Finding Genius Read online

  Given its expansive strategy to enter into new markets each year, Amazon is one company entrepreneurs universally fear. Rebecca Kaden of USV says she shares a healthy dose of fear, awe, and respect for what Amazon has established and how it continues to land and expand into new industries. Kaden says it is “naive to think new startups can take them on” — a perspective which informs how she approaches startup opportunities:

  “Amazon hasn’t won because of structural product advantage but by an execution advantage. They just do more things better. We speak at USV about a kill zone, where startups are advantaged or where they are not. We talk about a Facebook, Amazon, Google kill zone and we talk about early companies going up against them. At the beginning, you [a founder] are so structurally disadvantaged because of scale, capital, and data, so I don’t want to invest in companies that say they will take down Amazon because they’re so disadvantaged. Still, I think there are areas where founders can challenge a company such as Amazon. With commerce, my view is that Amazon is obviously dominant, but it is solving for a tactical piece of the commerce puzzle. They’re the best at speed and value. Amazon is a central repository where I can go when I know what I want. From my perspective, as I’ve learned with many of the upstart direct-to-consumer brands we’ve funded, there are more emotions involved with transactions, especially online, and Amazon is not doing well with the experience, entertainment or discovery piece of commerce. It’s hard to re-shape the emotional pie of the customer experience, and that’s where I see opportunity.”

  Kaden discussed a recent investment she made in a company called ShopShops, a cross-border commerce platform based on live streaming. Through this platform, hosts go to retail stores that are already struggling to maintain their businesses against Amazon, and the fashion-forward hosts live stream their shopping experience to a group of engaged communities and users. A massive number of international users are watching these hosts for entertainment and are also purchasing products in real time from these retailers. This is not a marketplace or a direct competitor to Amazon, but rather an alternate approach to shopping — one based on emotion. At the time of making this investment, Kaden shared that the founders understood this difference and were successful in conveying how they planned to build their market beyond Amazon’s core focus.

  On defensibility and competitive moats, a common overlooked differentiator is regulation. Trae Stephens, formerly of Palantir, and now with Founders Fund, believes that while regulation can be a massive hindrance to building a business, if a founder is able to navigate it and identify ways to work with the government, this can eventually turn into a tremendous regulatory moat. In his opinion, most businesses and founders do not have the competency to deal with regulation or the government in the appropriate way. He explains:

  “Most Silicon Valley businesses do not have any idea of how to deal with regulation. How potentially game-changing founders interact with the government — at the local or national level — is strategically important to the health of a business. Airbnb, one of Founder Fund’s portfolio companies, is one of the best companies at building a regulatory infrastructure and understanding the importance of working with municipalities. They have their own government affairs department and have invested in developing a positive brand image in every community they enter into. They work with regulators and invest in building the right way. Airbnb operates differently than Uber, a company that has not done that. This has affected Uber on a regulatory front, and they have to convince all these government regulators that they’re not evil. Because of that difference, you see cities putting taxes and restrictions in place around Uber. Outside of working with government, companies like Tesla and SpaceX have made progress by not being overly reliant on working with integrators or lobbying congress for change. Instead, they are building standalone vertical businesses and becoming private sector solutions where the government has failed.”

  When evaluating an investment opportunity against regulatory risk, VCs often determine a company’s potential value if regulation changes in its favor. Based on his investments, Heitzmann further explains regulatory moats:

  “Three of our portfolio companies, DraftKings, Ro and Airbnb, are facing increased regulation and regulation will never move as fast as technology. In an accelerated technology market, regulation lags. The debate happens as a public conversation, in real time, about whether a company is a benefit to society and consumers or not. If it is, the company will do well with consumers and succeed. Airbnb has done a very good job in getting consumer buy-in in those conversations. Uber has started to work well with regulators. Especially in Miami and Los Angeles, Uber has worked within the parameters. Understanding that they are going up against the taxi and limousine commission, Uber has proven regulators wrong about congestion by using real data, not theoretical data. The purpose of these companies that are on the fringe is to figure out where they compromise.”

  Investors who are vested in the success of companies that ‘are on the fringe’ of regulation work closely with entrepreneurs and regulators to better understand if the externalities of a company are negative or positive. If negative, regulators quantify the damage and oftentimes those debates play out through public discourse that influences regulation. As investors look at these risk factors and see the opportunity for a company to grow massive if it does figure out the regulatory hurdles, Heitzmann says these bets are a no-brainer:

  “Was there a risk the seed investors in Uber wouldn’t get to a Series A? Hell yes, but if you overcome that risk, is the return significant enough where Uber will be one of the best investments ever? Yes. And you should make those investments every time because that is where the option value exists.”

