An alternate history according to Elon MuskThe appearance of Elon Musk in the hall of fame on Sequoia Capital's website, and rapid disappearance, gave us the excuse to write about the colorful entrepreneur. The South African entrepreneur is now off the Silicon Valley scene, devoting himself to a grandiose mission to colonize space. But he was one of the iconic figures of the last internet boom, selling Zip2 and plunging straight into a new venture which he cannily merged with Paypal. Even his failures were successes. Musk, who has a liking for fast cars as well as fast spaceships, was too good a target to miss. In a 2,256-word response to the Valleywag items, after the jump, Musk explains how he stayed friends with the Paypal crew — even after Peter Thiel, one of the founders, funded a hostile account of the company's history. "Peter sounds like Mel Gibson in Braveheart and my role is somewhere between negligible and a bad seed." For more:
ELON MUSK — There were some pretty brutal pieces on Valleywag recently. I don't mind taking it on the chin if the criticisms are true, but most of them are either inaccurate or unfair.

First, it is worth saying that there is no significant rivalry or animosity that I'm aware of today between myself and Peter Thiel or Max Levchin. After PayPal was sold to eBay, the three of us co-invested in and serve on the board of Room 9, David Sacks's production company, which released "Thank You for Smoking" and will be making another satire this year on the modern art world. I'm also an investor in Peter's hedge fund, he and I have shared many a meal since I left the CEO role at PayPal, he has stopped by to visit me in LA and he expressed an interest in investing in SpaceX (we are not yet taking any outside investment) when we had dinner last year at the TYFS premiere.

The only negativity in recent years was due to a book called The PayPal Wars, written by a sycophantic jackass called Eric Jackson. This guy was one notch above an intern at PayPal in the first few years of the company, but gives the impression he was a key player and privy to all the high level discussions. Eric couldn't find a real publisher, so Peter funded Eric to self-publish the book. Since Eric worships Peter, the outcome was obvious - Peter sounds like Mel Gibson in Braveheart and my role is somewhere between negligible and a bad seed. However, to his credit, Peter didn't realize the book would be as bad as it was and apologized to me personally at a Room 9 board meeting at David Sacks's home in LA.

Regarding my first company, Zip2 was sold for about $300M, not $400M as you state in I'm don't know on what basis you conclude it was worthless. Zip2 counted the NY Times, Knight-Ridder, Hearst and other media companies as both investors and major customers for its Internet software & services, and would have gone public if not for the acquisition. After Compaq bought my company, it was merged with Altavista and the combined entity was rather poorly managed by execs whose main background was making PCs in Texas, but Zip2 was certainly valuable when it was sold.

As far as who deserves co-founder credit for PayPal, let me throw out a few reasons why it is probably fair to consider me for such (without detracting from Max and Peter's similar status):

1. I came up with the company's main viral growth mechanism, as David Sacks (PayPal Chief Operating Officer until the sale to eBay) plainly stated to the LA Times (ref. 1). There were other growth mechanisms, such as Max's automatic buying system on eBay, where he wrote an auction crawler that offered to buy things on eBay only if you accepted PayPal, but my viral email/incentive mechanism was the primary driver of growth.
2. The business model of charging fees only to heavy sellers and not to buyers or light sellers, while still being able to make a profit, was developed by myself and other executives. See details below.
3. A large percentage of the critical executives and other personnel came from X, including:

* Roelof Botha, who did a great job managing the finances and internal cost structure and took PayPal through a very difficult public offering as CFO. Now at Sequoia, Roelof was the partner who funded YouTube.
* Amy Rowe Klement, who ran the whole product group at PayPal until 2006.
* Julie Anderson Ankenbrandt and Sal Giambanco (still VP of HR at PayPal), who managed to build a huge customer service and fraud investigation group in Omaha, going from nothing to hundreds of personnel in the summer of 2000, when I was still CEO. Without them, PayPal would have melted down in a sea fraud and consumer lawsuits.
* Sanjay Bhargava, a former Citibank exec, who figured out the world's first low cost method of authenticating terrestrial bank accounts, which was critical to making the PayPal business model work.
* Jeremy Stoppelman, who served as VP of Engineering for PayPal until summer of 2003, went to Harvard Bus School, and then co-founded Yelp.

4. When X reached agreement to acquire/merge with Confinity, it had more personnel, more user accounts and a faster growth rate than Confinity (although it should be said that Confinity had more eBay users). Peter Thiel is a smart guy and would never have agreed to merge if X was just some lame Internet bank. Mike Moritz was not some Svengali.
5. I was CEO or Chairman of X/PayPal from Jan of 1999 to Oct 2000, just over half of the combined company's three and a half year existence before we agreed to sell to eBay in June of 2002, and was on the board of directors the entire time. I ran the combined company from April 2000 to Oct 2000 or about seven months. It was during this time that X/PayPal (the company was still called X until 2001) established itself as the leading email payments company through an aggressive viral growth system, figured out its business model, scaled from about 60 employees to several hundred, built the customer service & fraud center, added debit card & money market funds and laid the groundwork for multi-country, multi-currency capability.
6. By the time Peter became CEO of X/PayPal at the end of Oct 2000, the PayPal product and business model were largely as you know them today. Peter did a great job managing the company, particularly in controlling the level of fraud, for another year and a half until we reached an agreement to sell PayPal to eBay, but neither the business model nor the end product saw major changes over that period.
7. When PayPal was sold to eBay, I was the largest shareholder by a significant margin. Nobody gives away shares for free, so this is a reasonably objective indicator of contribution.

