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How to build or invest in a startup without paying capital gains tax

Peyton Carr
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Peyton Carr is a Financial Adviser to founders, entrepreneurs and their families, helping them with planning and investing. He is a Managing Director of Keystone Global Partners.
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Founders, entrepreneurs, and tech executives in the know realize they may be able to avoid paying tax on all or part of the gain from the sale of stock in their companies — assuming they qualify.

If you’re a founder who’s interested in exploring this opportunity, put careful consideration put into the formation, operation and selling of your company.

Qualified Small Business Stock (QSBS) presents a significant tax savings opportunity for people who create and invest in small businesses. It allows you to potentially exclude up to $10 million, or 10 times your tax basis, whichever is greater, from taxation. For example, if you invested $2 million in QSBS in 2012, and sell that stock after five years for $20 million (10x basis) you could pay zero federal capital gains tax on that gain. 

What is QSBS, and why is it important?

These tax savings can be so significant, that it’s one of a handful of high-priority items we’ll first discuss, when working with a founder or tech executive client. Surprisingly, most people in general either:

  1. Know a few basics about QSBS;
  2. Know they may have it, but don’t explore ways to leverage or protect it;
  3. Don’t know about it at all.

Founders who are scaling their companies usually have a lot on their minds, and tax savings and personal finance usually falls to the bottom of the list. For example, I recently met with someone who will walk away from their upcoming liquidity event with between $30-40 million. He qualifies for QSBS, but until our conversation, he hadn’t even considered leveraging it. 

Instead of paying long-term capital gains taxes, how does 0% sound? That’s right — you may be able to exclude up to 100% of your federal capital gains taxes from selling the stake in your company. If your company is a venture-backed tech startup (or was at one point), there’s a good chance you could qualify.

In this guide I speak specifically to QSBS on a federal tax level, however it’s important to note that many states such as New York follow the federal treatment of QSBS, while states such as California and Pennsylvania completely disallow the exclusion. There is a third group of states, including Massachusetts and New Jersey, that have their own modifications to the exclusion. Like everything else I speak about here, this should be reviewed with your legal and tax advisors.

My team and I recently spoke with a founder whose company was being acquired. She wanted to do some financial planning to understand how her personal balance sheet would look post-acquisition, which is a savvy move. 

We worked with her corporate counsel and accountant to obtain a QSBS representation from the company and modeled out the founder’s effective tax rate. She owned equity in the form of company shares, which met the criteria for qualifying as Section 1202 stock (QSBS). When she acquired the shares in 2012, her cost basis was basically zero. 

A few months after satisfying the five-year holding period, a public company acquired her business. Her company shares, first acquired for basically zero, were now worth $15 million. When she was able to sell her shares, the first $10 million of her capital gains were completely excluded from federal taxation — the remainder of her gain was taxed at long-term capital gains.

This founder saved millions of dollars in capital gains taxes after her liquidity event, and she’s not the exception! Most founders who run a venture-backed C Corporation tech company can qualify for QSBS if they acquire their stock early on. There are some exceptions. 

qsbs tax savings example

Do I have QSBS?

A frequently asked question as we start to discuss QSBS with our clients is: how do I know if I qualify? In general, you need to meet the following requirements:

  1. Your company is a Domestic C Corporation.
  2. Stock is acquired directly from the company.
  3. Stock has been held for over 5 years.
  4. Stock was issued after August 10th, 1993, and ideally, after September 27th, 2010 for a full 100% exclusion.qsbs stock acquired
  5. Aggregate gross assets of the company must have been $50 million or less when the stock was acquired.
  6. The business must be active, with 80% of its assets being used to run the business. It cannot be an investment entity. 
  7. The business cannot be an excluded business type such as, but not limited to: finance, professional services, mining/natural resources, hotel/restaurants, farming or any other business where the business reputation is a skill of one or more of the employees.

When in doubt, follow this flowchart to see if you qualify:

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The Urban.Us and BMW Mini accelerator focused on urban innovation names its latest cohort

URBAN-X, the accelerator program focused on companies developing technologies to increase the sustainability, resiliency and efficiency of cities, has selected seven companies for its latest cohort.

Operating as a partnership between BMW’s Mini brand and the early-stage investment fund Urban.Us since 2017, the accelerator has backed 51 companies, which have raised more than $100 million in the three years since its initial launch.

