Ex-Googlers Design an Algorithm for Investing in Young Entrepreneurs

3/18/13Follow @wroush

“Venture capitalists have long said, ‘We invest in people, not ideas or businesses.’ Well, not really. We are the first people really doing it.”

So says Dave Girouard, the founder of Upstart, a new operation in Palo Alto that’s part loan agency, part investment fund, part mentoring network, and part dream factory.

Made up mostly of ex-Googlers—including Girouard, who formerly led Google’s $1 billion enterprise apps division—Upstart finds up-and-comers in their early 20s and helps them raise modest amounts of money, usually enough to allow them to pay off student debt or cover living expenses while bootstrapping a startup. In return, these “upstarts” agree to pay backers a slice of their future income—up to 7 percent per year for 10 years.

You could look at Upstart as a really fancy bank, where the loan applicants are screened using sophisticated algorithms that calculate their likely future income based on factors such as their GPA, the schools they went to, and their past job offers. You could look at it as a Kickstarter-like crowdfunding platform, since the actual money comes from accredited investors who cruise Upstart’s profiles and choose which of the approved applicants they want to back. Or you could see it as a radical new type of angel fund, where the risk to investors is that some of the upstarts will end up in low-paying jobs, and the potential reward is that a few of them will see huge windfalls when they sell their own startups.

Dave Girouard, founder of Upstart

Dave Girouard, founder of Upstart

Either way, Girouard believes it’s time to find a Google-style solution for the problem faced by many talented young people: Just when they’re yearning to test their creative potential, they’re saddled with financial obligations that often force them into cookie-cutter corporate jobs. “People in their twenties are illiquid,” Girouard says. “They have the burden of student debt. They are not credit-worthy in any traditional sense. And they are generally forced to make a decision to deal with what is, in effect, a short-term economic challenge.”

The big idea at Upstart is to use mathematical models to find the most promising of these people and, in effect, help them borrow from their future selves. “The thought is to allow them to pull maybe $30,000 or $40,000 or $50,000 from their future, when they are statistically almost guaranteed to be successful, to the present, when that money could have the most impact,” Girouard says. That way, they won’t have to take a job they aren’t really excited about, or forego a dream like starting their own company.

Upstart debuted last April and has raised $5.25 million in venture backing of its own, from marquee firms like Kleiner Perkins Caufield & Byers, NEA, First Round Capital, and Google Ventures, as well as individuals like Salesforce CEO Marc Benioff, IronPort Systems co-founder Scott Banister, and Dallas Mavericks owner Mark Cuban. It’s starting small—so far, it’s funded only three dozen upstarts—but Girouard says the organization intends to scale up the program vastly.

“With the Google background in us, we can’t help but want it to be Gmail-like in size,” he says. Over time, the company will earn money by keeping a 3 percent share of the money upstarts raise, as well as an annual fee of 0.5 percent of the backers’ invested funds.

It’s far too early to tell whether any of this will work. But several of the early upstarts say the program has already freed them to pursue projects that would otherwise have been out of reach.

Omri Mor, a 2012 graduate of the University of Washington’s Foster Business School, says he had $182 left in his bank account when he was named an upstart last year. Before that, he’d been having trouble putting decent food on the table, let alone paying the team at his Seattle-based startup, Ziibra.

“Upstart helped me take care of my living costs, helped me bootstrap Ziibra, got us to the point where we got into an incubator, and got me to the point where I can start eating nutritiously,” Mor says.

I’ve known Mor for a while—he was a social media intern for Xconomy back in 2011. When I reached him to talk about Upstart, he was at the South by Southwest conference in Austin, recruiting people to join Ziibra, which lets fans support artists directly by paying them a subscription of $10 to $200 per year. (Unlike Upstart investors, though, fans on Ziibra don’t get an equity stake in the artists they back—instead they get exclusive access to prereleases. Mor calls it “Kickstarter for careers.”)

That’s exactly the kind of thing Girouard hopes the upstarts will try with the money they raise, which averages around $50,000. “If they are an entrepreneur and they need living expenses to get off the ground, which is one of the primary use cases, then that is a good amount for a year, assuming they don’t do anything too crazy,” Girouard says. The other primary use case: retiring student debt.