Taking the above points into account, if:
Founding the company that constituted half the post-merger equity and more than half the employees of the company that became what is known today as PayPal
Coming up with the business model & main customer growth mechanism
Hiring the people who served as CFO, VP product management, VP engineering, customer service, HR (etc) in the combined company
Running X/PayPal for the formative first half of its existence and being on the board the entire time
Being the largest shareholder when all was said and done
are not good tests for deserving co-founder status, then what are good tests?

Provided I've not bored you silly at this point, let's drill further into the background of PayPal, X and Confinity:

PayPal, Inc., as people know it today, is not the company founded by Max and Peter. It was effectively created in Feb 2000 (formally consummated in March) when X, founded by me, acquired/merged with Confinity, founded by Max and Peter. The resulting corporate entity was still called X until 2001, when the board decided to sync up the name of the company with the name of the product.

Confinity was started in Dec 1998 as a Palm pilot cryptography company (crypto is one of Max's many skills) and Max came up with an application for the crypto that involved beaming money tokens from one Palm Pilot to another via the infrared port. The website where those payments could be reconciled and transferred to your bank account, which only went live to the public in Nov 1999, was, but it was a far cry from the system you are familiar with today.

When I started X in Jan 1999 (formally incorporated in March 1999), the initial idea was to bring together a broad set of financial services in one seamless interface and then add special functionality, such as the ability to transfer money or securities instantly between account holders. However, when I showed the system to potential investors and beta customers, everyone was a lot more interested in email payments and not in the other stuff, so well before I had any idea what Confinity was doing, X shifted to an email payments focus.

That was the reason X and Confinity wanted to join forces. You say that X was a failed bank, but when did it even have time to fail, bank or no? Both the X and Confinity websites only went live in the last few months of 1999 and the first merger discussions started in Dec 1999.

Despite the shift to email payments in mid 1999, Mike Moritz asked that we talk to the press as though X was doing a bank. He was trying to avoid having other VCs fund email payments companies just because Sequoia was doing so, which I think made sense, but has resulted in a lingering misperception. This strategy is actually recorded in the X board minutes.

In addition to the email payments functionality, it is true that X did offer bank accounts through one partner (First Western National) and money market funds through another partner (Barclays Global), however X was never itself a bank. Although the banking partnership ended, PayPal still offers the money market fund (among the highest returning in the country) and the debit card (1% cashback!) that I put in place. These play an important role in encouraging customers to keep money in the system by offering a better return than most savings accounts and allowing easy access to the cash at real world stores. It may seem counter-intuitive, but the easier it is to access money conveniently from the PayPal system, the more willing people are to leave money in PayPal, rather than transfer it to their bank account.

As explained further down, getting people to keep money in the system has a big impact on PayPal's cost structure and is one of the fundamental reasons why PayPal succeeded when other email payments companies did not. Certainly, the idea of transferring money by entering an email address was originated by neither X nor Confinity. Billpoint (acquired by eBay in 1999) and Danny Shader's Accept (acquired by Amazon in 1999) were both there almost a year earlier. There were also many well funded competitors along the way, such as Citigroup, who spent hundreds of millions on their c2it email payment service, including exclusive distribution deals with MSN and AOL. There was BancOne's emoneymail, Yahoo's PayDirect, Western Union's BidPay, etc.

A vital competitive advantage over time was that PayPal had significantly lower transaction fees (Amex's high fees are the main reason that many merchants still refuse to accept that card). In order to achieve the lowest transaction fees for sellers, it is critical to minimize the amount of money that enters PayPal via credit card. PayPal is forced to pay almost 2% to VISA/MasterCard for a credit card transfer plus pay for any fraud or chargebacks, which adds about 1%, all things considered. On top of that, PayPal has to charge its own fee to pay for customer service, engineering, server operations and overhead. Add it all up and you are at 4% to 5% on transactions, which is not competitive with a merchant simply accepting credit cards directly.

The original business model of Confinity where the company would charge no fees and make money on interest (ref. 2) turned out to be broken, generating miniscule revenue. If you don't offer a competitive interest rate, customers quickly transfer their PayPal funds to their bank account. If you do offer a competitive interest rate, you can make at most about 1%/year net. Compare earning 1% over the course of a year vs. making 1% instantly when the transaction occurs. The difference is orders of magnitude.

The other part of the secret behind PayPal's much lower fee structure was having a low cost way to authenticate a customer's bank account, so that we could pull money into our system for a few cents per transaction (like writing a virtual check). To the best of my knowledge, PayPal is the only company that figured out how to do this. The credit for this idea is due to Sanjay Bhargava, a former Citibank exec that I hired into X in late 1999 and who was referred to me by Mike Moritz.

Sanjay came up with the idea of making two random deposits of less than a dollar into a customer's regular bank account, creating a four digit password that a user could enter into PayPal to authenticate that bank account. We biased the random amounts toward the low end, so it cost us less than 50 cents per authenticated account. As soon as a user authenticated, the system would default to paying by electronic check, which cost PayPal pennies per transaction vs. around 3% (incl. fraud/chargebacks) for a credit card payment.

In light of the above, now look at the PayPal fee structure of 1.9% to 2.9% per transaction. The company obviously makes no money on credit cards transactions! Almost all the profit comes from payments funded from customer balances funds or from bank account transactions, which have close to zero cost. Both of these methods, i.e. PayPal's fundamental business model, came from X. Even the fee structure itself, where business/heavy users are charged, but consumer/light users are not, was developed and implemented by me and David Sacks in the summer of 2000, when I was CEO of PayPal.