“Mini aims to inspire entrepreneurship, design and collaboration with innovative minds, and this ambition comes to life through URBAN-X,” said Esther Bahne, head of Mini Brand Strategy & Innovation.

Co-investors who have come in to invest behind the accelerator include: Fred Wilson, Brad Burnham, Edgar Bronfman Jr., BMW i Ventures, Draper Associates, Fontinalis Partners, Ekistic Ventures, Wireframe Ventures, Fifth Wall Ventures, Samsung NEXT, Story Ventures, Kairos, UL Ventures, Mark Cuban, Point 72 Ventures and Robert Bosch Venture Capital.

Some of the largest investments to date have been in companies like Blueprint Power, which raised $4 million for its technology that provides energy efficiency and demand response tools connecting real estate portfolios to the power grid; Roadbotics, roadway monitoring to optimize maintenance spending for cities, utilities and construction firms, which raised $11.4 million; and Versatile Natures, which provides safety and budget management tools for construction sites.

The latest companies to be accepted into the accelerator are:

  • ChargeLab: an electric vehicle charging management service for businesses, utilities, individuals and governments.

  • CoInspect: a service that automates the entire food safety and quality management workflow for restaurants and food processing facilities.

  • Eva: a provider of charging stations for healthcare and emergency responders operating cargo drones and associated vertical take-off vehicles.

  • Firmus: a machine learning-based software toolkit to expedite the construction design review process.

  • Hades: the developer of software to evaluate sewer and flood prevention infrastructure.

  • Metalmark: a new materials developer for highly efficient catalytic decomposition of air pollutants.

  • UsurpPower: the creator of a marketplace for sustainable finance for renewable power generation.

“URBAN-X, Urban Us and MINI are deeply committed to advancing the low carbon, resilient, high density future of our cities through technology, investment and mentorship,” said Shaun Abrahamson, URBAN-X Investment Committee and managing partner at Urban.Us, in a statement. “Startups are critical to playing an outsized role in reimagining the core sectors of our cities — like transportation, real estate and energy — and we’re thrilled to invest in this new class of creative and entrepreneurial minds.”

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Finally, an official Craigslist app

Fancy websites and services come and go, but Craigslist endures. And now one of its main shortcomings is fixed: there’s an official app. Currently available for iOS and in beta for Android, the app provides a true-to-form Craigslist experience: useful, unfussy and anonymous.

There isn’t much to say about the app beyond that it faithfully replicates the website, down to the color scheme. All categories of posts are available to browse or search; you can favorite things, save searches and change the way results look. Different categories have their pertinent settings, so when you look for a car you’ll get odometer, model year and so on the way you do on the site.

No account is required at all to browse listings or contact sellers, and conveniently all their contact info pops up easily, letting you email, text or call as desired.

Obviously the web app is still perfectly serviceable, and some may even prefer it. But it’s nice to have a native app, if only to deter the imitation Craigslist apps that piggyback on the popularity of the original no-frills listings.

The app was released yesterday and is already climbing the charts. Grab it today and start looking for free furniture!

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Nintendo’s Switch just had its best sales week in the US

Nintendo today noted that the Switch just had its best-ever sales week in the States. Over the course of Thanksgiving week, the three-year-old console moved more than 830,000 units. That brings the system up to a combined 17.5 million units in the U.S., by Nintendo’s count. It’s pretty impressive momentum for a mature console.

Back in late October, the Switch hit the 15 million mark in the States. It continues to sit atop the console sales charts posted by analytics firms like NPD. The numbers, of course, were juiced by both the upcoming holidays, the addition of the new, lower-priced Switch Lite and various Black Friday offers that bundle in things like a free copy of Mario Kart 8 Deluxe.

The system is expected to get another major boost outside of the U.S., with a forthcoming launch in China. Nintendo is teaming up with Tencent to deliver the system to a potentially massive market at around $300 a pop. Pre-orders in the country opened today, with sales starting on December 10, along with a trio of Mario titles.

As of late-September, the system has sold in excess of 40 million units globally — a healthy upgrade from its lukewarmly received predecessor, the Wii U, which only managed to move 13.5 million in its lifetime. The Switch still has some catching up to do with the eight-year-old 3DS, which has sold 75.5 million units globally. 

