You Only Have to Be Right Once (15 page)

But with growth came server bills. While Spiegel helped cover some of them with money from his grandfather, Murphy had to fork over half his paycheck. As monthly expenses approached $5,000, the guys needed a bailout.

Lightspeed Venture Partners' Jeremy Liew came to the rescue. His partner's daughter relayed how Snapchat had become as popular as Instagram and Angry Birds at her Silicon Valley high school. But Spiegel and Murphy proved difficult to track down; their website had no contact information, and no one was listed on the company's LinkedIn page. Liew finally did a “Whois” lookup to find the owner of the Web domain, linked the obscure LLC that it was registered under to Spiegel and eventually tracked him down via Facebook. “His profile picture was with Obama,” shrugged Spiegel. “So I thought he seemed legit.”

In April 2012, Lightspeed put in $485,000 at a valuation of $4.25 million. “That was the greatest feeling of all time,” said Spiegel. “There is nothing that will replace that.” On the day the money went through, he sat in a machine-shop class busily refreshing the Wells Fargo app on his iPhone. In a final homage to Zuckerberg, when the money appeared he walked up to the professor and dropped out of the class and Stanford, a few weeks from graduation.

• • •

SNAPCHAT HAS MOVED THREE
times since the initial investment, as the company grew, by early 2014, to a still-lean seventy employees. The latest offices, in a former art studio a block from the Venice boardwalk, are appropriately anonymous, with just a small ghost logo to identify it. Most of the development that has made it a viral sensation, however, took place in 2012, when the company was headquartered at Spiegel's dad's house. “He convinced us to drop out of Stanford and move down to L.A. over the course of a single conversation,” said Daniel Smith, who was hired along with Kravitz.

The team worked around the clock, sleeping where they worked. (Smith lived in Spiegel's sister's room, with enough girlish orange and pink polka dots, Spiegel remembers, “to give you an anxiety attack.”) “Bobby had a habit of pushing code changes and then going to sleep,” said Spiegel, who then found himself on debugging duty. “I'd wake up in the morning and go, ‘Oh my God!'” Added Murphy: “I still have nightmares about him stomping down the stairs.”

The arrangement proved oddly effective. Said Lightspeed's Liew: “They can call bullshit on each other, which makes their ideas better.” What emerged was an app that, rather than a tool for the likes of Facebook, can potentially challenge it. By both luck and design, Snapchat addresses three red flags for Facebook. First, it's more intimate and exclusive. Just as Facebook took the anonymous Internet and boiled it down to real people you knew, Snapchat narrows your world from Facebook “friends,” which range from long-forgotten schoolmates to nagging aunts, to your network of phone contacts. People, in other words, you actually talk to.

Second, it's perceived as young and cool. Most teens can probably find a grandparent on Facebook. Snapchat's mobile-first roots give it credibility with the app generation, who increasingly view PCs the way their parents viewed black-and-white televisions.

And in the age of Snowden, parental Facebook monitoring, and “revenge porn” (exes who publicly post nude pictures of former lovers), the self-destruction feature has become increasingly resonant. “This isn't a silly little messaging app,” insisted Liew. “It allows people to revert back to a time when they never had to worry about self-censorship.”

An entire subindustry—so-called ephemeral, or temporary, social media—has emerged behind it. Besides Poke (which has largely faded), there's Clipchat (a Snapchat/Twitter hybrid), Wickr (disappearing texts), and dozens of other apps pushing the boundaries of digital communication back toward what a telephone call used to be—a way to communicate with little risk it will come back to bite you.

All of them, however, are stuck chasing Spiegel and Murphy, who have evolved Snapchat into something fun and easy. (Though, in 2014, Snapchat agreed with federal regulators to stop overpromising, given several workarounds, that messages will surely disappear forever.) To view a snap, users hold a finger on their phone screens, a feature designed to make it still more difficult for people to photograph the image with another camera. Disappearing video is now an option. And while teens have embraced a medium unreachable by prying parents or future employers, grownups are catching on. All told, Snapchat users in early 2014 were sending 400 million photos and videos each day, matching the daily uploads to Facebook and Instagram combined.