Girouard says the idea for Upstart first hit him when he was still at Google, running the team of more than 1,000 people behind Google Apps (i.e., the enterprise versions of tools like Gmail, Calendar, Drive, Docs, Sheets, and Slides). Google gets so many job applications—about 75,000 arrived in one record week in 2011—that it has had to develop software algorithms for predicting whether applicants will be a good fit inside the famously geeky, data-driven company.

“We can look at a 25-year-old and very quickly assess whether he or she would be successful at Google,” Girouard says. “My whole thesis was, if you could use the same algorithms to predict whether he or she would be successful beyond that, in the business world, that would be pretty useful.”

At first, Giroaurd wasn’t sure how to turn that insight into a business. Once you’d collected applicants’ resumés, academic transcripts, and credit scores, and ranked them according to their future success, how would you assign a value to that potential—and how would you create a marketplace where people starting their careers could actually raise money?

Girouard’s first idea was to build an auction-style site where applicants would build personal profiles and let investors decide how much they were worth. Then he met Paul Gu, who had stopped out of Yale’s computer science and economics departments to join the inaugural group of Thiel Fellows in 2011. After Gu’s project to build a local-commerce startup had petered out, he had begun playing around with regression models for predicting people’s income, with the idea of starting some kind of investment vehicle. “He said he wanted to create a new financial instrument that was more like equity than debt, based on what somebody earns,” Girouard recalls. “I said, ‘Wow, come out and join me.’”

He did, and Gu’s regression models grew into Upstart’s pricing engine. The software looks at the data submitted by approved candidates (the program accepts less than 10 percent of all applicants, Girouard says) and calculates how much they can raise for each percentage point of their future income. It’s then up to the applicants how much of their income to commit.

On the high end, for example, Upstart’s engine might look at a student graduating from a top business school and decide that he or she is worth $20,000 per 1 percent. If that person decided to share 7 percent of their future income—the maximum amount—then they’d be allowed to raise up to $140,000 through Upstart. The smallest Upstart packages are for $10,000 (below that, it’s not worth the management expense, Girouard says) and the largest so far was for $170,000.

The next part of the process is reminiscent of Kickstarter and other crowdfunding platforms. Applicants post their profiles on Upstart’s site, often including videos and other supporting materials. Potential backers can browse the profiles and decide whom to fund, and for how much. If applicants hit their funding goal, they get the cash and become official upstarts.

The first payments are due almost immediately—starting the January after they get the money—and continue for 10 years. Upstarts who earn less than $30,000 in a given year don’t have to pay, but that year gets tacked on to the other end of their term, for a maximum of five extra years.

There are provisions that spare upstarts from owing extravagant amounts of money, should they hit it truly big. For the first group of applicants brought into the program in 2012, payments were capped at a 15 percent internal rate of return. To simplify the math, Upstart recently changed that rule, capping returns at 5 times the amount raised. (For example, say that an upstart raises $70,000, at $10,000 per 1 percent of her income, and she later makes $10 million on the sale of her first company. She’d still owe no more than $350,000.)

While Girouard certainly hopes there will be some home runs like this among the upstarts, he says “we are a singles and doubles business.” For investors, Upstart is designed to have a return of roughly 8 or 9 percent—slightly below that of the U.S. equities market.

“A very small fraction of our people are going to make zero dollars. Most people are going to pay back reasonably well. And a few people are going to pay back really well,” Girouard sums up. “Our notion is that if you invest not in one person, but in a portfolio of people, you can generate a good return. And in our world you are not necessarily a passive investor, as if you were putting $1,000 into IBM and hoping for the best. You can actively participate and help the person do well.”

In fact, the funded participants I talked to said that the network to which they’ve been admitted as upstarts is at least as valuable as the money itself. Mor, of Ziibra, says his Upstart connections helped him get his startup into Boost, a San Mateo, CA-based incubator funded by the Draper family. “I needed the money, but you can get money anywhere,” Mor says. “You can’t find people to give you advice—that’s much harder.”

Upstart Brandon Chicotsky, founder of BaldLogo.com

Upstart Brandon Chicotsky, founder of BaldLogo.com

Brandon Chicotsky, an upstart educated at UT-Austin and NYU, is the founder of an “animate social marketing” business, BaldLogo.com, that offers advertisers the chance to emblazon their logos on the heads of bald men like himself. He’s using the $15,000 he raised on Upstart to wipe out half of his student debt, and says his backers have helped him review pitch decks and sent offers of future business partnerships.