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GitGuardian raises $12M to help developers write more secure code and ‘fix’ GitHub leaks

Data breaches that could cause millions of dollars in potential damages have been the bane of the life of many a company. What’s required is a great deal of real-time monitoring. The problem is that this world has become incredibly complex. A SANS Institute survey found half of company data breaches were the result of account or credential hacking.

GitGuardian has attempted to address this with a highly developer-centric cybersecurity solution.

It’s now attracted the attention of major investors, to the tune of $12 million in Series A funding, led by Balderton Capital . Scott Chacon, co-founder of GitHub, and Solomon Hykes, founder of Docker, also participated in the round.

The startup plans to use the investment from Balderton Capital to expand its customer base, predominantly in the U.S. Around 75% of its clients are currently based in the U.S., with the remainder being based in Europe, and the funding will continue to drive this expansion.

Built to uncover sensitive company information hiding in online repositories, GitGuardian says its real-time monitoring platform can address the data leaks issues. Modern enterprise software developers have to integrate multiple internal and third-party services. That means they need incredibly sensitive “secrets,” such as login details, API keys and private cryptographic keys used to protect confidential systems and data.

GitGuardian’s systems detect thousands of credential leaks per day. The team originally built its launch platform with public GitHub in mind; however, GitGuardian is built as a private solution to monitor and notify on secrets that are inappropriately disseminated in internal systems as well, such as private code repositories or messaging systems.

Solomon Hykes, founder of Docker and investor at GitGuardian, said: “Securing your systems starts with securing your software development process. GitGuardian understands this, and they have built a pragmatic solution to an acute security problem. Their credentials monitoring system is a must-have for any serious organization.”

Do they have any competitors?

Co-founder Jérémy Thomas told me: “We currently don’t have any direct competitors. This generally means that there’s no market, or the market is too small to be interesting. In our case, our fundraise proves we’ve put our hands on something huge. So the reason we don’t have competitors is because the problem we’re solving is counterintuitive at first sight. Ask any developer, they will say they would never hardcode any secret in public source code. However, humans make mistakes and when that happens, they can be extremely serious: it can take a single leaked credential to jeopardize an entire organization. To conclude, I’d say our real competitors so far are black hat hackers. Black hat activity is real on GitHub. For two years, we’ve been monitoring organized groups of hackers that exchange sensitive information they find on the platform. We are competing with them on speed of detection and scope of vulnerabilities covered.”

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Instagram finally launches 13+ age checkups

Instagram is done playing dumb about users’ ages. After nine years, Instagram is finally embracing more responsibility to protect underage kids from the problems with social media. It will now ask new users to input their birth date and bar users younger than 13 from joining. However, it won’t be asking existing users their age, so Instagram will turn a blind eye to any underage kids already amongst its 1 billion members.

Instagram will later start using age info to offer education about settings and new privacy controls for younger users. It’s also adding the option to only allow people you follow to message you, add you to a group or reply to your Story.

Yesterday we published an opinion piece noting that “Instagram still doesn’t age-check kids. That must change.” after receiving no-comments from Instagram after mobile researcher Jane Manchun Wong spotted Instagram prototyping an age-check feature. As the code she found indicated, Instagram will keep your birthday and date private, and sync it with your Facebook profile if you link your accounts.

Instagram had fallen far behind in protecting underage users. It’s relied on ignorance about users’ ages to avoid a $40,000 fine per violation of the Child Online Privacy Protection Act that bans services from collecting personal info from children younger than 13. “Asking for this information will help prevent underage people from joining Instagram, help us keep young people safer and enable more age-appropriate experiences overall,” Instagram notes.

Facebook, Snapchat and TikTok already require users to enter their birth date as soon as they start the signup process. TikTok built a whole separate section of its app where kids can watch videos but not post or comment, after it was fined $5.7 million by the FTC for violating COPPA.

As for why it took so long, an Instagram spokesperson tells TechCrunch, “Historically, we didn’t require people to tell us their age because we wanted Instagram to be a place where everyone can express themselves fully — irrespective of their identity.” That seems like a pretty thin excuse.