“We certainly didn't invest in this to flip it,” said Mitch Lasky, a Snapchat board member and partner at venture capital firm Benchmark Capital, which led Snapchat's $13.5 million fundraising round in 2013 (they also raised $60 million from Institutional Venture Partners)—and invested in Twitter way back in 2009.

• • •

AMID THE ASTOUNDING GROWTH,
valuations, and talk of an independent future, one key ingredient is missing: revenue. Asia offers a possible blueprint. There, a handful of wildly popular mobile messaging services upsell users with in-app purchases. Spiegel's party line, when discussing revenue, feels as if it's read from a script: “In-app transactions followed by advertising, that's the plan we're sticking to.”

Drilling down through some of the companies that Spiegel cites raises more questions than answers. China's WeChat, a massive messaging app owned by the Chinese Internet behemoth Tencent, encourages users to subscribe to celebrity greetings and to purchase physical goods. But it's mostly a texting app, and the messages don't disappear. Korea's KakaoTalk and Japan's Line make most of their money via mobile games, which don't seem a natural fit with Snapchat. And, of course, digital goods, like premium sticker packages, emoticons, and animations, are also moneymakers in Asia, though Spiegel seems to disapprove. “It'll make sense in a Snapchat way,” he said. “But it will not be stickers.”

Advertising is similarly tricky. Snapchat's core strengths in gaining users (your privacy is protected and your images disappear!) cripple the targeted advertising that most social media companies rely on (Snapchat knows little more than e-mail, age, phone number—plus your ads disappear!).

But it has one advantage that virtually no other digital advertiser can claim: guaranteed engagement. Users must keep their fingers on a photo or video to view it—and that applies to any ads thrown their way. Snapchat can tell advertisers with absolute certainty whether their ads were viewed, a rare data point in the metric-driven world of digital advertising.

Like Facebook, the company can also charge businesses for setting up branded accounts. Acura, Taco Bell, and the New Orleans Saints have already used the app to debut new products and show behind-the-scenes footage. The company's Stories feature, which lets users display a compilation of snaps taken over the last twenty-four hours, is useful for brands looking to tell a longer story. Example: Online retailer Karmaloop used the feature to show clips of posing models sprinkled with discount codes and new items. Others, like frozen yogurt chain 16 Handles, have experimented with “exploding coupons.”

Spiegel and Murphy, slow in their college days to adapt to emerging platforms, also seem keen to not make that mistake again. In September 2013, for example, Snapchat debuted on the Samsung Galaxy Gear smartwatch. “People haven't thought about use cases on new computing platforms,” said Thomas Laffont, managing director of Coatue, the hedge fund that provided the latest $50 million infusion. “In one tap you take a photo, one more and you can share it. Imagine [the difficulty] trying to post on Instagram from a Google Glass device.”

Ah, Instagram. Zuckerberg's Poke might be languishing, but he still has the last billion-dollar app to come out of Stanford. Kevin Systrom's $1 billion sale in 2013, in fact, is often held up as the reason Snapchat was right to turn down Facebook's preemptive billions. (Instagram would likely be worth as much as ten times more now.) Zuck is going after Snapchat again with a tweak to Instagram—Instagram Direct, a Snapchat knock-off with a key difference: The images don't vanish unless users go in and delete them.

Spiegel and Murphy have another headache: Brown's lawsuit, which asks for one-third of the company plus punitive damages. “It's definitely over a billion dollars we're seeking,” said Luan Tran, one of Brown's three lawyers. Insiders say Snapchat is eager to try the case, but videos of depositions, presumably leaked by Brown's team, show Spiegel and Murphy far more equivocal and forgetful than their opponent. “I'm just hoping it gets resolved so it doesn't prove to be a distraction,” said Benchmark's Lasky.

The proverbial “adults” have been brought in, including Philippe Browning, the vice president of monetization, nabbed from CBS, and COO Emily White, poached from the business division of, yes, Instagram. But, tellingly, the company prevented
Forbes
from interviewing either of them.

