Regardless of the merit of Google’s acquiring YouTube for $1.65 billion, and its valuations, one must not underestimate the power of guanxi amongst the silicon valley networks. The co-founders of YouTube had all worked together in engineering at PayPal, the online card payment system provider, which was later acquired by eBay. After PayPal was sold to eBay, the PayPal alumni stayed in touch with each other. Since leaving PayPal, they have helped each other out, finding them new contacts, introducing them to their personal networks, tapping into their start-up DNA pool and learning from their previous mistakes.

Like the original Fairchild, which spun out companies like Intel, AMD, National Semiconductor, Signetics (Philips-NXP), LSI Logic and Applied Materials, the PayPal alumni have also spun out quite a few companies. As an example, ex-PayPal executive Reid Hoffman started LinkedIn - a career industry networking site, with investment from the ex-CEO & co-founder of PayPal, Peter Thiel. Mr Thiel has also set up a hedge fund called Clarium Capital, which has purportedly reported generating $2.0 billon in net assets from a very low initial investment.

Dropping out of university can be habit forming
Jawed Karim had first gone to the University of Illinois, home to Marc Andersson of Netscape fame (who dropped out of college). Steve Chen, who had also studied at the University of Illinois, was hired by the co-founder of PayPal, Max Levchin, his ex-class mate. Jawed Karim didn’t want to hang around to finish his studies and dropped out of university to join his friends at PayPal. Chad Hurley, who had studied at the University of Pennsylvania, met the team when he joined PayPal.

While most people quit university to do start-ups, Jawed Karim, who is only 27, went the other way and went back to college to finish off his studies. He left PayPal after it was sold to eBay, cashing in some of shares and started a masters course at Stanford.

Connecting with the right VCs and partners
The original co-founders of YouTube all met at a PayPal alumni dinner, where Jawed Karim shared his problem of not being able to easily share the video that he had taken, with his pals Chad Hurley and Steve Chen. That is when YouTube was conceived. They started the company in Chad Hurley’s home, after which they were introduced to a VC fund via Roelof Botha, who is a partner at Sequoia Capital and also happened to be the ex-CFO of PayPal.

Of course it helps a great deal if your VC has all the right connections and influences. In contrast to most VC funds that look for experienced management teams, Sequoia backs new technologies and its use in totally unproven new sectors. Each of their investments have been different rather than following a single prescriptive formula, which sometimes pays off handsomely. They add value by cultivating and making use of their extensive network of contacts. This gives its portfolio companies a huge leg-up, especially in second-guessing the next big market waves.

Sequoia just happened to be one of the original VC investors in Google and no doubt they still have some influence there. Sequoia’s original R1 and R2 investment of $11.5 million within a six month period, assuming a conservative 30 percent stake, will give them a massive 50x return or near enough $0.5 billion.

Si Valley: a networking pedigree

Silicon Valley has an edge when it comes to networking and the start-up DNA pool. This has been built up over the decades, from numerous success stories as well as failures, which are an equally important form of learning curve. The other area in which it wins is the numerous formal and informal networking conduits, from which information, knowledge and skills are passed from one generation of entrepreneurs to the next. Of course it is a great help if your previous start-up has been successful and you can afford to take higher risks in new start-ups setting out in new untried technologies and in unexplored territories.

PayPal spin-outs include:

Room9 - an entertainment and film production company started by the ex-COO of PayPal David Sacks.

LinkedIn - a career-industry networking site started by Reid Hoffman, executive VP of PayPal.

Slide - a slide-show site started by Max Levchin, ex-CTO of PayPal.

Yelp - a user-driven consumer review site.

It helps to start young
Of course it helps if you created something at your school or college and learned how to create a team around you. This becomes very handy when you are doing your first start-up after leaving college.

A lot of schools and colleges in the US are setting up small VC type funds as part of the entrepreneurial culture and facilitating inter-networking via their alumni network. If nothing else the students learn how to practice some of the skills from their courses and leverage from alumni networks.

The school funds are managed by societies, local retirees, local businesses, ex alumni, teachers and parents, some of whom become entrepreneurs in residence.

Union College has a $500K fund called ‘The Vash Fund’ set by an alumni, Arthur Vash, who graduated from the college. He subsequently went to become CEO of Epco Packaging and Phillip Screws, as well as setting up Gryphon Ventures with a $33m fund.

Local business owners get kudos by contributing to the local economy and positive free PR, the youngsters involved get an early introduction to venture funding practice and writing effective business plans, due diligence scrutiny, prospecting, networking, polishing a company image, and invaluable extra experience which puts them into a different orbit altogether and then focus and look for new opportunities, identifying niche markets rather than spend time getting a full time job at the local big company.

The University of Michigan, Maryland and Cornell, all have their own VC funds that deliver an endowment from which bursaries are awarded. From the school's point of view it is ROI (return on investment) calculations, from which it can produce star pupils who will succeed in the industry. Some of the pupils will come back and reward the schools handsomely, in terms of donations, whole buildings, libraries, labs, bursaries, quality advice and re-inforce the guanxi, i.e. the alumni and their own wider global business network.

Did you know that Robert Noyce got his old school Grinnell College in Iowa to invest $300,000 in his fledgling start-up company, which we now know as Intel. In return, his contribution to the college was more than a thousand times this. They have named a building there the Noyce Science Centre.

guanxi, coined from a Chinese word, deals with interplay of complex relationships, influences and connections in one’s network. Modern day guanxi take a lot of energy and effort to build up and maintain. Unlike start-up companies, they cannot easily be acquired, but the trick is to find models which allow us to tap into each other’s guanxis.