Adding the age check is a good first step for Instagram. But it should consider how it can do more to verify the ages users enter and keep out those who don’t belong exposed to strangers across the app. Moving in line with industry standards is attaining minimum viable responsibility. But an app so appealing to younger users and that deals in such sensitive data should be leading on safety, not just following the herd.

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Android’s ‘Focus Mode’ exits beta, adds new scheduling features

Google is expanding its suite of “Digital Wellbeing” tools for Android devices with a new feature, Focus Mode, launching today. This feature allows users to turn off distractions — like social media updates or email notifications — for a period of time, so you can get things done without interruption. Focus Mode was first announced at Google’s I/O developer conference this May, and has been in beta testing until now, Google says.

Unlike Do Not Disturb, which can mute sounds, stop vibrations and block visual disturbances, Focus Mode is only about silencing specific apps.

Within the Digital Wellbeing settings, users select which apps they find most distracting — like Facebook, YouTube, Gmail, games or anything else that tends to steal their attention. These apps can be paused temporarily, which stops those apps’ notifications. Plus, if you try to open the app, Focus Mode reminds you they’re paused.

During beta testing, Google said tester feedback led to the creation of a new enhancement for Focus Mode: the ability to set a schedule for your app breaks. This allows you to continually block app notifications for the days and times you choose — like your 9 AM to 5 PM working hours, for example.

There’s also a new option to take a break from Focus Mode, which allows you to use the blocked apps for a time, then return to Focus Mode without entirely disabling it to do so. In addition, if you finish your work or other tasks early one day, you can now turn off Focus Mode for that day without breaking its ongoing weekly schedule.

The Focus Mode feature is one of now many investments Google has made into its comprehensive Digital Wellbeing feature set, which was originally introduced at Google I/O 2018 but initially only on Pixel devices. Since then, Google has expanded access to Digital Wellbeing features and further integrated its features — including parent control app Family Link — into the Android OS.

It has also developed digital well-being apps outside of its core Digital Wellbeing product, with October’s launch of a handful of well-being experiments. This set of apps included a notification mailbox, unlock clock and even an easy way to print important information from your phone so you don’t have to keep checking your device throughout the day, among other things.

Elsewhere across Google’s product line it has developed settings and controls devoted to well-being, like YouTube’s reminders to “take a break,” automations for Gmail, downtime settings for Google Home and more.

Google says the new version of Focus Mode exits beta testing today and is rolling out to all devices that support Digital Wellbeing and parental controls, including Android 9 and 10 phones.

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Lessons from M-Pesa for Africa’s new VC-rich fintech startups

In African fintech, the fourth quarter of 2019 brought big money to new entrants.

Chinese investors put $220 million into OPay and PalmPay — two fledgling startups with plans to scale in Nigeria and the broader continent. Several sources told me the big bucks had created anxiety for more than few payments ventures in Nigeria with similar strategies and smaller coffers. They may not need to fret just yet, however: lessons from Africa’s most successful mobile-money case study, M-Pesa, suggest that VC alone won’t buy scale in digital finance.

Startups and fintech in Africa

Over the last decade, Africa has been in the midst of a startup boom accompanied by big growth in VC and improvements in internet and mobile penetration.

Some definitive country centers for company formation, tech hubs and investment have emerged; Nigeria, South Africa and Kenya lead the continent in numbers for all those categories. Additional strong and emerging points for innovation and startups across Africa’s 54 countries and 1.2 billion people include Ghana, Tanzania, Ethiopia, and Senegal.

The continent surpassed $1 billion in VC to startups in 2018 and per research done by Partech and WeeTracker, fintech is the focus of the bulk of capital and deal-flow.

By several estimates,  Africa is home to the largest share of the world’s unbanked and underbanked population.

This runs parallel to the region’s off-the-grid SME’s and economic activity — on display and in commercial motion through the street traders, roadside kiosks and open-air markets common from Nairobi to Lagos.

IMF estimates have pegged Africa’s informal economy as one of the largest in the world. Thousands of fintech startups have descended onto this large pool of unbanked and underbranked citizens and SMEs looking to grow digital finance products and market share.

In this race, the West African nation of Nigeria — home to Africa’s largest economy and population — is becoming an epicenter for VC. Many fintech-related companies are adopting a strategy of scaling there first before expanding outward.