So for now the doubters carry the day. “There's an almost ritual incantation when these things reach 50 million daily active users and people say, ‘Well they're not making any revenue,'” said Lasky. “It's unfair to expect these things to generate revenue while growing so quickly.” To his point, the same was said about Twitter and Facebook. But it was also intoned by the dot-com oracles on the eve of catastrophe fifteen years ago. Will Snapchat wilt like MySpace, get out at a peak valuation the way Mark Cuban sold Broadcast.com, or prove to be the next great social media IPO? We should get our answer by 2016, just in time for Spiegel to turn the ripe old age of twenty-five.

Palmer Luckey, Oculus VR: Virtual Reality, Tangible Fortune

When
Forbes
magazine highlighted Palmer Luckey, a twenty-one-year-old video game tinkerer, on our annual “30 Under 30” list in January 2014, many readers chuckled. Barely old enough to drink, Luckey had a company with no revenues, not even a commercial product—just a prototype with a bizarre name, Oculus Rift. Less than three months later, however, no one was laughing. Mark Zuckerberg ponied up $2 billion in cash and stock to bring Oculus—or more specifically, Luckey's virtual reality headset—into the Facebook fold. But what makes Luckey's score so revolutionary isn't his precocious age or even the potential that “the Rift” holds to change how we view the world. Instead, as David M. Ewalt deftly shows, it's how he was able to create incredible value by enhancing the work of others, without paying them for it, and then crowdfund it through the wallets of others, without giving up any equity. The age of open-source entrepreneurship is upon us.

 

I
t's dark and creepy in the cargo hold of the
Sevastopol
; something could be hiding in here, and I'd never know it. As I walk between the piles of crates, I stop and peek around every corner. A noise makes my heart skip a beat. I tell myself it was just dripping water.

I shouldn't have been scared, since I knew this is just a video game—a demo of
Alien: Isolation
, an upcoming horror-adventure based on the decades-old movie. But I was also wearing a virtual reality headset called the Oculus Rift, and the Rift makes it real: The game filled my entire field of vision—when I turned my head to look around, the world moved with me. It felt like I was actually on a space station being stalked by one of those same creatures that stalked Sigourney Weaver. And that wasn't a good feeling.

There was another sound, and I turned to see a heavy blast door slide open at the end of a corridor. Behind it, there was a crouching, bipedal form, the size of a large man, covered in a shiny black exoskeleton. I stared, frozen, as the alien rose, closed the gap between us, and wrapped its arms around my body. Its dripping mouth opened, and inner jaws plunged toward my face.

An involuntary squeal of panic emitted from my mouth. From behind me—this time in the real world—I heard a laugh. Palmer Luckey, the twenty-one-year-old creator of the Oculus Rift, had been watching as I played. “You got eaten?” he chortled. “You didn't last very long.”

Luckey had been preparing for a game like this since he was a kid—which wasn't that long ago. He started making virtual reality headsets when he was sixteen. At nineteen, he founded his company, Oculus VR. And now, finally old enough to drink, he sold this company for $2 billion to Facebook, despite the fact that his start-up had no revenue at the time, or even a commercial product. Instead, Zuckerberg ponied up that number, one as fantastical as the alien that had devoured me, for a simple reason: He believed that Luckey was on the verge of doing what generations of technologists before him tried and failed—bring virtual reality to the masses.

• • •

THE PATH TO THIS
new world began in the setting of so many modern success stories, which has almost become a cliché: a California garage. But Palmer Luckey wasn't a striving Stanford graduate or dot-com refugee; he was an obsessed teenager, eldest of four children, the homeschooled son of a Long Beach car salesman and a stay-at-home mom, and he spent every spare minute with either video games (
Chrono Trigger
and
GoldenEye 64
were among his favorites) or science fiction (particularly high-tech fantasies like
The Matrix
and
The Lawnmower Man
.) These passions both led him to the same place. “Virtual reality is in so much science fiction, across a wide variety of stories, that even if you're not particularly interested in VR, if you're a sci-fi enthusiast you end up learning a lot about it,” said Luckey. “That's what happened. I grew up my whole life thinking virtual reality was very cool, and I thought that it must exist in secret military labs somewhere.”

The idea for immersive computer displays emerged in the 1960s. Early VR prototypes were primitive, bulky, and hugely expensive, built mainly for government and military applications like air force flight simulators. In the 1980s, the personal computer boom raised hopes for smaller, more consumer friendly headsets, and inspired new art that romanticized virtual worlds: Consumer interest in the technology took off after William Gibson's 1984 novel
Neuromancer
, and peaked when nearly a dozen related films (including
Johnny Mnemonic
,
Virtuosity
, and
Strange Days
) were released in 1995.