  Ajay Agarwal believes that it is often the founders of these companies that offer the biggest competitive moat. While it is not always important in the case of a founder of a consumer company to be a deep subject matter expert, Agarwal believes that the founders of SaaS companies need to be domain experts and ‘deep product thinkers’ in order to offer a competitive product. SaaS companies need deeply entrenched, defensible moats as their customers are often paying millions of dollars across multi-year contracts in search of a solution that can solve a core problem faced by a large institution. Agarwal tests for this ability during his diligence process by having a discourse with the founder on their vision for the product and how it evolves over time to remain valuable to organizations. Agarwal expands on his investment thesis for enterprise SaaS companies:

  “Being a deep product thinker doesn’t mean that you’re necessarily technical, but it means that you have a deep understanding of the problem you’re trying to solve for the customer, the product you’re building and where that product can go. Genius founders have the ability to articulate all of that in one to two sentences so anyone can understand it, but they can also go as deep into the problem or enterprise as you need them to go. With our investment in Kiva Systems, the autonomous robot and mobile shelving company focused on e-commerce that was eventually acquired by Amazon, the founder spoke about the dimensions of an assembly-line robot down to the tenth-of-an-inch. He explained that a half inch affected the turning radius of a robot and therefore, affected the size of the aisles and as a result, the cubic density of warehouse. He knew, that in this domain, because of his experience, that storage density was the biggest problem large enterprises in e-commerce were facing. He could explain at a high level why e-commerce was taking off, why they needed flexible fulfillment solutions, and why Kiva Systems could be the most innovative software company for e-commerce companies. I was giddy when I met the founder. He was the most amazing person I had met because he just knew everything about the industry.”

  Copy What Works

  While disruptive innovation and creative genius can often appear to be random strokes of brilliance, the VCs featured in this book have made it clear that there is deep-seated knowledge and insights behind this randomness. With Disruptors, I found that many entrepreneurs
have an uncanny ability to take their learning from one situation and connect it to an entirely different environment. In one such instance, Wayne Mackey, a neuroscientist with New York University studied the reaction times of police officers and helped create digital modules to improve their cognitive abilities. While selling this module to municipalities and police departments, Mackey recognized a long sales cycle and began to offer the module to them for free as he set his eyes on an entirely different market. As an avid player of video gamers, Mackey saw a parallel use case for this training module in the rapidly growing electronic sports market. Like professional athletes training their muscles, Esports athletes were searching for training tools to make them more accurate or faster in the games they played. I spoke with Mackey as he launched a startup, called State Space Labs, to service this space. I was fascinated by his ability to draw connections between multiple industries and areas of discipline to create a compelling business.

  Many of the successful people I’ve interviewed for Disruptors and Finding Genius possess this trait to find morsels of wisdom from one industry and find new opportunities to adapt those learnings elsewhere. The VCs, often unprompted, boasted about the number of books they read because it helped them to be better investors. Within these books are anecdotes or experiences that they adopt to their personal life and business ventures. They are able to derive patterns from history, biographies, and stories on how businesses should be run or lessons on how consumers behave. Keith Rabois shared that he re-reads High Upward Management every year and calls it the ‘bible of starting a startup.’ He admits to borrowing learnings from that book when investing in companies and executing with the founders of those same companies. As an operator, Rabois disclosed how his ability to borrow ideas and supplant them into new situations helped create billions of dollars of value at companies such as LinkedIn and Square:

  “At LinkedIn, I borrowed an idea from Yelp, where I had been serving on the board. With Yelp, restaurants were fairly long-tail searches on Google, so restaurant owners were able to create compelling content that was unique to them to optimize for their businesses on the search engine. Yelp profited off of this and the search indexing of a restaurant led to more reviews. I realized that the same way Yelp had succeeded to do this for restaurants, LinkedIn should be able to do that for people. Both humans and restaurants are long-tail searches on the Internet. No company had ever indexed people on the Internet before, so I came up with the idea that we could create a public profile of these users and then optimize the search engines for this. A user’s LinkedIn profile would now be the first result on Google, which would lead to LinkedIn adoption or growth. Now, 12 years later, that has worked. LinkedIn will now always out-compete other social companies like Facebook on indexing public profiles. That simple lesson from Yelp led to an increase of 33% in usage. It became a mainstream value proposition that didn’t really exist before. By accident, we innovated by borrowing an idea from Yelp. I can take one idea and adopt it to another; the more you read the more you’re able to do that.”

  SECTION 3

  THE VENTURE CAPITAL & ENTREPENEUR PARTNERSHIP

  CHAPTER 8

  ALIGNMENT AND TERMS

  A venture capitalist’s primary responsibility is to the LPs of their fund and the company they have invested in. And while it’s ideal for a founder and investor to be aligned, the entrepreneurs themselves are not a venture investor’s primary responsibility. There is a common misperception that venture capitalists work for the entrepreneur and as a result, founders are often bewildered when their investors behave differently. Once an investment is made, an investor will do what it takes to preserve the equity value of the underlying company. It is not only in the investor’s interest; it is their fiduciary duty.