Enter PalmPay and OPay

That includes new entrants OPay and PalmPay, which raised so much capital in fourth quarter 2019. It’s notable that both were founded in 2019 and largely incubated by Chinese actors.

PalmPay, a consumer-oriented payments product, went live in November with a $40 million seed-round (one of the largest in Africa in 2019) led by Africa’s biggest mobile-phones seller — China’s Transsion. The startup was upfront about its ambitions, stating its goals to become “Africa’s largest financial services platform,” in a company statement.

To that end, PalmPay conveniently entered a strategic partnership with its lead investor. The startup’s payment app will come pre-installed on Transsion’s mobile device brands, such as Tecno, in Africa — for an estimated reach of 20 million phones in 2020.

PalmPay also launched in Ghana in November and its U.K. and Africa-based CEO, Greg Reeve, confirmed plans to expand to additional African countries in 2020.

If PalmPay’s $40 million seed round got founders’ attention, OPay’s $120 million Series B created shock-waves, coming just months after the mobile-based fintech venture raised $50 million — making OPay’s $170 million capital haul equivalent to roughly a fifth of all VC raised in Africa in 2018.

Founded by Chinese owned consumer internet company Opera — and backed by 9 Chinese investors — OPay is the payment utility for a suite of Opera -developed internet based commercial products in Nigeria that include ride-hail apps ORide and OCar and food delivery service OFood.

With its latest Series A, OPay announced it would expand in Kenya, South Africa, and Ghana.

In Nigeria, OPay’s $170 million Series A and B announced in the span of months dwarfs just about anything raised by new and existing fintech players, with the exception of Interswitch.

The homegrown payments processing company — which pioneered much of Nigeria’s digital finance infrastructure — reached unicorn status in November when Visa took a reported $200 million minority stake in the venture.

A sampling of more common funding amounts for payments ventures in Nigeria includes established fintech company Paga’s $10 million Series B. Recent market entrant Chipper Cash’s May 2019 seed-round was $2.4 million.

There is a large disparity between fintech startups in Nigeria with capital raises in ones and tens of millions vs. OPay and PalmPay’s $40 and $120 million rounds. Conventional wisdom could be that the big-capital, big spending firms have an unmistakable advantage in scaling digital payments in Nigeria and other markets.

A look at Kenya’s M-Pesa may prove otherwise.

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AWS launches discounted spot capacity for its Fargate container platform

AWS today quietly brought spot capacity to Fargate, its serverless compute engine for containers that supports both the company’s Elastic Container Service and, now, its Elastic Kubernetes service.

Like spot instances for the EC2 compute platform, Fargate Spot pricing is significantly cheaper, both for storage and compute, than regular Fargate pricing. In return, though, you have to be able to accept the fact that your instance may get terminated when AWS needs additional capacity. While that means Fargate Spot may not be perfect for every workload, there are plenty of applications that can easily handle an interruption.

“Fargate now has on-demand, savings plan, spot,” AWS VP of Compute Services Deepak Singh told me. “If you think about Fargate as a compute layer for, as we call it, serverless compute for containers, you now have the pricing worked out and you now have both orchestrators on top of it.”

He also noted that containers already drive a significant percentage of spot usage on AWS in general, so adding this functionality to Fargate makes a lot of sense (and may save users a few dollars here and there). Pricing, of course, is the major draw here and an hour of CPU time on Fargate Spot will only cost $0.01245364 (yes, AWS is pretty precise there) compared to $0.04048 for the on-demand price,

With this, AWS is also launching another important new feature: capacity providers. The idea here is to automate capacity provisioning for Fargate and EC2, both of which now offer on-demand and spot instances, after all. You simply write a config file that, for example, says you want to run 70 percent of your capacity on EC2 and the rest on spot instances. The scheduler will then keep that capacity on spot as instances come and go, and if there are no spot instances available, it will move it to on-demand instances and back to spot once instances are available again.

In the future, you will also be able to mix and match EC2 and Fargate. “You can say, I want some of my services running on EC2 on demand, some running on Fargate on demand, and the rest running on Fargate Spot,” Singh explained. “And the scheduler manages it for you. You squint hard, capacity is capacity. We can attach other capacity providers.” Outpost, AWS’ fully managed service for running AWS services in your data center, could be a capacity provider, for example.