But while the movies sold tickets, the products went nowhere. Sometimes, excessive costs killed them in their infancy: In the early 1990s, Hasbro spent $59 million and more than three years developing a console and headset called the Home Virtual Reality System, before abandoning the project. CFO John O'Neill told the Associated Press that the gadget's $300 price tag would have priced it out of the consumer market.

More often, VR was doomed by technical problems. In 1996, Nintendo released a $180 video game console called the Virtual Boy, but its promise of three-dimensional graphics fell flat. The headset's red monochrome display, low resolution, and use of high-speed vibrating mirrors gave its users neck pains, dizziness, nausea, and headaches. Nintendo sold less than 800,000 units and discontinued the product after a year.

The teenage Luckey went hunting for evidence of this arcane technology. He scoured eBay sales for outdated and abandoned bits of VR hardware, and slowly amassed an impressive collection; in one score, he bought a $97,000 headset for only $87. To fund his efforts, he taught himself basic electronics, and made $30,000 by buying broken iPhones, repairing them, and flipping them for a profit.

From these failures, Luckey hacked something new. “I was modifying existing gear really heavily, using new lenses, trying to swap lenses from one system into another,” said Luckey. “I built some shitty stuff.”

With time, his work improved. In 2009—when he was only seventeen—Luckey started building the PR1, or Prototype One. “The entire optical system was all custom for that head-mounted display,” he said. Meanwhile, college beckoned, and the homeschooler stayed close to home—Cal State, Long Beach, studying journalism, of all things. (“I wanted to be a tech journalist who understood how the technology worked.”)

He kept working on VR systems in his free time, and in the summer of 2011 landed a part-time job working with virtual reality pioneer Mark Bolas at his lab in the Institute for Creative Technologies at the University of Southern California. “Without Mark, there would be no Oculus,” said Jaron Lanier, a computer scientist who popularized the term “virtual reality.” Bolas and his students had spent years refining hardware and software for VR headsets, and all their innovations were open-source; Luckey absorbed their wisdom and their technology, and quickly applied them to his own work.

In April 2012, nineteen-year-old Palmer Luckey completed the sixth prototype of his home-brewed VR rig. He named it after the gap he hoped it would bridge between the real world and the virtual: the Rift.

• • •

PALMER LUCKEY'S PRODIGIOUS SUCCESS
could not have happened even a generation before. The open-source head start allowed him to begin his quest on second or even third base, for free, without legally owing anyone a penny. He then harnessed the hive to hone his thinking, collaborating in discussion groups like the forums of a website called MTBS3D, or “Meant to Be Seen in 3D.” Each of his six prototypes was constructed with help from these online enthusiasts, and in turn, Luckey frequently helped solve technical problems for other members of the crew.

At least one of those forum members was no ordinary hobbyist. John Carmack made his first splash in the video game business when he cofounded id Software in 1991; over the following decade, he cemented a legendary reputation working as lead programmer on games including
Quake
and
Doom
. In April 2012, he posted for help modifying a Sony head-mounted display. Remembered Luckey: “We had a public discussion about why it would be very difficult to do . . . and then a couple weeks later, he contacted me in a private message and asked if he could buy or borrow one of my prototypes.”

Luckey shipped out one of his Rifts. Two months later, at the annual E3 video game industry expo in Los Angeles, Carmack demoed a version of
Doom 3
on the hardware, and sung the rig's praises to anyone who would listen. Word of Luckey's gadget spread quickly. Brendan Iribe, then chief product officer at game-streaming company Gaikai, met him for a demo, and was so impressed he offered an investment on the spot. In July 2012, with a few hundred thousand dollars of Iribe's money as seed capital, Oculus VR was born.

The crowdsourcing, however, was just beginning. On August 1, 2012, Luckey launched a campaign to raise funds so he could build a new prototype and put it in the hands of software developers. He chose Kickstarter, a site that helps people fund passion projects—documentaries, invention prototypes, or whatnot. Donors at the time were banned from getting equity stakes, due to securities laws (the JOBS Act loosened up crowdfunding rules in 2013)—instead, they usually got anything from a T-shirt to the product they were helping to develop.

