova Nordisk would have been canceled. - Oh my gosh. - We know because the company they were going to merge with two years later was bought by Merck. And that's what happened. - Oh my god. - 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 was gonna work. And like, everyone's like, why are we funding this thing? Seems like it's never gonna work, but they kept the faith. If you fast forward 20 years, this intervention caused Nova 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. - Sure, this is long term, which is a theme over and over 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. - Okay. - I mentioned before that most founders have never read their corporate coverage. 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've heard that people are like boring. Who cares? I mean, I remember with these start, at least start up as a book about management. And I remember telling people like it's going to talk about manager. They're like, management, so boring. Yeah. So because we delegate this to lawyers and bankers and whoever else, we like when it comes back to buy this in the butt, we're like totally unprepared. I think builders have to get a lot more savvy about 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 Nova Nordisk style of company where you have this two tiered foundation. That's called an industrial foundation structure and academic literature. Companies with that structure, there's a lot of them. The German Optics Company's ICE had this structure in 1885. Oh, wow. 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. That made some 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 is a Delaware C Corp. Everything's standard, best practice, best practice. And we've been deprived of our birthright. There's way more options out there than we're being told. And I just always help 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, well, 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? Well, we need VC funds to not be 10 year funds. Well, that's a huge problem. 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, 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 dollars. Like it just the scale of an IPO was much less of a big deal back there. It used to be the three year overnight success. Now it's the 20 year overnight success. 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 ring 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 feel like more of a founder control, which is, I mean, yeah, honestly, what we advocate for is better than nothing. 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 right 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 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 Novonaurus Condustrial 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 they had to be like having the votes is not the only thing that matters. It'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 to 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 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 like emperor for life billionaire types out on social media, like having a mental breakdown in front of us all, like part of what's going on is that like this is a mental illness. This is not actually a good structure because we had 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 if you know, in 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 year 100 year company, you've got to last longer. One of the more profound reasons to start a company is actually wanting to create something that outlives you. I think so. I think that's actually part of why entrepreneurship is so awesome. Like as a career. With the first time I ever heard of a PPC actually was from my friend Scott Phoenix. He started a lab called Bicarious and he very explicitly said, I'm going to do it as a PPC. We're going to try to create a GI. And if we create a GI, we don't want to be sort of forced into a paperclip maximization world. No, you have a GI 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. So I'm curious. I mean, what was that like? Oh, wild. Yeah. Yeah. Listen, I do not take credit for anthropic success. Okay. Just for the record, I played only a bit part and all credit to Dario and Daniella and the whole team. They're on such a run. Love them. But if you talk to people about why then anthropics are so successful, they'll often say something like, well, they're inference costs are lower. That's definitely not true right now. Yeah. Or whatever it is, right? They have better superior focus. The models are fantastic. Models are better. But like if you ask why, you're like, well, they have a better technical architecture. But why? Well, because they better doing this thing and that thing. But why? Well, eventually how do it's 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. Unbelievable. So many incredible people want to work there because they are like 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, whatever you 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 open AI. Their team was very aligned to people that were leaving people 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 Vaigman-Fried. So actually turned out not so much to be. But they thought that's what they thought at the time. They would have made that whole situation whole apparently. The stake that the bankruptcy has of those shares is worth more than the whole. All the entire fraud by a lot. And it's going to be worth even more when the time comes yet. So one of the most bizarre situations in history. It's pretty wild. And in spite of having so carefully curated their cap table, one of the most tightly curated cap tables I've ever seen for a company like this, a huge chunk of the company wanted 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, I thought they had. But they were also really worried about this paper quit maximizer thing. Like what happens if we're sold to the highest bidder? What happens? What they understood this technology would be where trillions of 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 have 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 a series C when they finally established this thing called the long term benefit trust, which is not a non-profit foundation. It's actually what's called a perpetual purpose trust, which is a different legal category. But it's the same idea outside trustees who have the power to appoint directors to the for-profit board. People very frequently ask me why I'm throwing up like 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, well, what does it mean? The right thing. Are you saying they're absolutely right? They're morally perfect. No, you want me to criticize Anthropic? I get to think a lot 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 is 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. Oh, wow. Yeah. Man, when I tell you that San Francisco Tech company had it 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. Clawed went to number one when they did that. They couldn't have known that was going to happen. They could like they who knows what's going to happen next. Obviously long way to go within 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. Eric, thank you so much for joining us. This is truly epic. It's an honor. I really think this is a message that YC founders need to hear and pay attention to. So I'm just I'm really excited to see this finally get out of the world. [MUSIC]