These new features and prices will be officially announced in Thursday’s re:Invent keynote, but the documentation and pricing is already live today.

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This 16-game arcade for AIs tests their playing prowess

Figuring out just what an AI is good at is one of the hardest thing about understanding them. To help determine this, OpenAI has designed a set of games that can help researchers tell whether their machine learning agent is actually learning basic skills or, what is equally likely, has figured out how to rig the system in its favor.

It’s one of those aspects of AI research that never fails to delight: the ways an agent will bend or break the rules in its endeavors to appear good at whatever the researchers are asking it to do. Cheating may be thinking outside the box, but it isn’t always welcome, and one way to check is to change the rules a bit and see if the system breaks down.

What the agent actually learned can be determined by seeing if those “skills” can be applied when it’s put into new circumstances where only some of its knowledge is relevant.

For instance, say you want to learn if an AI has learned to play a Mario-like game where it travels right and jumps over obstacles. You could switch things around so it has to walk left; you could change the order of the obstacles; or you could change the game entirely and have monsters appear that the AI has to shoot while it travels right instead.

If the agent has really learned something about playing a game like this, it should be able to pick up the modified versions of the game much quicker than something entirely new. This is called “generalizing” — applying existing knowledge to a new set of circumstances — and humans do it constantly.

OpenAI researchers have encountered this many times in their research, and in order to test generalizable AI knowledge at a basic level, they’ve designed a sort of AI arcade where an agent has to prove its mettle in a variety of games with varying overlap of gameplay concepts.

The 16 game environments they designed are similar to games we know and love, like Pac-Man, Super Mario Bros., Asteroids, and so on. The difference is the environments have been build from the ground up towards AI play, with simplified controls, rewards, and graphics.

Each taxes an AI’s abilities in a different way. For instance in one game there may be no penalty for sitting still and observing the game environment for a few seconds, while in others it may place the agent in danger. In some the AI must explore the environment, in others it may be focused on a single big boss spaceship. But they’re all made to be unmistakably different games, not unlike (though obviously a bit different from) what you might find available for an Atari or NES console.

Here’s the full list, as seen in the gif below from top to bottom, left to right:

  • Ninja: Climb a tower while avoiding bombs or destroying them with throwing stars.
  • Coinrun: Get the coin at the right side of the level while avoiding traps and monsters.
  • Plunder: Fire cannonballs from the bottom of the screen to hit enemy ships and avoid friendlies.
  • Caveflyer: Navigate caves using Asteroids-style controls, shooting enemies and avoiding obstacles.
  • Jumper: Open-world platformer with a double-jumping rabbit and compass pointing towards the goal.
  • Miner: Dig through dirt to get diamonds and boulders that obey Atari-era gravity rules.
  • Maze: Navigate randomly generated mazes of various sizes.
  • Bigfish: Eat smaller fish than you to become the bigger fish, while avoiding a similar fate.
  • Chaser: Like Pac-Man, eat the dots and use power pellets strategically to eat enemies.
  • Starpilot: Gradius-like shmup focused on dodging and quick elimination of enemy ships.
  • Bossfight: 1 on 1 battle with a boss ship with randomly selected attacks and replenishing shields.
  • Heist: Navigate a maze with colored locks and corresponding keys.
  • Fruitbot: Ascend through levels while collecting fruit and avoiding non-fruit.
  • Dodgeball: Move around a room without touching walls, hitting others with balls and avoiding getting hit.
  • Climber: Climb a series of platforms collecting stars along the way and avoiding monsters.
  • Leaper: Frogger-type lane-crossing game with cars, logs, etc.

You can imagine that an AI might be created that excels at the grid-based ones like Heist, Maze, and Chaser, but loses the track in Jumper, Coinrun, and Bossfight. Just like a human — because there are different skills involved in each. But there are shared ones as well: understanding that the player character and moving objects may have consequences, or that certain areas of the play area are inaccessible. An AI that can generalize and adapt quickly will learn to dominate all these games in a shorter time than one that doesn’t generalize well.

The set of games and methods for observing and rating agent performance in them is called the ProcGen benchmark, since the environments and enemy placements in the games are procedurally generated. You can read more about them, or learn to build your own little AI arcade, at the project’s GitHub page.

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