“Backers are seeking energetic and bright workhorses in the startup environment,” Chicotsky says. “That’s what I am. I’m excited by the opportunities my new mentors have for me.” Which touches on another interesting point: If you’re an investor, there may be no earlier way to get an early look at tomorrow’s hot startup founders than to invest in them just as they’re leaving school.

But if you were able to subtract the network effects, would getting funded on Upstart still pencil out as a good deal for the upstarts? It’s hard to say. Chicotsky says that by paying off student debt, he has “basically traded one interest rate for a better one.” But he won’t know that for sure until 2022, since the total amount he ends up paying to his Upstart backers over the next decade will depend on the success of BaldLogo and his other future ventures.

In an interview, I put it to Girouard that a jaded observer might look at the Upstart model and think of a very old parallel: indentured servitude. If you remember your history, that was a system under which hundreds of thousands of young workers—mostly males under 21 from England and Germany, with dreams of starting their own farms or businesses—got free passage to the American colonies in return for several years of labor.

Girouard, naturally, bridled at this comparison, calling it “completely upside down in terms of the logic.”

“If you think about having a fixed-rate loan that requires you to have a job at all times so that you are capable of repaying, that is the definition of servitude,” Girouard says. “Ours is the opposite. You have the freedom to do what you want, and you merely share some of the upside or the downside with other parties.”

The fact remains that the upstarts are responsible to their backers—if not as servants, then as investment vehicles. But the same thing is true, roughly, of startup founders who sell equity to venture or angel investors. Which bears out Upstart’s tag line: “The startup is you.”

The leap Upstart is taking is smaller than it would have been if predecessors like Kickstarter, Lending Club, and Kiva hadn’t paved the way in the world of creative financing, Girouard says. Still, the idea is “very new and different, and it takes startups like us to prove the concept,” he says. “We don’t have a lot of track record. But the backers in our early stages believe in the model, and they have an interest in helping these young adults do awesome things.”

Here’s a video produced by Upstart.

Wade Roush is Xconomy's chief correspondent and editor of Xconomy San Francisco. You can subscribe to his Google Group or e-mail him at wroush@xconomy.com. Follow @wroush

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  • http://twitter.com/sardire Steve Ardire

    Yeah Indentured Servant 2.0 business model !

    • http://www.facebook.com/jarrod.wageman.7 Jarrod Wageman

      No shit. I read this part “In return, these “upstarts” agree to pay backers a slice of their future income—up to 7 percent per year for 10 years.”

      So, if the “venture” fails, the entrepreneur and co-founders have to payback 7% of income for the next 10 years?

      That is an investment I would not take.

      A smart idea on part of the founders of the Upstart fund though in my opinion. I wonder how many would default on their payback obligation after they go broke trying to keep their company afloat.

      Yeah, yeah. Haters gonna hate.

  • http://twitter.com/shuimaojin shuimaojin

    Bald logo – great – hope more inspired young leaders are supported in their dreams

  • Jimdandy

    Indentured servant 2.0 is right.

    • jj the jj

      Especially when failure rate (even with mentor support) still exceeds success. And furthering the individuals odebt. Seems opportunistic (and unethical) on Girouard’s part.

  • http://www.facebook.com/john.j.adams.986 John J. Adams

    The one problem I see even in my own city is too much support for young entrepreneurs and too little for middle aged or older ones that have been there, failed been there again, fail, and now are there and are profiting but cannot find support to get to the next level because many investor resources are focused on that young/startup segment. The government only helps that segment. It is actually a very strange thing to me. I think I would prefer to put my money and resources into a growing business than a total unknown and untested and most importantly no-experience entrepreneur.

    • http://www.facebook.com/shannon.gass Shannon Gass

      Thank you. The first comment I felt needed to be made, has been. As a middle aged person, I can attest that life opportunities are often wasted on the youth, and the approach of only rewarding 20somethings with the right “credentials” begs the question of why do we fail to reward talent. Ah, that’s right, it’s not about talent, but about the newest sort of actuarial table, eh? Betting on future earnings… do you have a formula for children, yet?

  • http://www.socialbakers.com/ Michal Smetana

    “Venture capitalists have long said, ‘We invest in people, not ideas or businesses.’ Well, not really. We are the first people really doing it.” The first part of this statement is so much true. Venture capitalists always say that they invest in people, but in reality they invest just in the ideas these people come up with. Lets see, how this one will turn out.