“If I'm an investor, what are the odds that I'm going to want to invest in this product, no matter how cool it seems, when there's such a precedent for virtual reality failing horribly?” Luckey said. “I think it would have been very hard to get any other investments . . . but with Kickstarter, you don't have people who are looking to make a large financial return; you have people who just want the thing you're making.”

Under the terms of the fund-raiser, anyone who was paid at least $300 could receive their own Rift prototype, which they could use to start making software for the platform. Luckey knew there would be strong demand from VR enthusiasts, but was worried that community wasn't very big, so he set the campaign's goal at a relatively modest $250,000.

Once the public saw the Rift in action—and heard testimonials from video game luminaries like John Carmack, Valve cofounder Gabe Newell, and Epic Games design director Cliff Bleszinski—Luckey's fears melted away. The Kickstarter leapt past the $250,000 mark in less than two hours.

During the first day of the fund-raiser, Luckey was in Dallas, Texas, at the annual QuakeCon gaming convention, running demos of the Rift for interested players. “We were probably the smallest booth at the whole show,” said Luckey. “We didn't have any signage, just a black table. And we had a line that was over two hours long the entire weekend. That's when I realized, ‘Oh man, this is gonna be huge. Ordinary people are interested in virtual reality, not just us crazy sci-fi nerds.'”

As the Kickstarter boomed—after thirty days, it topped out at $2.4 million, from 9,522 backers—it became clear that Oculus VR was going to have legs as a company. And Luckey, unlike other wunderkinds, saw his limitations as an executive. His seed investor, Brendan Iribe, became CEO. Shortly after, John Carmack left a post at ZeniMax Media to become CTO. Luckey's title would simply be “founder,” and he would continue in a grander, more general role, as the face of virtual reality.

• • •

THE KICKSTARTER HOME RUN
provided more than just a war chest (and one that didn't carry any dilution, other than being on the hook for hundreds of prototypes). It turned Luckey, and Oculus, into video game world superstars.
At events like South by Southwest and the Game Developers Conference, attendees continued to stand in line for hours to get demos of the Rift.

Venture capitalists started lining up, too. In June 2013, Oculus closed a $16 million Series A funding round co-led by Spark Capital and Matrix Partners, with participation from Founders Fund and Formation 8. The pre-money valuation was $30 million. Six months later, Andreessen Horowitz led a $75 million Series B, with additional capital from all four original firms at a valuation likely in the $300 million range.

“The dream of VR had been around so long that most people in the technology community had given up on it,” says Chris Dixon, a partner at Andreessen Horowitz. “When we first met Palmer, we saw he not only continued to believe in the dream but also understood how to put all the key underlying technologies together to make it a reality.”

Valuing a twenty-one-year-old's prototype headset at $300 million struck many as euphoric. Within weeks, though, it was proven to be a genius investment. Facebook's Mark Zuckerberg had reached out to Luckey in his preferred fashion, via e-mail, a few months earlier. The older wunderkind and the younger bonded over technology and, yes, sci-fi, and eventually, Zuck came to the Oculus office to try the Rift.

“We started off talking to Zuckerberg because we wanted to show off our stuff,” said Luckey. “He's a big fan of virtual reality, and I think he believes in the same vision that we have, that everyone in the world is going to be exposed to VR.” Zuck in turn told Luckey and Iribe that they may have stumbled into the next generation of computing—an entirely new way for people to communicate, rather than just a new route to Facebook.

A month after that visit, the two teams spent a week hammering out a deal, which eventually totaled $2 billion, including $400 million in cash up front, Facebook stock to fill out the rest, and another $300 million in incentives. Luckey was enamored by the credibility Facebook could bring. “I have been a skeptic of Oculus,” said Michael Pachter, an analyst at Wedbush Securities, tellingly. “And then Facebook came along. Facebook is looking at the hardware as a platform to do other things than gaming—maybe instruction, teaching—and Facebook will get third parties to make content. Now Oculus can realize a broader strategy, with a big bank account behind them.”