  A high-profile example of this unfolded in 2017 around the popular ride-sharing company, Uber. An early investor, Benchmark Capital, sued Uber’s founder, Travis Kalanick, for breach of contractual obligations and fiduciary duty. Benchmark made a $12 million investment in Uber and Travis Kalanick early in the company’s lifecycle. At the time of the investment, Bill Gurley, a partner at Benchmark, likened Kalanick to Jeff Bezos of Amazon. In an interview with Forbes, Gurley said about Kalanick: ‘It’s great that people have instincts about product, but you also have to have instincts about business. Travis loves product, loves innovation, he loves technology, but he loves running a business also.’ As of 2017, Benchmark’s investment of $12 million was worth well over $7 billion and had the potential to return even more to their investors in the likely scenario of a liquidation event. Benchmark’s responsibility was to ensure that nothing got in the way of the company’s ongoing success, even Kalanick himself.

  The previously indomitable relationship between Benchmark Capital and Travis Kalanick weakened as claims surfaced from 2014 to 2016 of sexual harassment, accusations of corporate theft, and a deceitful program called “Greyball” — a software program that allowed Uber to avoid law enforcement officials in cities and operate illegally without detection — tainted Uber under Kalanick’s leadership. Uber’s equity value, created by its users, had not completely recovered from a “#DeleteUber” social media campaign sparked by protestors the prior year. During this campaign to punish Uber for its practices, more than 200,000 people had deleted their Uber accounts, accounting for nearly 5% of the company’s market share. That same week, Lyft passed Uber in the Apple App Store for the first time. Uber was rapidly losing its darling image in Silicon Valley and Kalanick provided his investors with little consolation that he would stabilize the ship to preserve their equity holdings.

  With concerns around a devaluation and the future of Uber at stake, five major investors demanded Kalanick resign from the company with Gurley led the charge. Uber, which had raised more than $14 billion from investors since it was founded, had a growing and diverse base of investors other than the ones who signed a letter calling for Kalanick’s resignation. Uber’s investors also include TPG Capital, the Public Investment Fund of Saudi Arabia, and Blackrock. If Uber were to be marked down in valuation, investors could lose billions of dollars.

  The investors succeeded in making this management change, exhibiting their responsibility to a company over the CEO or founder. At the end of 2017, before the dust had even settled around the Kalanick lawsuit, Uber’s board hired Dara Khosrowshahi to fill the role of CEO at Uber. Khosrowshahi is an experienced CEO who served as the CEO of Expedia Group and as a member of the board of directors for Hotels.com and The New York Times Company. Regardless of Kalanick’s actions, or lack thereof, Khosrowshahi represented what some investors look for in CEOs of companies that have matured beyond the startup stage. Some investors believe that a startup CEO should transition control over time to a more seasoned CEO once the company has achieved product/market fit. Some would argue this is what Apple did when it fired Steve Jobs, or what Groupon’s board did when it fired Andrew Mason.

  Ben Horowitz of a16z writes in the company blog that his fund ‘goes against the conventional wisdom’ and prefers to support the original founder regardless of the ups and downs of that relationship. In that same post, he went on to list over two dozen successful companies including IBM, Oracle, Dell, Amazon, Apple, Adobe, Salesforce, and other disruptive enterprises that achieved scale and maximized impact under the direction of the original founder. However, the larger debate centers around alignment between founders and their investors, and the lengths investors will go to protect their investments in a company.

  Founder & Investor Alignment

  ‘Alignment’ is a theme that came up frequently in my conversations with entrepreneurs and investors alike. Jeremy Liew of LightSpeed Venture Partners, an early investor in Snapchat, claims that the misalignment between an investor and an entrepreneur in mission, values, or motivations can be catastrophic to an early-stage company. On a values level, perhaps this is what played out at Uber. With earlier stage companies however, investors claim that misalignment is often the result of found
ers not knowing how an investor’s job works or what they are looking for from a company, despite being overtly clear about it.

  Brett Martin is a former entrepreneur turned venture capitalist who willingly talks about the failure of his startup, Sonar. While he has documented the many reasons behind this failure, he attributes misalignment with his investors as one of the major reasons behind the demise of the company that, from his perspective, still had tremendous potential to grow. Brett says the job of picking your investors is important and as a novice entrepreneur, he did not fully understand the impact that a misaligned cap table might have on the company. Martin describes the relationship with one of Sonar’s equity holders:

  “The decoupling of responsibility from control created ambiguity and confusion, tension, and frustration for all parties. From day-to-day decisions such as negotiating an employment contract to company-defining ones such as when to sell the firm, alignment was a constant challenge. Occasionally, we were simply at odds. Avoid bad relationships like the plague but when you inevitably find yourself in a difficult partnership, don’t waste precious energy wailing against it. Make it work or move on quickly.”